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Sino-US Trade War: Won in translation?

“The diplomatic cable from Beijing arrived in Washington late on Friday night, with systematic edits to a nearly 150-page draft trade agreement that would blow up months of negotiations between the world’s two largest economies…

…Changing any law in China requires a unique set of processes that can’t be navigated quickly, said a Chinese official familiar with the talks.”  Reuters, 8 May 2019

Trade deals take forever to negotiate and, more often than not, end with little achievement particularly when viewed relative to their original objectives. Discussions are laborious. Months of conferences may result in a comma or an apostrophe being added or removed, lists of thousands upon thousands of products are examined and debated line-by-line and each negotiation session is punctuated by months of recess. The Doha Round of trade negotiations, sponsored by the World Trade Organisation, has been running for 10 years already and achieved nothing.

So it is both amusing and perplexing that one party to the Sino-US trade pact decided to unilaterally take aim at the 150 page document that had been painstakingly negotiated over months and pepper it with ‘systematic edits’.  These edits, Reuters reported, involved reneging on undertakings to change Chinese laws to reflect the trade rules that were agreed to.  How can this happen?

Chinese politics is centralised and secretive, precisely the opposite of the US political system which is multi-faceted and leaks like a sieve.  For the Chinese trade negotiators to be forced to rescind their commitments suggests that they must clearly have stepped on the toes of some very senior Politburo member(s) to the point of exceeding their authority.  Without these senior party officials buy-in to the agreement, everything had to be reversed.

President Trump, correctly, held off from reacting for 2 days, no doubt in order to verify the changes. His response then was to impose broad tariffs on an array of Chinese goods. More importantly, however, the Chinese despatched their Vice Premier to Washington carrying a personal letter from President Xi to President Trump which the latter described as ‘beautiful’. The whole exercise looks like it’s being stage managed in order to appease the senior Chinese leaders who have objected to the translation of any trade deal into legislation.

The key is translation.  Agreeing to change Chinese law to satisfy the US seems to be the bone of contention, not the trading terms themselves. ‘Changing any law in China requires a unique set of processes ‘ is the polite way of saying that the senior Chinese leaders weren’t consulted, or if they were, due process was not followed. The reason for pushback could be administrative (organising a plenary session of the people’s congress is no easy feat), nationalistic (why should we change our laws to satisfy th US?) or just political (my authority was not respected so I am not supporting it). Whatever the reason, the solution in the short term needs to avoid changing laws while at the same time delivering a trade outcome.

For its part the US had demanded that the trade pact be guaranteed in legislation. This is not going to happen now, so the Chinese will have to make greater concessions that are not backed by new laws to bring  the US back to the table. Trump’s card to ensure compliance is the threat of tariffs being imposed quickly should the Chinese transgress, just as he is doing today…

Ironically, the US tariff action gives President Xi the ammunition he needs to show his Politburo that the costs are very real if China does not find a way to commit to more equal trading terms. Vice Premier Liu said yesterday that everybody agrees on the terms, they just ‘disagree on how to phrase it’.

In the absence of legislation, the solution could be as simple as appointing a Sino-US trade czar whose job is to make regulations (not laws!) required to give effect to the agreement.  Alternatively, a market based system that imposes tariffs on goods that contravene the trade deal might have legs.  Certainly, the Americans would be open to any market based suggestions. A system that identifies each tradeable item and offers it for sale broadly to anybody might be a way to surface forced transfers of IP and technology to China at infra-marginal cost.

It will take a few weeks while the enforcement aspects of the trade deal gets sorted out. Overall, however, this looks like a win for the US as China has clearly changed the playing field as it grapples with its internal conflicts.

 

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The US-China trade war ‘Punch and Judy show’ is about to end

The US- China trade war is a short-term phenomena that will correct itself despite the warnings of some.  The pessimists cite the classic Prisoner’s Dilemma model  as the reason a trade war will have long-term consequences.  This is wrong…

In the Prisoners Dilemma, two felons are confined separately and interrogated.  They are offered the choice of snitching on their fellow culprit with the reward being freedom or clamming up and risking that their accomplice snitches.  The equilibrium in the game is the (snitch,snitch) pair where they both fess-up and they both go to jail.  The optimal strategy, on the other hand, is the (clam,clam) pair which ensures that they both go free.(1)

Despite its romantic left-wing appeal(2), it is a little known fact that the Prisoners Dilemma actually breaks down in a world where the fuzz can re-interrogate a prisoner – the so called ‘repeated game’.  In this more realistic setting, snitching on your mate does not allow you to walk free – the police just pick you up again and you, too, go to jail.  So the optimal strategy in the repeated game is to (clam,clam) thus ensuring that both felons remain free.

The reality is that trade wars are repeated games with the optimal strategy being the Free Trade choice.  The US sanctions China and China responds tit-for-tat. This goes on for a few rounds, makes headlines, but eventually the sanctions are abandoned and we all live happily ever after. If the optimal strategy is Free Trade, why would the US impose sanctions and why would China respond?  In the case of the US, there is always a saddle-point in mixed strategies and it may be advantageous to test your friend and opponent’s resolve. In the case of China’s response, the tit-for-tat sanctioning is a method for proving China’s credible threat point.  But once the Punch and Judy show is over, it is in the interest of all parties to return to the Free Trade position as soon as possible.

 

Note

(1)  This was a major discovery in economic theory since, prior to John Nash’s Nobel prize winning insight, it had always been held that equilibrium strategies were simultaneously optimal and vice versa.  Nash showed that the equilibrium could be sub-optimal

(2) Governments and other Left Wing entities use the Prisoner’s Dilemma to justify almost everything