Trade conflict presages technology battle

The trade conflict between the United States and China swings wildly between escalation and thawing. Events are following each other in rapid succession. There is a growing realisation that there are no winners in a prolonged conflict. Moreover, further escalation threatens to do great harm to the global economy. At first sight, the growing trade deficit in the United States appears to justify the hard trade policy of the US government. But that interpretation does not stack up. Fundamentally, the debate is not about free trade, but about technology. Technological leadership will determine economic leadership in the future. As a consequence, the confrontation between China and the United States, and by extension the economic power struggle between the West and the emerging economies, will not be an overnight sensation but a quest stretching for years in search of a new and workable model for future globalisation. What we are currently experiencing is merely a foretaste of the major challenges posed by the structural redrawing of the global economic map. Only better international protection of international property rights offers a structural solution.

Looking at the trade balance differently

Recent figures show that the US trade deficit increased further in February 2018 to 57.6 billion USD. The main reason is the imbalance in trade relations with China. US President Trump has repeatedly referred to the unfairness of this deficit. At first sight, this appears to be a justified concern: the American trade deficit with China is a long-standing and structural problem. Yet the trade balance tells only part of the story. A substantial proportion of so-called Chinese exports to the United States comprises products that are actually made by US multinationals in China, which are then exported to the United States. Throwing up trade barriers against Chinese products could thus threaten the interests of American companies. Even if the tariff increase already announced and any similar moves in the future largely spare American ‘made in China’ products (which is technically possible, but difficult), the current trade conflict still threatens to bring severe consequences for US multinationals operating in China, because the possibility cannot be ruled out that China will throw up other kinds of trade barriers, such as red tape, regulations and excessive inspection procedures, to make it more difficult for Western companies to enter or operate in the Chinese market. This is an area where China already has a very bad reputation.

Not trade, but technology

The relatively mild response from China has led many to hope for a rapid thaw in the present trade conflict. That hope is not very realistic. It seems more likely that the dispute will move away from trade issues to focus on the heart of the matter: technology. China cherishes economic ambitions which go well beyond its present role as ‘factory of the world’. China wants to join the great world powers by focusing more on the production and export of products with high added value. This ‘Made in China 2025’ strategy requires access to technology in a broad sense: knowledge, product and process innovation, new technical insights, etc., and in many sectors.

China is seeking this access to technology through several channels. In an early phase of its development, China made intelligent use of joint ventures with Western companies to achieve knowledge transfers. The weak protection of intellectual property has been a thorn in the flesh of Western companies for many years, but their legal battle in China has produced little in practice. International legal principles, including through the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) under the aegis of the World Trade Organisation, also offer inadequate protection. These Chinese imitation practices have gradually taken on bigger proportions as more international companies have set up bases in China. Trade serves as an access portal for technology. President Trump has referred explicitly to the unauthorised appropriation of American technology by Chinese companies. Thanks to additional support from the Chinese government in the form of a ‘China first’ industrial policy, Chinese companies are succeeding in rapidly copying and implementing foreign technology. This is no longer an innocent strategy of a developing country.

A second arm of the Chinese quest for technology takes the form of an active foreign acquisition policy. Nervous reactions in the West show that no one likes to sell out to Chinese investors, but the latter are often willing to pay high prices, even if there are no other prospective investors, as happened for example during the European debt crisis. Various initiatives have been taken or are in preparation, both in the United States and the European Union, to curb the Chinese access to technological or strategic sectors. This protectionist attitude is understandable given China’s intentions.

The real solution

Denying China access to foreign technology or foreign markets threatens to put a brake on future global economic growth. Taking that route means everyone loses. Finding a genuine solution tothe current conflict demands a more structural approach.

In principle, China could simply accept the proposed US tariff increases. As trade between China and the US becomes more balanced, the tensions could ease. However, that is not a solution either, because it does not tackle the core of the problem. 

China must commit to better protection of intellectual property. A more prominent role in the global economy also brings more responsibility. Proper international protection of intellectual property will in time have a positive effect on innovation and investments in research and development at the global level. This is not an obvious solution for China, however, from either a strategic or cultural perspective. Yet it offers the only guarantee for creating a fair starting point for future cooperation and further globalisation. Robust protection rules would also make future Chinese investments in the West less politically sensitive. In exchange for better protection of intellectual property, China could gain permanent access to Western technology, or technological cooperation between the West and China could become possible.

Modernisation and extension of TRIPS appears to offer a good starting point for achieving this international protection. The advantage of a multilateral agreement is the clarity it gives to all countries. That is useful, given that other emerging economies are in a comparable situation to China, or will be in the future.

Although the solution is clear, reaching it is anything but straightforward. Whilst waiting for a structural solution, conflicts such as the present trade tussle will become the norm. Western countries will have to accept that they are no longer able to dictate the multilateral rules of the game, while some emerging economies will, at least partly, have to reconcile themselves with practices that are common in Western market economies. The search for the best of both worlds needs to begin urgently.

Disclaimer:

Any opinion expressed in this KBC Economic Opinions represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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