Author: Daniel Poon, UNCTAD

The US–China trade dispute is on-again, off-again. While many are stressing the rights and wrongs of reining in Chinese trade policies, there is little open contemplation of why China adopted such practices in the first place and what that might suggest about development prospects under existing global trade rules.

It is no secret that only a small number of developing countries have joined the ranks of high-income countries in the post-war era, and only a handful of these have done so by establishing competitive home-grown industries in capital- and technology-intensive manufacturing sectors. This handful is concentrated in East Asia in countries such as Japan, South Korea and Taiwan .

It is also widely acknowledged that the strategic role of the state in these cases was substantial, but some argue that the relevance of these experiences today is limited because the global trading system has changed. Policy instruments like ‘performance requirements’ were banned when the World Trade Organization (WTO) came into force in 1995. Other practices like technology licensing agreements were dissuaded in favour of foreign direct investment flows, which allow foreign investors greater control over technology transfers.

Under the new rules, the trading system has become much less permissive of the instruments and areas of government intervention in the economy. Rules that once focussed on reducing tariff barriers have been expanded to areas such as service sectors, intellectual property rights and domestic subsidies. Efforts to extend multilateral rules to issues of investment, government procurement, anti-trust measures and trade facilitation were resisted, but inroads have since been made via the proliferation of regional and bilateral free trade agreements.

Some flexibility is included in these new policy prescriptions, but this flexibility is generally limited in scale, scope and time. Flexibility that did remain is often of little use to countries with weak organisational and financial capacity.

Trade rules are important in providing a reliable framework for exchange, but the multilateral trade regime has become a glaring example of institutional overreach: the WTO, backed by its strongest developed-country members, has reduced the policy space of developing countries. This is known as ‘kicking away the ladder’, whereby rich countries deny other countries the policy tools that they used during their own development process.

China started its economic reform and opening up 40 years ago, but it only joined the WTO in 2001. Under the stricter rules of the WTO and the spread of global value chains, China’s policymakers faced tough reform choices, but they were well aware of what they had (and had not) signed up to.

As Long Guoqiang, deputy director of the Development Research Center of the State Council, put it: ‘the design of an opening-up strategy is to serve national development objectives. By itself, opening up is not an objective. At any given stage of development, designing an opening-up strategy is to realise national objectives for that stage of development’.

This nuanced view to economic openness speaks to the pragmatic but sequential pace of reform measures in China’s development strategy. As the country pursues its ‘Made in China 2025’ plan to upgrade its industrial base, for instance, only now is it switching to a ‘negative’ list for foreign direct investment (FDI) after over 20 years of using a ‘positive’ list that classified sectors as encouraged, restricted or prohibited for foreign investors.

The number of foreign equity restrictions has been relatively steady since China’s first FDI ‘guidance catalogue’ in 1995, reaching a peak of 186 in 2007. Only by 2015 was there a clear reduction to 95, with the number of restrictions dropping further to 63 in 2017. By industry, the focus of these restrictions has shifted over time from manufacturing to service sectors. The guidance catalogues were possible because China kept complete discretion in the ‘pre-establishment phase’ of foreign investments.

During China’s opening-up, many conditions were set in terms of market access, equity, product, scope and supervision. China can now relax some of these restrictions because its leaders are assured that the Chinese economy is at a stage of development where fewer restrictions are needed.

To take a specific example, China’s banking sector has been ‘restricted’ since the first guidance catalogue, with foreign investors later allowed but limited to a 25 per cent equity stake. But when foreign banks’ share of total banking assets fell from 2.4 per cent in 2007 to 1.3 per cent in 2016, restrictions could gradually be relaxed.

In the context of recent US–China trade frictions, China’s size and ‘strategic patience and calm’ has brought the United States back to the negotiating table. From the view of unorthodox economic policy, the US Trade Representative’s Section 301 report on China provides a rare glimpse of how a country can (still) put back the development ladder that has been kicked away.

Size is important, but it is the dynamics and degrees of bargaining power that are at the crux of trade negotiations. Developing countries of all shapes and sizes must practice strategic patience in reclaiming lost policy space while also identifying sources of new spaces. To this end, major endeavours like China’s Belt and Road Initiative present an opportunity for other countries to creatively leverage the focus on infrastructure (rather than rules) to graft much-needed policy flexibility onto the global trading system.

Daniel Poon is an economist with the United Nations Conference on Trade and Development (UNCTAD).

A version of this article first appeared here in the South China Morning Post.