Do We Need A Floor?

The debate over U.S.-China economic and trade relations continues to drive both the policy and the business communities in the U.S. I touched on this topic a few months ago to observe that there was no real decoupling taking place, though there was a rebalancing.

This debate has come back to life in recent days with the Biden administration’s exploration of U.S.-China mutual tariff reductions, a move that would be an economic gain for both countries but would irritate those whose goal is irritation. So if you want to help the U.S. economy, tariff reduction makes a lot of sense. But if your primary goal is to cause friction with China, tariff reduction is not appealing.

Let’s look at the broader debate over whether the United States should reduce economic activity with—“decouple” from—China. Is the U.S. to prohibit normal commercial trade with China? Or should it be permitted, but alternative channels should be actively encouraged through tax or other incentives? Or does decoupling mean to be mindful of concentration risk if companies source disproportionately from China? Or does it mainly pertain to the national security set of issues such as granting market access to Chinese tech companies or importing material from China that might be used in the U.S. defense industrial base?

All of these concerns might have some validity, but we should be mindful of counterarguments as well. General economic engagement with China is not undertaken through altruism or naïveté, but through a desire to access the China market, be it to source components or (increasingly) to sell goods. This we can describe as normal economic activity and it can be differentiated from those issues with national security consideration. In the interest of disclosure, I work in this area. My company helps U.S consumer brands sell to China, and they see success in the market every day. Chinese consumers like these products for the same reason American consumers do: From Nike to Coke to Fender Guitars, American companies make great products. Should we continue to sell to China, mindful of the issues involved? Let me offer some guidelines:

First, economic engagement between the U.S. and China brings considerable benefits to both countries. If Chinese inputs are less expensive, they make the final American product more competitive and boost U.S. exports. That’s right, imports from China can create jobs in the U.S. The U.S. and China should allow this normal economic activity to be determined by the market. China and the U.S. should be as open as possible to foreign trade and investment for commercial activity. This ranges from the U.S. selling autos and toothpaste to China to China selling steel and iPhones to the U.S. We should also include services in the mix, so a U.S. accounting firm can readily sell audit services in China just as a Chinese animation studio can produce cartoons for a U.S. customer. In that spirit of economic engagement, let’s applaud President Biden’s discussion of mutual tariff reduction and hope that he takes this initiative ahead. And there can be collateral benefits in re-establishing occasional patterns of cooperation between the two countries.

Second, China retains more barriers to this traditional trade than the U.S. and should work to bring its trade practices in line with world norms. The announcement by China to no longer require live animal testing for cosmetics imports is a good example of China reducing barriers and supporting humane policies as well. But despite improvements, China still lags in terms of openness. The World Bank tells us that China’s simple average tariff is 5.3%, the EU’s is 1.7%, and the U.S.’ is 2.9%, and even these figures mask unfair practices such as dumping. No one should be surprised there is resentment in Europe and the U.S. over this unevenness.

Third, U.S. national security concerns are legitimate and there should be measures in place that restrict Chinese tech firms access to the U.S. when necessary. But let’s limit these restrictions to security threats and allow Chinese firms to compete in other areas.

Fourth, concentration risk is primarily a commercial matter. Companies need to think through their exposure if they source exclusively or disproportionately from any one market. It behooves companies that source from China to develop an “insurance policy” by establishing alternative sources of production even if these alternatives are marginally more expensive. That marginal difference is the cost of insurance.

In sum, despite all the friction and complaints, it is in the U.S.’ interest to maintain a level of functionality in the relationship. Let’s keep U.S.-China trade in context and remember that it allows all participants to benefit. The double-edge nature of trade means that as we see more benefits from trade than ever before, we also see more trade problems than ever before.

China and the U.S. face a multi-faceted relationship, in which some elements are beneficial, some are competitive, and some might even be adversarial. But statecraft argues that we do what we can to enhance the beneficial relationship, making it perhaps a bit easier to contain and stabilize the other areas. In other words, a floor under the relationship is required.