A Trans Pacific Trade Conflict is on the Horizon

When Xi Jinping lauds, “markets as playing a decisive role in resource allocation,” do you think he intends to A.) Implement structural reform to decentralize resource allocation, generally weakening state control, B.) Create a narrative to shield China from global governance, OR C.) Other?

I’m going with option B.

When Xi Jinping signs “cyber espionage agreements ,” do you think he intends to A.)  Implement structural reform to stop cyber theft, generally weakening state control, B.) Create a narrative to shield China from global governance and retaliation, OR C.) Other?

I’m going with option B. This blog post will describe unique state control mechanisms within China, and I will show how recent laws are not structural reforms in nature, but buzzwords to create a narrative. This narrative is important because global governance structures such as the WTO are unable to effectively govern. Countries wanting to limit China’s foreign influence, I argue, will now have to do so unilaterally, as part of larger trade agreements, or accept Chinese influence all together.

The Nature of the Problem

Call me crazy, but I have never considered mixed ownership reform in China, where targeted SOEs sell roughly 30-40% equity to private investors, actual reform.

Per Caixin, my emphasis added:

Most big state-owned companies that have been listed to date remain firmly in control of the central government, which typically maintains 50% or more of the company’s shares. Under that arrangement, the central government sees anyone who buys shares on the open market as purely financial investors, and typically gives them little or no say in the company’s management or strategic planning. The new plan treats investors as strategic partners who can profit through their equity stake if the partnership succeeds. Those partners have a specific mandate to work with the state-owned company to create new products and services that can be jointly developed and marketed by both sides

To think that China or the Chinese Communist Party wants private strategic partners is laughable, however what is genuinely absurd and intellectually insulting is the idea that the central government retains control of these companies by retaining a majority of given shares.

The Chinese economy is unique when considering its combination of irregularities which involve state control.  Let me introduce three irregularities before circling back to, global governance obfuscation.

512px-National_Emblem_of_the_People's_Republic_of_China.svg

First, SOEs have all assets held by the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). Per Wikipedia, my emphasis added.

The State-owned Assets Supervision and Administration Commission of the State Council (SASAC) is a special commission of the People’s Republic of China, directly under the State Council. It was founded in 2003 through the consolidation of various other industry-specific ministries.[1] As part of economic reform, nearly half of state-owned enterprises were sold off in the form of stocks. SASAC is responsible for managing the remaining SOEs, including appointing top executives and approving any mergers or sales of stock or assets, as well as drafting laws related to state-owned enterprises. As of 2017, its companies had a combined revenue of more than 23.4 trillion yuan (US$3.6 trillion) and an estimated stock value of 50 trillion yuan (US$7.6 trillion),[2][3] making it the largest economic entity in the world

Every SOE is actively managed as a portfolio company in the same way that a private equity company might treat its holdings. Each level of government replicates this structure. Provinces and municipalities have their own SASAC, reporting up to the central government’s SASAC, and these local agencies serve as the controlling shareholders of the critical SOEs in their regions. For example, Jiangsu Province’s SASAC controls the province’s key enterprises in sectors such as agriculture, hospitality,
minerals, and so on. Imagine if one U.S. government agency controlled General Electric, General Motors, Ford, Boeing, U.S. Steel, DuPont, AT&T, Verizon, Honeywell, and United Technologies.

Second is the National Development and Reform Commission (“NDRC”). The NDRC is the present-day incarnation of the State Planning Commission (“SPC”). During Mao’s reign. The SPC was the central planning authority that oversaw the Soviet-style planned economy. The NDRC oversees the creation of China’s Five-Year Plan, a role that the SPC once played. But unlike other countries, such as India, where the Five-Year Plan serves merely as an aspirational guide, the NDRC has several tools available to implement its plan. The NDRC is in charge of pricing commodities that are not yet completely set by the market. Examples include electricity, oil, natural gas, and water. This allows the Chinese state to set input prices, thereby affecting costs. In addition, whenever a large infrastructure project or investment requires government approval, the NDRC is the final authority, regardless of whether the entity seeking approval is an SOE, private company, foreign company, or joint venture. Examples include new bridges, factories, and even a Disneyland theme park. This oversight provides the NDRC with broad power to affect market supply and capacity.

This structure is replicated at the provincial and local levels (similar to the structure of SASAC). Each province and municipality has its own Development and Reform Commission (“DRC”), which coordinates economic policy for that region. The provincial/local DRC reports vertically to the NDRC as well as horizontally to the corresponding level of government. This structure ensures that the state has the full ability to coordinate economic policies both within and across sectors and regions.

Third, the Party is everywhere. Although China is a one-party state, the Party functions as its own organ independent of the state. For example, although the Party oversees the
state’s public security and judiciary, it also operates its own separate investigation, detention, and disciplinary processes.  The Party appoints the leadership of SASAC, the NDRC, and Central Huijin, as well as the various ministries charged with overseeing the economy. It also controls appointments of CEOs and top management of SOEs, as well as  banks.

Each and every organization with more than three Communist Party members must form a Party committee within the organization. This requirement extends not only to SOEs, but also to private companies and foreign firms. The inner workings of the party committees are not made public. Nevertheless, this structure provides the Party with a high degree of potential oversight over Chinese corporations or any group in China.

Western Misreadings

President George H.W. Bush visited China  in 1998. When meeting with Premier Zhu Rongji, President Bush asked how China’s privatization plan was proceeding. Premier Zhu, obviously surprised, responded that China was not undergoing privatization but simply corporatizing its state assets. President Bush reportedly responded, with a nudge and a wink, and when Premier Zhu Rongji described the process, Bush responded by saying “we know what’s going on.” (McGregor, supra note 26, at 43.)

George HW

It turns out, he didn’t know what was going on.  Coming off a victory in the Cold War Western expectations for China centered on the inevitability of democracy, capitalism, and universal values codified in Western states.

This is not to suggest that the Chinese concealed their true intentions. Throughout the 1990s, Chinese leaders openly and repeatedly stated that they sought to forge their own unique economic and political system. China’s reformers are often painted as adopting an incremental, gradualist approach, however at no point has China and the Chinese Communist Party sought, vocalized, or signaled towards what the West dreamed of, a China that reformed away communism for democracy and capitalism.

Foreign observers never stopped looking for the next sign of reform, never stopped believing that Chinese reform would fit their vision. Articles like this, written four years ago, read as comedy today, my emphasis added:

The Chinese government’s central economic planning ministry (NDRC) dominated economic policy-making in the Hu-Wen era, and came to epitomize the model of state capitalism associated with their decade in office. The organization’s approach to economic management, however, is in direct conflict with the vision laid out by Xi Jinping’s administration which has promised to give a “decisive” role to market forces. Much uncertainty remains over NDRC’s future although the organization shows signs of positioning itself for a new role as a macro-economic coordinator that is relevant to a more market-driven Chinese economy.

Yes, only now is Chinese state control in conflict with promises and talking points. These promises, just like promises on cyber security, are empty. I contend that no one should take merit in Chinese government promises.

Although this blog post will focus on economics, obfuscation is not limited to one sector. China recently held a forum on human rights.  Details are worth reading (full text and propaganda ). My favorite quote from the Xinhua propaganda piece, my emphasis added:

Although the topics of the events varied from economic globalization to cooperation among political parties, the messages in Xi’s speech and letters radiated a China vision of global governance

Conjecture

When China joined the WTO, there was a fifteen year period in which countries were able to designate China as a NME (non-market economy). That designation would allow countries to raise tariffs or limit Chinese imports. That period has ended, and now, just over 15 years later, China has done well to obfuscate governance able to address China’s exporting of domestic imbalances. My key contention is that some of China’s structural changes are designed to obfuscate global governance, specifically the WTO. The most often mislabeled reforms are SOE ownership reform and capital allocation mechanisms. These are buzzwords designed to placate developed economies.

I believe, purely as personal conjecture, that China has been preparing for a trade war for some time, and China correctly identified the WTO as where the first shots would be fired. China has gone to great lengths to obfuscate how its markets function, rendering the WTO unable to effectively mediate the effects of their domestic imbalances. Perhaps most importantly, America is at least a decade behind the ball.

Testifying before Congress in 2000, U.S. Trade Representative Charlene Barshefsky declared that the “agreement deals appropriately with the special and unusual characteristics of the Chinese economy. She then boasted that “no agreement on WTO accession has ever contained stronger measures to strengthen guarantees of fair trade and to address practices that distort trade and investment.”

She was wrong largely due to fundamental changes that enhanced state control starting in 2003 (SASAC, NDRC, and the Party). While China has undergone large structural changes, the WTO hasn’t had a large structural change since the Uruguay round of negotiations concluded in 1994.

WTO

WTO Headquarters in Geneva

To be sure, China’s status in the WTO has been up for debate, a debate that in recent months has escalated. This article by Xinhua is illuminating. Besides describing American objection to Chinese trade practice as “reckless,” the problem at hand is easily summarized: “In fact, the case has nothing to do with whether China has been granted market economy status or not, as there are no standards in the WTO rules for the status.”

The roughly $600 billion in bilateral trade is obviously at stake, but the Chinese economic system, designed to export Chinese savings, is also at stake. China can hardly afford to forcefully adjust from its debt creating model. To safeguard their system and the ability to export domestic distortions, China has been all too happy to proclaim itself as the defender of globalization. It has everything to gain from preserving the status quo.

The problem the WTO has failed to address is, “what entities should be considered part of the state?” This is critical because the WTO prohibits certain forms of subsidies while allowing recourse against subsidies with adverse trade effects. However, these rules only apply to subsidies provided by governments and their associated entities. The WTO tried to preempt loopholes by referring to entities separate from government, but controlled by the government as public bodies, which are subject to government like restrictions. The greatest issue regarding Chinese public bodies are groups providing subsidies as opposed to receiving them.

If GE capital provides a preferential loan to GE aviation, there is no foul play, because it was not state directed. However, in China the entire banking system is under state control. Remember, every SOE adheres to state planning provided by the NDRC and is under control of SASAC.

In this 2010 case the United States argued public bodies were organizations with a majority stake held by the government. That was rejected. In this 2014 case the United States argued an organization is a public body if a government can control a companies asset as its own. That was rejected. The WTO, in the appellate court’s decision in 2010, further gave guidance to what constitutes a public body. A public body, the appellate body declared, “must be an entity that possesses, exercises or is vested with government authority.” Where an express statutory delegation of authority exists, the inquiry is straightforward. However, even without express delegation, an entity may nevertheless
constitute a public body. What is important is “evidence [of] a sustained and systemic practice” of the entity “exercising governmental functions.” Ownership, by itself, does not suffice. Evidence must show that “the formal indicia of government are manifold” and “such control has been exercised in a meaningful way.”

The Chinese government’s reforms over the past few years have strengthened the party and state control, while loosening the formal indicia of government. The Bank of  China may have quasi government intent written into its being, but China has effectively deleveraged the state control language of its economy and largest domestic distorters.

America’s New Response

America after 2010 has decided to bring cases to the WTO to halt unfair trade practice. Here is Obama stating how his administration has brought more cases to the WTO. Note, those cases failed to create a victory for the United States, hence not bragging about winning cases at the WTO, merely sighting the number of brought cases. China has cleverly adopted reform and buzzwords to combat American discontent.

Recent ‘reforms’ don’t seem to be reforms at all, and the only effect I can see from reforms in the past 7 years is to strengthen China’s ability to obfuscate WTO global governance. China has privatized state assets before, and real reform for SOEs would be getting rid of NDRC and SASAC involvement as opposed to privatizing minority stakes. It seems more likely that those reforms are aimed to get ahead of American public bodies arguments. I’d say the same thing for resource allocation statements.

And herein lies the rub. China is succeeding in the WTO. The WTO as it stands today is unable to mediate issues relating to China. The laws are 20 years old. Perhaps more importantly, can the WTO make rules for one country? Could you imagine a negotiation where the world agrees on Chinese trade practices, trade practices that are largely emulated in East Asia. China presents a unique rule set due to its sum of rare state controls, but many countries in Asia, not to mention Germany, export savings.

So it is now that, faced with years of stinging failure under the Obama administration to fix the issue, Democrats and Republicans, in the midst of a partisan bloodbath, come together. Only now, following New Zealand and Australia, is America realizing its losses and vocalizing its discontent. Chinese tech companies are on the brink of developing world changing technology on American soil, while American companies struggle for basic market share across China. A new technology Chinese panopticon is no longer page 7 news with the realization that human rights are indeed not improving. As the left rails against Donald Trump, there is quiet but firm agreement across the aisle that reciprocity is needed. Allies of China bring new threat of nuclear holocaust against a people who were fat, happy, and oblivious to the machinations of the East Asia. No longer.

It is under these conditions that the United States now has abandoned the WTO. The Section 301 investigation against China is serious. I expect the United States to move unilaterally before the 301s stated deadline (1 year). I expect the United States to try to fix its balance of payments issue through trade disagreements with China. I expect the United States to fail in addressing economic imbalances. I expect the wider world to support China right until the very moment it falls under the weight of its debt burden.

Obama got a peace prize upon being elected. I don’t expect any aid from the developed world with Trump in office. The pieces seem set. China under Xi has failed to reform. America under Trump has abandoned global governance.

The sky is grey today.

 

 

 

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