Industrial policy is at the center of the growing conflict between China and the United States. Both countries have enacted economic policies designed to protect domestic industries, including subsidies, tariffs, and other protectionist measures. Both countries have entered into regional trade agreements designed to shift supply chains toward their allies. The outcome of these industrial policies is trade diversion rather than trade creation. Geo-economic fragmentation of trade is estimated to reduce global output by 12 percent.
When we shift our focus to industrial policy at the industry level a different picture emerges. In some industries, private firms have entered into agreements that will result in trade creation rather than trade diversion. A good example is the electric vehicle (EV) industry. Elon Musk recently received approval from the Chinese to introduce “Full Self Driving” (FSD) vehicles in the Chinese market. Tesla will develop the navigation technology for these cars in a joint venture with the Chinese firm Baidu. This joint venture should help Tesla to compete in the highly competitive market for EVs in China. China has approved a similar joint venture between Volkswagen and the Chinese firm XPeng.
Unfortunately, U.S. industrial policy is now focused on “beggar thy neighbor” policies, including higher tariffs and other protectionist measures targeting Chinese imports. Both presidential candidates are running on platforms that promise even higher tariffs and restrictions on Chinese imports. Former President Donald Trump has promised to increase levies on Chinese EVs that would virtually preclude them from the U.S. market. Volkswagen recently ran afoul of U.S. restrictions on imported vehicles that incorporate parts from Chinese firms on the sanction list. We should expect the protectionist policies pursued by the United States to lead to further deterioration in trade with China.
There is an alternative to these protectionist policies. The United States must reaffirm a commitment to free trade and investment in a global trading system that includes China. In the current political climate this may seem like an impossible task. I suggest a new approach to trade negotiations with China that I call the Texas Two Step. The first step in these negotiations would be informal discussions focused on industries, such as EVs, where there is a precedent for negotiation, market opening, and reform. These negotiations would be outside the framework of formal trade negotiations between the Chinese and U.S. governments.
In the EV industry, the success of firms in the long run, including Tesla, will depend on innovation and technological change. Comparative advantage should lead to joint ventures similar to Tesla’s joint venture in designing navigations systems with Baidu. Deregulation should be combined with trade reforms to reduce tariffs and other protectionist measures. This would likely require a transition period in opening the U.S. market to Chinese vehicles, like U.S. policy toward Japanese auto imports in the 1980s.
Skeptics will question whether China and the United States could agree to such negotiations. However, there is a precedent for such informal negotiations: the Summer Palace Dialogue. These informal negotiations between the United States and China were organized by the private sector and occurred from 2009 to 2011. The meetings were held in both the Summer Palace in Beijing and Washington, DC.
The Summer Palace Dialogue led to the second step in negotiations between China and the United States. The negotiations resulted in concrete recommendations for opening trade and investment between the two countries, including joint ventures. The recommendations of the Summer Palace Dialogue were the basis for future formal negotiations between the Chinese and U.S. governments.
We are now experiencing a new “China Shock” as low-cost Chinese goods again flood U.S markets, which helps explain the xenophobic response of our elected officials. A second Summer Palace Dialogue could help both countries reaffirm their commitment to free trade and investment in a global system of trade.
Barry Poulson (think@heartland.org) is a policy advisor with The Heartland Institute
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