China – US: Buy America and subsidies mix with national security to see off the rules based order

Jun 12, 2023
Paper ship with American flag on newspaper pages with course tables.

Today the global trade system faces three systemic challenges. None are new, but strategic competition between China and the United States has brought a dangerous edge to each of them.

The first is the dramatic shift in the composition of international economic interaction. When the Bretton Woods system was first set up, global trade was overwhelmingly in physical merchandise. Over time, the importance of services trade and, in the past few decades, data flows, has left large parts of global trade under regulated or uncovered by global rules entirely. While this is a long-standing issue, the increasing weight of China in the digital economy has caused major angst in Western countries, some of which have gone as far as banning Chinese companies from building key infrastructure like 5G.

The second, related challenge is the increasing imbrication of national security and economic policy. The two have never been entirely divorced, but in recent years the use of economic weapons to extract political outcomes, particularly by China and the United States, has risen markedly. Article XXI of the GATT always allowed countries to impose restrictive measures for genuine national security reasons. The exemption was never intended to be a blanket one, though: there was an implicit agreement not to overstep the mark that stopped the rules of the GATT and then the WTO from being shredded in the name of national security. Donald Trump’s steel tariffs were an overt violation of that agreement, as the WTO’s ruling on those tariffs demonstrated despite American protestations.

It is not, of course, the case that national security concerns might not ever override economic ones. There might be legitimate, if rare, occasions when a nation might choose to curtail trade or investment because there is no way to make the transaction ‘safe’ (trade in certain kinds of weapons is an obvious example). But as Gary Hufbauer notes in the first of this week’s lead articles, the policy apparatus for determining these decisions is not set up to evaluate trade-offs, and are deeply opaque. ‘US decisions as to whether a country, company, product or technology threatens US national security are shielded both from public and judicial scrutiny and deliberately ignore economic costs.’

As Hufbauer argues, the damage might be limited under a Biden administration in which there are still some pockets of internationalist sentiment. The important speech of National Security Advisor Jake Sullivan on the Biden administration’s international economic policy at least pays lip service to the idea that American policy must consider the good of the world economy as a whole, even if that idea is missing in its specific policy action. A returning Trump administration — which remains a live possibility — will not even honour both with lip service. It is much more likely to heighten the use of national security excuses to inflict irreparable harm on the global trade system.

The third challenge facing the system is another old problem with a new twist: the return of industrial policy in the North Atlantic, particularly in the form of protection for ‘green’ industry. Here the opinions of economists are mixed. The introduction of massive subsidies for green technology in Biden’s Inflation Reduction Act are on the one hand a recognition of the political reality that a first-best solution to the climate change problem — a nation-wide carbon price — would never make it through Congress.

Addressing this political reality through subsidies, however, comes with major risks to the global system, as well as to the American economy. The GATT and the WTO have always struggled with industrial policy: discriminatory subsidies are forbidden under their disciplines, but the prohibition has constantly been flouted, sometimes with the tacit approval of the original guarantor of the system, the United States. Even under GATT rules prior to the Uruguay Round, special and differential treatment of some protective policy was given to developing countries, recognising that transition to full and complete free trade would be more difficult for those countries than for advanced economies. But there was at least a general recognition that discriminatory subsidies, and other protective measures, were to be eliminated in the long term.

The return of North Atlantic industrial policy has more or less blown away that consensus, and the ramifications for the rules-based trading regime will be significant. Many of the provisions of the Inflation Reduction Act will have complicated impacts on global supply chains due to restrictive local content requirements. Already the response of the European Union — a massive increase in its own subsidies for green industry — point to the prospect of a damaging retreat into a segmented and cartelised global economy, and that could even damage the global transition to a net zero emissions future.

As David Dollar points out in the second of this week’s lead articles, various provisions in America’s new industrial policy work at cross-purposes: ‘The [Biden] administration believes, correctly, that a transition to electric vehicles and renewable generation of power is key to the nation’s long-term prosperity and security. But the ‘Buy American’ provisions will make electric cars, batteries and renewable technologies more expensive in the United States than elsewhere, slowing down the transition.’

The rhetoric of people like Sullivan suggests that the past 15 years or so, from the Global Financial Crisis onwards, have shown up the weaknesses of the global economic system built by the United States in the aftermath of World War II. There is but a germ of truth in this — global trade rules have lagged behind global economic reality, and the international financial safety net has holes in it — but for most of the troubles for which the global economic order is identified as the prime suspect, it is in fact a scapegoat.

Blowing up the rules-based order to address the economic decay of the American Midwest or the troubles of supply chains during the pandemic is not just throwing away the baby with the bathwater: it’s more like throwing away the bathtub, too. The rest of the world, even China, must realise that it is far too invested in the bathtub of global trade rules to let that happen.

 

Republished from EASTASIAFORUM June 5, 2023

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