Trump or no Trump, China is still a problem

While Canadians fixate on the all-important U.S. election, other news takes less priority. One example is the escalating trade dispute between Australia and China. Tonnes of Australian lobsters have been sitting in Chinese airports this past week as China seethes over Australia's coronavirus inquiry.

Chinese custom authorities are also threatening to ban Australian wine, copper, barley, coal, sugar and timber, according to latest reports. The Australians are warning that Chinese discrimination against Australian products would violate World Trade Organization rules, which could lead to countervailing measures.

Hardball Chinese tactics in trade disputes are well known. Canada suffered a canola boycott starting last year after Huawei CFO Meng Wanzhou was arrested in Vancouver. The harm was partly mitigated by indirect sales to China, exports to other countries and Canadian farmers switching to new crops. Disappointingly, Canada shied away from retaliatory action, even failing to disqualify Huawei from supplying 5G technology for security reasons.

These politically driven trade disputes are not the only examples of distorted economics. China has used direct and indirect subsidies for industrial policy and has stolen technology and imposed compulsory transfers and other limits on foreigners accessing Chinese markets. These unfair trading practices and subsidies have become a focus for both Republicans and Democrats in the U.S., as well as for EU member countries. The subsidies include low financing costs from state banks, favourable real estate prices for industrial projects, artificially low energy prices for strategic industries and low-cost access to certain raw materials for domestic producers.

Chinese state-owned enterprises (SOEs) earn almost negligible profits (about one per cent return on equity) as their state owner is focused on growth and employment instead. With their minimal expectation of profit, the SOEs are effectively given subsidized state equity finance.

In the past decade, China has been reforming its SOE sector to improve governance, including by selling companies to minority shareholders. Because the state majority owner continues to have important influence, however, mixed enterprises earn profits at less than half of what private companies would normally do. When partial privatization of SOEs became popular in the West during the 1960s and 1970s, it became clear that “mix” does not work. Public and private owners have wildly different objectives — eventually companies either become fully privatized or fully nationalized.

Subsidies have enabled Chinese companies to overwhelm international competitors. The OECD found that 17 Chinese aluminum producers received US$63 billion in subsidies from 2013-17, enabling them to acquire two-thirds of global aluminum production and half of melting capacity.

Highly indebted Chinese SOEs also account for half of global steel capacity. Chinese subsidized companies account for two-thirds of world semiconductor capacity and a third of solar energy capacity. One study found that subsidies accounted for half of the after-tax profits of SOE non-ferrous metal producers.

China's industrial policy might be good for its own economic expansion but it comes at a large cost to the world economy. The excess capacity created in different products not only drives out production and investment in other countries, it also eliminates competing products and technologies. The heavy subsidization of solar panels, for example, makes it less appealing to adopt unsubsidized GHG emission-reducing technologies such as hydroelectricity or nuclear energy.

How did the world get into this mess? It is very much the fault of Western governments that enabled China to join the WTO in 2001 with preferential access to their markets but few constraints on its industrial policies and subsidies. As China qualified as a developing economy, it did not have to fully open up to foreign trade or investment and could continue to subsidize its SOEs to promote their own international expansion.

But China is no longer a developing country. It should not be permitted to distort trade retaliation-free. The Trump tactic of imposing punishing tariffs on Chinese products to counter Chinese trade distortions and technology theft does not provide a clear path to international co-operation in removing trade distortions.

A better approach would be to get China to agree to international free trade through the World Trade Organization. Though China so far has been reluctant to do so, foot-dragging is no longer acceptable. The EU and U.S. should push to revamp WTO rules to sanction the types of subsidies frequently given to SOEs, such as forgiveness of debt, unlimited guarantees, low-cost land and aid to insolvent companies. Forced technology transfers should be explicitly prohibited. China should have to open its market to foreign competitors on a reciprocal basis. Trade distortion investigations should be undertaken frequently, providing opportunities for China's trading partners to impose countervailing tariffs when appropriate.

Joe Biden, the likely winner of the still-contested U.S. election, has promised to work with allies to improve international trade. Canada should join these efforts but also take strong actions on its own to ensure that Chinese SOEs operate on a level playing field in Canada's domestic market. Over several decades we made extraordinary efforts to privatize our own crown corporations. We should not allow the effective renationalization of important Canadian economic sectors by foreign SOEs.

Canada's best strategy is to work with its most important ally, the United States, no matter whether a Democrat or Republican is in power. Our trade with China should be pursued only if China agrees to international rules.