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Enough is Enough: Confronting Chinese Innovation Mercantilism

February 28, 2012
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In the last decade, China accumulated $3.2 trillion worth of foreign exchange reserves and now enjoys the world’s largest current account balance. In 2011, it ran a $276.5 billion trade surplus with the United States. This “accomplishment” stems largely from the fact that China is practicing economic mercantilism on an unprecedented scale. China seeks not merely competitive advantage, but absolute advantage. In other words, China’s strategy is to win in virtually all industries, especially advanced technology products and services. One may argue that all countries do this and assert it is the essence of competition. But China’s policies represent a departure from traditional competition and international trade norms. Autarky, not trade, defines China’s goal. As such China’s economic strategy consists of two main objectives: 1) develop and support all industries that can expand exports, especially higher value-added ones, and reduce imports; 2) and do this in a way that ensures that Chinese-owned firms win. It is time for policymakers in the United States and other countries to begin responding to today’s reality for Chinese mercantilism represents a fundamental threat to not only the U.S. economy, but to the entire system of market and rules-based globalization.

Because China is so large and because it’s distortive mercantilist policies are so extensive, these policies have done significant damage to the United States and other economies. The massive subsidies to keep production artificially cheap both reduce the cost of Chinese labor and move the world production system more towards labor and away from capital, reducing global productivity. The theft of intellectual property and forced technology transfer reduce revenues going to innovators, making it more difficult for them to reinvest in R&D. The manipulation of standards and other import restrictions balkanizes global markets, keeping them smaller than they otherwise would be, thereby raising global production costs. Further integration of global supply chains that link the United States and China could be good for both nations but not if Chinese policies continue to be based on absolute advantage and mercantilism. In this case, the results will be more of the same: the loss of U.S. industrial and high-tech output, and the jobs and GDP growth that go with it. The logical evolution of this path for America is something akin to what happened to Great Britain: an economy that was once great but now suffers from a hollowed-out traded sector and hence now experiences great difficulty in creating good jobs and rising living standards.

China’s goal of absolute advantage through innovation mercantilism runs counter to the effective functioning of the global trading system, which is grounded in the notion of competitive advantage: nations finding what they are good at or can be good at and exporting products and services in these areas to pay for the imports of goods and services they are not as good at producing. Running an integrated global trading system that maximizes global economic welfare is impossible when the second-largest economy rejects the fundamental premise. As such, China’s autarkic goals and mercantilist policies are fundamentally at odds with the principles of the open and rules-based international trading system that China committed to when it elected to join the World Trade Organization (WTO) in 2001. Countries that join the WTO make a commitment to a trading system, not an exporting system. Rolling back Chinese innovation mercantilism, while continuing to integrate China into the rules-based system of market-led global trade and investment, should be a key priority of U.S. (and European) trade policy.

The stakes could not be higher, for this conflict is not just about China, but about the future of the entire global trading system, especially as developing nations become more active participants in it. China’s autarkic and mercantilist approach reflects a fundamental ideological difference between how China sees its role in bringing about state capitalism and the traditional western model of capitalism supported by global organizations such as the WTO. As China increasingly touts the superiority of the “Beijing consensus” over the “Washington consensus” (the latter rests on the premise that market forces work and governments should play only a minimal role in promoting the interests of their countries’ companies and workers), there is a real risk that the former, not the latter, will become the guiding star of other nations around the globe seeking to boost their living standards. We already see this in nations like Brazil and India that are looking to emulate China by ramping up mercantilism. If this happens, it will be extremely difficult to maintain a global trading system that operates along the lines economists originally envisioned. In 1990 Francis Fukuyama wrote his well-regarded book The End of History and the Last Man which postulated that “a true global culture has emerged, centering around technological driven growth and the capitalist social relations necessary to produce it and sustain it.” Fukuyama did not, and perhaps could not, have foreseen that out of the ashes of the authoritarian anti-capitalist regimes of the right and left could emerge a powerful and successful alternative to free-market capitalism, in this case state capitalism as embodied in what could be termed the Beijing consensus.

If free trade is to prevail over the Beijing consensus, it’s not enough to tout the superiority of the Washington consensus, for it is in fact now a deeply flawed model for growth and prosperity. It places too many limitations on legitimate government roles to spur innovation and competitiveness. But the Beijing consensus is also not only seriously flawed, it is a fundamental threat to global economic integration. Instead of a choice between these two schools of thought, it is time to consider an alternative model, what might be termed the “Helsinki consensus.” Finland and many other countries are fundamentally committed to a vision of global integration and free trade, but at the same time recognize that “good”, non-mercantilist innovation policies (e.g., funding for applied industrial research and technology transfer, support for STEM education, R&D tax incentives, national technology strategies, etc.) are critical to enable them to effectively compete in global markets. They focus on both consumer and producer welfare and recognize that globalization is an unalloyed good but only if other nations also play by the rules. Yes, the Washington Consensus suggests funding basic research and education, but it is loath to develop a real national innovation strategy focused on key technologies and industries. It also assumes companies compete against other companies and ignores the fact that countries also compete, whether through legitimate or dubious means. The World Bank, IMF, and other multilateral organizations need to start advocating the Helsinki consensus around the world so that nations are not forced into an unproductive choice between the Washington consensus and the Beijing consensus. For if their choice is so limited, too many will default to the latter, especially as they look at the respective economic performances of the United States and China.

Highlight image from futureatlas.com.