• Fixed Income

An alternative history of finance: What if China had never joined the WTO?

In a new column, AIQ imagines how hypothetical scenarios in finance and economics would play out. In this issue, we explore how the world would look if China had never joined the World Trade Organization.

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In January this year, Robert Lighthizer, the US trade representative, put out a report stating unequivocally that the US had made a mistake in supporting China’s entry into the World Trade Organization (WTO) in 2001. Lighthizer argued that China, together with Russia, had undermined the WTO by not trading fairly with other members of the organisation.

These comments were no mere words. In March, Donald Trump announced a series of tariffs on imports from China, a move that was rapidly followed by reciprocal tariffs from China on US goods. While talks between the two countries have since continued in an effort to prevent tensions escalating further, it’s clear that under the Trump administration a fundamental principle of US trade policy has been reversed.

It is unfair to blame the growth of the US trade deficit solely on China

After decades of the US viewing membership of the WTO as a way to ensure better trading relations with China, the current government believes having China outside the organisation would make it easier to take action against what it claims are unfair practices, which have damaged US domestic manufacturing, led to widespread job losses and caused the US trade deficit to soar.

Reshaping the Chinese economy

The US can’t turn back the clock to December 11, 2001 – at least not without abandoning the entire WTO framework. But let’s consider what might have happened if US opposition had resulted in a rejection of China’s application to join the WTO. This did not seem entirely implausible in the late 1990s, when the Clinton administration struggled to persuade Congress to back a deal. What would the Chinese, US and global economy look like if those efforts had failed?

The long process of China’s WTO accession began in the 1980s, when it applied to join the General Agreement on Tariffs and Trade (GATT), the predecessor to the WTO. This process required the government to undertake a substantial number of economic reforms intended to open domestic markets to foreign firms.

These reforms had the effect of weakening the influence of the state-owned enterprises that previously dominated the Chinese economy and enabling the growth of private firms, which acquired greater freedom to participate in international trade. By the late 1990s, many of the domestic conditions that would drive the growth of the Chinese manufacturing sector were already in place.

Confirming the status quo

What’s more, even before China joined the WTO, it had more or less the same access to the US market that WTO members enjoyed, under an annual waiver of a 1974 law intended to restrict trade with Communist countries – a waiver that had been passed by Congress every year since 1980. So WTO accession did not in practice immediately increase access to the US market for Chinese goods.

Still, because this waiver was subject to an annual review – which was sometimes controversial – there was always a risk the US could increase barriers on Chinese goods. This may have limited the extent to which US firms were willing to relocate manufacturing activity to China. Indeed, if the US trade deficit with China had begun to grow as rapidly under a scenario in which China was not a WTO member as it did in reality, it’s quite possible Congress would have rejected the waiver or imposed additional conditions.

However, it is unfair to blame the growth of the US trade deficit and the decline of domestic manufacturing solely on China: both trends were well under way before China joined the WTO. For example, the trade deficit grew from around two per cent in the mid-1990s to around four per cent by 2000, going on to peak at around six per cent in 2005.

It seems likely that even if the US raised additional barriers to Chinese imports, the trends we saw in US-China trade would simply have taken a different form. The most plausible alternative seems to be that more US manufacturing would have shifted instead to Mexico and to other Asian economies – most likely Southeast Asia, where currencies had collapsed against the dollar following the 1997 Asian financial crisis.

These destinations would have offered lower costs than US manufacturing. However, they did not offer the exceptionally-low costs, economies of scale and convenience that China’s vast workforce offered. The result might therefore be similar growth in the US trade deficit and a decline in jobs – but without all the cost savings that China delivered. To put it bluntly: the US economy might have been worse off.

Undermining the WTO

Surely, however, China would also have been significantly worse off? That would depend on how the rest of the world reacted to the US decision.

Other nations supported China’s accession to the WTO. If the US – the key supporter of liberalising global trade – had rejected it, the status of the WTO might have been weakened.

It is plausible other countries would then have sought to manage trading relationships with China outside the WTO. China’s participation in global trade would probably have continued to grow, but in a different form: for example, we would have seen more exports of intermediate goods from China to Southeast Asian economies for completion and subsequent export to the US under WTO terms.

If the US still considered that China was following unfair trade policies, it could have attempted to persuade other countries to join it in taking wider action to limit China’s involvement in global trade. However, if the US was perceived as having damaged the WTO – and the framework for resolving trade disputes – by excluding China from the organisation, it’s not clear it would have enjoyed much support.

There is also little evidence that US administrations before Trump would have wanted to take action of this type. After all, in addition to the standard WTO dispute-resolution process, the terms of China’s accession to the WTO provided the US with the ability to take action if Chinese imports were shown to be disrupting US markets.

This provision, known as Section 421, was barely used: just one order, on tyre imports, was imposed by the Obama administration in 2009. If the US was unwilling to use options already at its disposal, it’s difficult to imagine it would have implemented wider measures or persuaded other countries to join it in blocking China.

A poorer world without China

If China had not joined the WTO, the global economy today would undoubtedly look a little different. China would have probably grown more slowly, meaning fewer opportunities domestically and also for foreign investors in the country. Major importing economies might be worse off, due to higher costs and greater inefficiencies. But it seems plausible that many of the same imbalances would still exist.

Few would have benefited if China had not joined the WTO

The only obvious gains might have been for countries considered to be an alternative destination for export manufacturing over the past 15 years. In short, the global economy overall would probably have been a little poorer if China hadn’t joined the WTO. Few would have benefitted – regardless of what the Trump administration appears to think.

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