Written by Professor SHENG Hong, Director of Unirule Institute of Economics

Translated by Mr. MA Junjie, Project Researcher of Unirule Institute of Economics

This essay was first published by FT Chinese on July 4th: http://www.ftchinese.com/story/001078304?page=4&archive

Before people rejoice in the joint statement to solve the trade conflict between China and the US on May 19th, President Trump announced to take a some USD 50billion tariff on Chinese commodities. This came as a surprise. Many speculate that this had something to do with President Trump’s characteristics, which is justifiable. Take a look back at the joint statement and we could hardly doubt the capability of Trump’s team. In the statement, there were only some accounts of principles in addition to the promise that “China will significantly increase purchases of United States goods and services”. Regarding America’s accusation of China’s “unfair trade”(as I mentioned as a four-point summary in my essay “Why a Sino-US ‘Trade War’ Can be Turned into a Win-Win?”), the only point that was mentioned was “China will advance relevant amendments to its laws and regulations in this area, including the Patent Law.” The joint statement failed to mention the other three points I summarized, such as government subsidies, the free flow of Internet data, and further opening the Chinese market. Apparently, this is an imbalanced joint statement. 

The US side spoke highly of the chief representative of the Chinese government, Mr. Liu He, as a “smart guy” and a “market guy”. Perhaps it was because of Liu He’s superb performance that such an imbalanced joint statement was achieved. However, what determines whether a written agreement is going to be undertaken by both parties is not superb negotiation skills, but the fact that such an agreement recognizes the values and interests of both parties. When Trump’s advisors found that the joint statement emphasized that “substantially reducing the United States trade deficit in goods with China” has scored in the political term without bringing about any concrete changes to “unfair trade”, it is anticipatable that they would go back on it. However, as we later witnessed, the US delegation came to China in vain. This seems to show that the Chinese government did not want to make substantial compromises in what the US saw as key areas. That is to say, the Chinese government is diehard on government subsidies, restricting the free flow of Internet data, and limiting the entry to the Chinese market. The Chinese government then reacted equivalently to the US announcement only to find that the US side enlarged tariffs on commodities that’s worth USD 200 billion. In this light, a trade war was initiated only because both parties cannot reach consensus on the principles of fair trade. 

To everyone’s surprise, the wording used by both parties are similar. President Trump said he was not against free trade and what’s he’s against is “unfair trade”; the spokesman of China’s Ministry of Commerce replied that the Chinese government vowed to “maintain and defend the free trade system”, and accused the US with “unfair trade”. It seems to me that even though the differences are telling, both parties are constrained by the political correctness of their wording. Perhaps this is the consensus of both sides. That is to say that free trade is a trade of fair principles; and only by trading fairly can free trade lead to prosperity. Since both parties uphold fair free trade, where’s their difference? In this regard, the Chinese government did not bring up the specific principles of “fair trade”, and the four pointer of the US side specified the principles of fair trade. 

Back to the textbooks, fair trade principles is the fair competition principles. They include explicitly defined and protected property rights; fair competitors, i.e., none of the competitors should be treated with discrimination or favor; and free entry into the market. From this point of view, these are the principles the US stressed. For instance, the intellectual property rights issue, the unfair competition by government subsidies, or the market entry via Internet. We need to take note that the Chinese government does not object the principles that make up the fair market competitions. The CPC’s third plenum of the 18th congress has stipulated the principle of “market playing a decisive role in resource allocation”, and the protection of property rights, including the intellectual property rights have been stressed in multiple policies and occasions; the same with breaking the administrative monopoly, upholding fair market competition and market entry, etc.. Then, why would there still be difference between China and the US? Why wouldn’t the Chinese government accept the specific standards about fair trade by the US? There seems to be a tremendous interest blackhole that causes the deviation of the Chinese policy.

Let’s take a look at who would benefit from refusing these three accusations. It would shine some light upon where the blackhole is. Who would benefit the most if government subsidies are not canceled? Apparently the Chinese state owned enterprises. According to Unirule research, from 1994 to 2013, a in-exhaustive estimate of the amount of government subsidies received by the state owned industrial enterprise accounted for some RMB 639.4 billion. This is just the tip of the iceberg. The bigger subsidies come in the form of free use of state owned land, low interest bank loans, and low royalties for acquiring natural resources. The underpaid land rent by state owned industrial enterprises amounted to some RMB 6,426 billion from 2001 to 2013; the uncollected loan interest amounted to some RMB 5,712.4 billionl; and the underpaid resource rent amounted to some RMB 1,113.8 billion.(See Unirule Institute of Economics, the Nature, Performance and Reform of Chinese SOEs, 2nd edition, 2015) These government subsidies not only resulted in huge amount of unfair wealth transfer and sustained the inefficient enterprises in the Chinese marketplace, but also led to breach of the fair competition principle, exclusion of highly efficient private enterprises, distortion of the resource allocation, and the harm to the interest of the Chinese economy. What foreign competitors feels unfair about is the spillover effect of such unfair behaviors of the Chinese enterprises. 

As for market entry, after China joined the WTO, most of its domestic market is open for foreign goods and services. However, there are still some market areas that are closed. We have to be clear, this is not for the protection of Chinese enterprises, but for some Chinese enterprises, that is the state owned monopolies. For example, the areas that the US complained about include credit cards, telecommunication, and the film industry. These areas are also closed to the Chinese private enterprises, or heavily regulated for censorship reasons. In the Chinese domestic market, efforts have been taken in order to break the monopoly of commercial banks, telecommunication and the gas industry. Although the 19th party congress vowed to “break administrative monopoly”, not much concrete development has been seen. Our research also found that the annual average monopoly rent of the telecommunication industry between 2003 and 2013 accounted some RMB 22.3 billion, which can also be considered as transferred consumer welfare; whereas the monopoly profit of the gas industry due to the monopoly high price accounted some RMB 1,328.9 billion. Thanks to the low interest rate for deposits and the banking monopoly, the monopoly state owned banks unfairly took over RMB 1,470.9 billion in the year 2013 alone. It cannot be more clear that keeping these market closed is for the benefit of the monopoly interest, which first and foremost harms the interest of the Chinese people and the Chinese private sector. 

Regarding the market entry for the Internet industry, due to the fact that it’s an emerging industry in China, issues were understandably neglected over the past few years. From the perspective of economics, this industry constitutes another form of market which should also be bond by the market rules or the principles of free trade. The barriers of the Internet industry is the Internet channels that are easily regulated and controlled by technical measures. Such measures are known as the Great Fire Wall(GFW) of China. If we take the Internet as a market place, then the GFW acts as the virtual customs, except that such a customs is not regulated by the WTO rules. The GFW arbitrarily blocks goods and services the Internet  from the outside world, just like entry barriers for real goods and services. Such restrictions exist in the domestic market, too, only with different technical measures. The Internet monitoring administrations often shut down or block certain website by applying their discretion, or making it impossible for the websites, microblogs, or WeChat public accounts to operate by undertaking measures such as deleting posts messages, technical problems, or restriction of reposting or retweeting. By doing so, these administrations are, in fact, putting up barriers for Chinese citizens and enterprises to entry the market. 

Needless to say that the restriction on the free flow of Internet data would also damage the social and political life in China. Although the Cybersecurity Law of the People's Republic of China vows to protect the information security of Chinese citizens and enterprises, without the explicit restriction of Article 35 of the Constitution and effective rein on Internet monitoring administrations, the abuse is pandemic, which infringes the citizens’ freedom of expression and suppresses criticism and disclosure of corruption. Even when it involves some major social issues, sometimes on totally civil footing, such as the Red Yellow and Blue Kindergarten or the Hongmao Medicine Liquor scandals, online discussions were interfered or forbidden by the administration. One extreme example is a case where a citizen was taken in custody simply on the ground of him complaining about the dishes in a county hospital canteen. This administration abuses its power in a regular basis, which cultivates a hotbed for corruption. Its former head, Lu Wei, is an example. In this sense, it is not only an economic issue, but also a political one to ensure free entry and free flow of data regarding the Internet; it is also an issue of global trade, and an issue that exists in the domestic market and society. 

If we take a look at the intellectual property rights issue, we need to recognize the progress made in this area. However, from a structural point of view, there are two mechanisms that promotes technological innovation. One is the intellectual property rights which plays an important role in civil society; the other is government subsidies where there are countless government-backed innovation funds. There is a rent seeking mechanism that offers more government resources to certain groups of people without really promoting innovation. In the current government system, government backed funds are hardly received by those with real innovative capabilities. The Hanxin events showcased that such funds are hotbeds for frauds and corruption. From a structural perspective, state owned enterprises rely more on such funds, therefore hardly are capable of innovation. What they do is to buy patents and acquire technology, such as the so-called “self-innovated” high speed railway system that was dependent on the technology acquired through the massive domestic market advantage as a bargaining tip from Japan, Germany and France. Therefore, the state owned enterprises do not possess intellectual property rights but as the ones who acquire them. For these state owned enterprises, protection of intellectual property rights weighs way less than getting government backed innovation funds. 

What’s interesting is the US does not seem to understand the implications of China’s government subsidies, which explains why the US has been objecting a Chinese policy document, that is the Made in China 2025. In fact, other than massive description of future development, the most important thing in this document is to offer fiscal subsidies and financial support for technological innovation. Although the document also mentions improving IPR protection, judging from the administrative departments practice, those parts are merely an account of principles. From my experience, China has not made much progress in terms of IPR protection. I initiated two IPR lawsuits in the past and won both. However, the compensation for those cases have never managed to find its way to my bank account. What the Americans worry about is the extra advantage this document would give to the Chinese enterprises, that they might overtake American enterprises. However, in fact, this document harms the interest of China the most, because it encourages more enterprises to seek subsidies from the government in stead of the IPR institution and the market, resulting in more waste of resources in rent-seeking instead of investing in real technological innovation. 

In this light, when the Chinese side refused to compromise in the areas of government subsidies, free flow of Internet data, and opening of the domestic market and IPR protection, what it was really doing was to protect the interest of vested interest groups and administrative departments, to violate the principles of fair market competition, and to go against the basic principle set by the Chinese Communist Party that “the market should play a decisive role in resource allocation”. This makes a trade war due to Chinese interest groups’ maintaining its own interest a trade war between Chinese interest groups and the Chinese people and the US. This trade war risks the interest of Chinese citizens and enterprises, which is ridiculous in nature. It is this interest group that obstructs other enterprises to enter certain markets, weakening the Chinese people by price monopoly, and claiming that the interest of itself is the national interest. It also asks the victims of its behaviours to stand by it and defend its interest. How absurd!

However, some mainstream domestic media seem to be saying that this trade war was started deliberately but he US, a blackmail, or even “trade terrorism”. What they are doing is to assist the interest group, incite populism and economic nationalism, and cover up the fact of monopoly that makes the loss of the public their gain. In fact, what matters in the China-US trade dispute is not the amount of trade deficit, but the issue of whether the principle of fair trade and fair market competition are observed. For years, this interest group in China has accumulated billions of wealth through unfair measures, monopoly high price, and government subsidies. As a Chines citizen, why would someone sacrifice his own interest and defend something like a high monopoly gas price, say 21% higher than the average level of other major countries, or a 1~1.5% interest rate on deposit that is much lower than what’s necessary to maintain a fair market level?

Apparently, the only thing that’s good to the Chinese enterprises and citizens is to maintain and follow the principle of fair market competition, i.e., the fair rules of global trade. Once the monopolies are broken, massive enterprises that were previously excluded would enter various industries and their institutional and technological advantages would be of use. More efficient competition would bring about cheaper products and services and promote innovation. Chinese people have never feared fair competition for they have been a diligent and wise people. History, especially the history after China joined the WTO, has proven that Chinese can succeed in global competition. Chinese people would benefit more with an open Internet market, free flow of Internet data, and stricter IPR rules. Therefore, the China-US trade war is not really a trade war between the two peoples, but really a war between China’s interest group and the Chinese people, a war between the fair market competition principles and the unfair ones. What to choose, then?

According to the Constitution, the Chinese government serves the interest of the Chinese people, from the perspective of the whole interest of the country, instead of from the perspective of an interest group. Regarding this trade dispute, what came as a surprise was that whenever someone from the Chinese side spoke, from President Xi, to Mr. Liu He, to Chinese ambassador to the WTO and the spokesman of the Ministry of Commerce, they spoke about “free trade” and “following market rules”. The white paper of “China and the World Trade Organization” is also full of liberal economic language. How could such a government so conceived in economic liberalism be America’s enemy? The real enemy is the one who believes in government subsidies, SOE monopolies, and restriction of the Internet market and the real economy, judging from free trade and market rules. 

What’s worth noting is that considering the massive political resources possessed by the monopoly and abusive interest group, they would do whatever they can to coat their interest as the “national interest”, therefore further influencing China’s trade policy. Hence, a trade war can only be defused by putting the interest of the Chinese people first, eliminating the influence of the interest group, explicitly fight for the rules and principles of fair trade and fair market competition, implementing the “Market Entry Negative List”, substantially “break the administrative monopolies”, cancel government subsidies for SOEs, enhance IPR and weaken the government backed funds for innovation, and at least partly tear down the GFW. By doing so, the Chinese economy would also prosper by fair market principles. I just noticed that the Chinese government shortened the negative list for foreign investors. It is good news indeed. But China needs to do more.