Author: Stephen Roach, Yale University

From tariffs and the blacklisting of Huawei to democracy and human rights concerns over Hong Kong and Xinjiang Province, the United States raised the heat on China to a boil. A so-called Phase I trade deal lowers the immediate threat of tariffs but doesn’t end a deep-rooted structural conflict. Washington is caught in the grips of a ‘China deceit’ narrative, convinced that China has broken a solemn pledge made at the time of its WTO accession in late 2001 to mould itself in the image of the West.

This narrative is at best patently naive or at worst an outright fabrication. There was literally nothing in China’s WTO accession protocols that guaranteed anything close to such a system-changing commitment. Yes, China has not lived up to all its WTO promises — especially regarding subsidies of state-owned enterprises. But to turn such complaints into a sense of intense moral outrage risks a policy blunder of epic proportions.

All this has an eerie sense of deja vu. Just as it did some 30 years ago with Japan, the United States is now blaming China for trade deficits of its own making. Nations suffering from a shortfall of domestic saving grow only if they run trade deficits in order to attract surplus foreign saving. Courtesy of the Reagan budget deficits which depressed US saving, the first half of the 1980s saw Japan accounting for 42 per cent of America’s mounting merchandise trade deficits.

Today, chronic post-crisis budget deficits, exacerbated by outsized Trump tax cuts, have led to an even more serious shortfall of domestic saving. This time, it’s China that has grabbed the lion’s share of America’s external imbalances — 47 per cent of the trade deficits over the past 6 years.

It is absurd to believe that a Phase I trade deal with China, which features a narrowing of the US–China bilateral trade imbalance, will fix this problem. Reflecting a net domestic saving rate of just 2.4 per cent of national income in 2018, the United States had merchandise trade deficits with 102 nations. There can be no bilateral China fix for America’s multilateral trade problem.

All that will occur is trade diversion — shifting the Chinese piece of the US trade deficit to others. Without addressing the saving problem — not exactly the outcome that falls out of the ominous US budget deficit trajectory projected by the Congressional Budget Office — Phase I will backfire because the trade diversion away from China will go to higher cost producers, effectively a tax on American consumers.

The US strategy toward Huawei is equally flawed. While hardly the perfect actor, Huawei has been vilified as the greatest threat to US national security since the KGB. But this conclusion is largely based on the presumption of intent taken from a surprisingly short list of serious transgressions — against Cisco (settled out of court in 2004), T-Mobile (2017) and alleged Iranian–North Korean sanctions violations (2018). For that, Huawei has been added to the dreaded ‘entity list’ that closes off its access to US markets and suppliers.

This approach underscores the strategic miscalculation of a decoupling from China. Blacklisting Huawei effectively untethers the company from the US sphere of influence, as both a source of demand as well as a choke point in its supply chain. That encourages further impetus to China’s push for self-sufficiency.

And that is exactly what is now happening. Huawei’s latest smartphone, the Mate 30, was just released without any US components. China has reportedly ordered an outright ban of foreign computers and software from its government offices. These are unmistakable signs that China is capable of moving down the path of self-sufficiency much more quickly than conventional US wisdom believes. For the United States, that spells nothing short of a loss of control over a key aspect of its relationship with China.

There is a far better way for the United States to frame its China strategy. The goal should be aimed at engagement — not decoupling or containment — in order to provide incentives for cooperative behaviour and penalties for uncooperative behaviour. Three policy options would go a long way in that direction.

First, the United States should reverse its 2017 decision to opt out of the Trans-Pacific Partnership (TPP), a multilateral pan-Asian trade agreement. As an outsider, China would then have great incentive to join. That would require Chinese compliance with tough TPP standards on labour practices, environmental remediation, food safety, intellectual property rights and subsidies.

Second, the United States should restart negotiations on a bilateral investment treaty with China. Both nations would gain significantly by having fair and open access to the other’s markets. Significantly, providing US multinationals with direct access to the extraordinary growth potential of a consumer-led China would be a huge opportunity for US growth.

Third, both nations should commit to macroeconomic adjustments that would narrow their saving disparity and related trade imbalances. The United States needs to save more and that can only occur with a long-term reduction of its budget deficit. China needs to save less, using its surplus to fund the nation’s social safety net, which would temper insecurity and boost discretionary household consumption.

Yes, the US body politic has lost its patience with China and can hardly be expected to embrace such an agenda with open arms. But ultimately it boils down to a clear choice between a destructive and costly confrontation on the one hand and a tough but constructive engagement on the other. China now understands much better what is at stake if the conflict continues to deepen. Unfortunately, the United States is at the other end of the strategic engagement spectrum. That, too, could change. Presumably, that’s what presidential elections are all about.

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China (Yale University Press, 2014).

This article is part of an EAF special feature series on 2019 in review and the year ahead.