Can the Trading System Survive US–China Trade Friction?
| Date | 01 September 2018 |
| Author | Robert Z. Lawrence |
| Published date | 01 September 2018 |
| DOI | http://doi.org/10.1111/cwe.12256 |
©Peterson Institute for International Economics, reproduced by permission from PIIE
China & World Economy / 62–82, Vol. 26, No. 5, 2018
62
*Robert Z. Lawrence, Nonresident Senior Fellow, Peterson Institute for International Economics; Albert L.
Williams Professor of Trade and Investment, John F. Kennedy School of Government, Harvard University,
USA. Email: robert_lawrence@hks.harvard.edu. The author thanks Fred Bergsten, Yeling Tan and Steve
Weisman for their comments and Madona Devasahayam for superb editorial assistance.
Can the Trading System Survive
US–China Trade Friction?
Robert Z. Lawrence*
Abstract
Donald Trump has sought to change US trading relationships by raising protection
at home and taxing the offshore activities of US companies abroad. These measures,
which both use and violate trade rules, have provoked retaliation from other countries.
Such friction has restricted and distorted trade and investment, undermined the rules-
based trading system and perhaps permanently damaged global value chains that
depend on stable rules for market access. Trump has justied some of his measures as a
response to China’s alleged unfair practices and indeed, China has adopted industrial
and technology policies that are formally neutral between domestic and foreign rms
but in practice have led foreign rms to complain about discriminatory practices that
favor Chinese rms. The US friction with China is unfortunate because instead of trying
to bully China into submission in a tariff war, the US could have dealt with many of its
concerns more effectively by cooperating with other countries and taking actions that
are consistent with maintaining the rules-based system. While the US has undermined its
leadership role, the overall damage to the trading system could still be limited if other
countries, especially China, take actions that sustain and strengthen it.
Key words: industrial policy, trade rules, trade war
JEL codes: F1, L5, P0
I. Introduction
The global trading system has enhanced the living standards of billions of people
in many countries by developing a production system that is based on global value
chains. In this system, trade no longer consists mainly of goods and services that are
produced entirely in one country and sold in another. Instead, countries specialize in
tasks rather than products, and nal goods are assembled using intermediate components
©Peterson Institute for International Economics, reproduced by permission from PIIE
Trading System and US–China Trade Friction 63
and services that originate from many countries; in short, goods and services are now
“made in the world.”1 This system has been enabled by improvements in logistics,
transportation and information technology (Baldwin, 2016), but ultimately has depended
on governments complying with agreed rules that set the conditions for market access
and non-discriminatory treatment of foreign goods, services and rms.2
The current trade friction between the US and its trading partners could wreak
havoc on this system that depends on confidence that governments will respect
the rules. As I will describe, the tariff measures imposed by the US in the name of
providing safeguards, ensuring national security and dealing with unfair trade, violate
both the letter and the spirit of the trading rules. These measures and other countries’
retaliation to them will restrict trade and investment and damage US relations with
most of its largest trading partners. While there are legitimate US concerns about
Chinese economic policies, they are unlikely to be solved through a trade war between
the US and China that inhibits supply chains with escalating tariffs, will inflict
immediate damage on individual markets and products, and impose costs not only in
these two countries, but in the other economies that supply them with capital goods
and intermediate products. The impact could be especially damaging over the long run
if it undermines the condence of rms that have made investments and production
plans on the assumption that global markets will be integrated. This friction is
particularly unfortunate because instead of trying to bully China into submission in
a tariff war, the US could have dealt with many of its concerns about China more
effectively by taking actions in concert with other countries that have experienced
similar problems and are consistent with maintaining the rules-based system (Hillman,
2018). Nonetheless, while the US has undermined its leadership role, the damage to
trading system could still be limited if other countries, especially China, take actions
that sustain and strengthen it.
To set the context for this discussion, two sets of prefatory comments are in order.
The first relates to the flawed ideas about trade that have shaped Donald Trump’s
trade policies; the second relates to the behavior of China’s economic system in which
industrial policy decisions by the state, the communist party and the private sector are
closely intertwined and as a result has created problems for a trading system in which
the rules are based on clear distinctions between private and public actors (Wu, 2016).
1See the Trade in Value Added Database, available from: http://www.oecd.org.
2As argued by Piece and Schott (2016), for example, China’s entry into the WTO enhanced condence that its
products would be given most-favored-nation treatment and had a powerful impact on encouraging rms to
produce products for the export market in China.
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