In the Era of Trump, Will China Take the Lead on Free Trade?

Update: Since the original posting of this article on January 24th, Trump has followed through on his threat and effectively terminated America’s role in the TPP. A proposal to replace the USA with China in the agreement has since been made by the Australian government.

Last week saw two historic events: On January 17^th Xi Jinping became the first Chinese president to give a speech at the World Economic Forum in Davos. On January 20^th Donald Trump was inaugurated as the 45^th president of the United States of America. While the United States has been a strong supporter of free trade and open markets for decades, China is a country rather known for the omnipresent influence of the party-state on economic activities and for its far-reaching industrial policies, more often than not on the brink of protectionism. Yet, things seemed to be upside down in Davos: President Xi presented China as a strong advocate of globalization and free trade. Then still President-elect Trump did not attend the Forum. But he has made very clear, not only in his election campaign, but also after, that he prefers protectionism over free trade to “make America great again”.

The timing of the world’s largest economy going protectionist could not be worse: As we have shown in our 2016 Globalization Report, countries worldwide have been able to increase their per-capita income thanks to increasing globalization. However, globalization is now stagnating and needs revitalization rather than new impediments. Also, international institutions like the World Trade Organization (WTO) and the World Economic Forum (WEF) have issued repeated warnings of late against a resurgent global protectionism and the consequent negative impact on the world economy. But the message of the positive effects of globalization does not seem to reach the broader public anymore. Instead, populists are on the rise, who regard free trade – an important part of economic globalization – as the scapegoat for a range of national economic issues, most prominently the transfer of jobs to low-cost countries and the decline of whole industries. Since January 20, the President of the United States has become their most important spokesperson.

The United States are likely to part with free trade

The United States plays a crucial role for the world economy in terms of their contribution to world GDP and global trade flows (figure 1), not to mention the importance of the US-dollar as the international lead currency. However, Trump does not seem to care about the fact that along with this role comes a certain international responsibility, especially given the fact that the United States itself led building our current global economic architecture after World War II. Trump’s trade policy agenda could turn things upside down and it is certainly a nightmare for free trade proponents worldwide. He has been toying with the idea of retreating from several important free trade agreements, such as NAFTA (in force since 1994), TTIP (under negotiation) and TPP (awaits ratification). The world could even be faced with a scenario of US import duties amounting to 45 percent and non-tariff barriers amounting to 15 percent for all US trade partners. This would not only harm the US economy which would see a decline in GDP by up to nine percent, as recent calculations by the ifo Institute Munich have shown. Trade barriers like this imposed by the world’s largest economy would cause serious frictions in global trade flows for several reasons, as Thieß Petersen, Senior Advisor of the Bertelsmann Stiftung, noted in his recent blogpost on “Trump’s War on Trade”:

 

“At first glance, import duties appear to be a suitable means of improving economic performance in one’s own country. In reality, however, this restriction on international trade weakens growth and employment levels in all national economies which are affected by these trade restrictions – including the country that introduces them.”

Hope remains that at least some degree of economic rationality will prevail and Trump will refrain from such extreme measures in the end. His recent personnel decisions regarding his cabinet, which include several critics of free trade, however, are less than reassuring. We might have to reconcile ourselves to the idea that the “Land of the Free” will be no partner in global free trade any longer.

Will China fill the gap?

In contrast, Xi reminded the world of the benefits of globalization and free trade in his Davos speech. He emphasized that “pursuing protectionism is just like locking oneself in a dark room: while wind and rain may be kept out, so are light and air.” Xi’s speech reverberated the China-led G20 Leaders’ Communique of the 2016 Hangzhou Summit, which made a strong case for openness and against protectionism. It is the second time within a few months that China positions itself as an advocate of free trade on the international stage. Given that China is a heavyweight in the world economy, this appears to be a good thing, especially at a time when the US is turning its back on free trade.

However, the big question now is: Is China really willing to go beyond mere rhetoric and set a good example in regard to economic openness? Doubts arise, when we look at a number of national measures which China has taken in the past few month parallel to promoting openness on the international level. The planned quota for electric cars, requiring automakers to produce a certain ratio of these vehicles, and the newly imposed restrictions for capital outflows, which make it harder for foreign companies to transfer their earnings abroad, are only two examples. One could get the impression that in the end China regards free and fair competition as a one-way street, while officially claiming the opposite. China might thus already be an economic heavyweight due to its sheer size, but it is still a dwarf in terms of economic openness compared to the United States.

This is also shown by several indices assessing restrictions on economic activities. For example, China ranks second last in the FDI Regulatory Restrictiveness Index of the OECD, which measures restrictions on foreign direct investment (FDI) in 59 countries”. The United States ranks 37 and was the country with the highest inward FDI flows and stock worldwide in 2015, making it the most important hub for global FDI. In the Economic Freedom Index, published by the Fraser Institute, the United States ranks 16^th, with higher rankings occupied by small countries or regions such as Hongkong (1) and Singapore (2), which normally tend to have a higher degree of economic openness due to their small domestic market and hence dependence on foreign markets for better growth opportunities. Ranking 113^th, China merely holds a position in the third quartile, which is close to the least free quartile starting from position 118.

One can see that China still has a long way to go, if it was to really become the United States’ equal in the global economy in terms of leadership and to put its case against protectionism and for more openness into practice. However, it currently is far from certain that this will be on top of the Chinese government’s agenda. Here, we will rather find political and social stability as well as a decent degree of economic growth on the way to restructuring China’s economic growth model from export-driven to consumption- and innovation-driven.

Free trade needs less restrictions – not more

It is a truism that free trade increases prosperity for all nations involved. However, as we have argued before, “certain basic conditions have to be met in order for free trade to actually lead to an improvement in people’s living conditions.” The removal of discriminatory trade restrictions and market transparency are among them. Protectionism means the opposite and will often provoke retaliation measures by trade partners, which could very well be the beginning of a trade war. The result will be the reduction of growth and the prosperity in all countries involved in the long run – including the one that initiated the measures in the first place.

Well aware of this vicious circle, Chinese President Xi Jinping highlighted in his Davos speech that „no one will emerge as a winner in a trade war“. The world should take China by the word and expect the country to put a good example in levelling the playing field – starting at home.

Update: Since the original posting of this article on January 24th, Trump has followed through on his threat and effectively terminated America’s role in the TPP. A proposal to replace the USA with China in the agreement has since been made by the Australian government.