Pinpoint the issue: America’s real China problem

By DARON ACEMOGLU, SIMON JOHNSON

NEW DELHI: Instead of assuming that more international trade is always good for American workers and national security, US President Joe Biden’s administration wants to invest in domestic industrial capacity and strengthen supply-chain relationships with friendly countries. But as welcome as such a reframing is, the new policy may not go far enough, especially when it comes to addressing the problem posed by China.

The status quo of the last eight decades was schizophrenic. While the United States pursued an aggressive – and at times cynical – foreign policy of supporting dictators and sometimes engineering CIA-inspired coups, it also embraced globalization, international trade, and economic integration in the name of delivering prosperity and making the world friendlier to US interests.

Now that this status quo has effectively collapsed, policymakers need to articulate a coherent replacement. To that end, two new principles can form the basis of US policy. First, international trade should be structured in a way to encourage a stable world order. If expanding trade puts more money into the hands of religious extremists or authoritarian revanchists, global stability and US interests will suffer. Just as President Franklin D. Roosevelt put it in 1936, “autocracy in world affairs endangers peace.”

Second, appealing to abstract “gains of trade” is no longer enough. American workers need to see the benefits. Any trade arrangement that significantly undermines the quality and quantity of middle-class American jobs is bad for the country and its people, and will likely incite a political backlash. Historically, there have been important examples of trade expansion delivering both peaceful international relations and shared prosperity. The progress made from post-World War II Franco-German economic cooperation to the European Common Market to the European Union is a case in point. After fighting bloody wars for centuries, Europe has enjoyed eight decades of peace and increasing prosperity, with some hiccups. European workers are much better off as a result. Still, the US had a different reason for adopting an always-more-trade mantra during and after the Cold War: namely, to secure easy profits for American companies, which made money through tax arbitrage and by outsourcing parts of their production chain to countries offering low-cost labor.

Tapping pools of cheap labor may appear consistent with the nineteenth-century economist David Ricardo’s famous “law of comparative advantage,” which shows that if every country specializes in what it is good at, everyone will be better off, on average. But problems arise when this theory is blindly applied in the real world. Yes, given lower Chinese labor costs, Ricardo’s law holds that China should specialize in the production of labour-intensive goods and export them to the US. But one still must ask whence that comparative advantage comes, who gains from it, and what such trade arrangements imply for the future.

The answer, in each case, involves institutions. Who has secure property rights and protections before the law, and whose human rights can or cannot be trampled? The reason the US South supplied cotton to the world in the 1800s was not merely that it had good agricultural conditions and “cheap labor.” It was slavery that conferred a comparative advantage to the South. But this arrangement had dire implications. Southern slave owners gained so much power that they could trigger the deadliest conflict of the early modern era, the US Civil War.

It is no different with oil today. Russia, Iran, and Saudi Arabia have a comparative advantage in oil production, for which industrialized countries reward them handsomely. But their repressive institutions ensure that their people do not benefit from resource wealth, and they increasingly leverage the gains from their comparative advantage to wreak havoc around the world.

China may look different, at first, because its export model has lifted hundreds of millions out of poverty and produced a massive middle class. But China owes its “comparative advantage” in manufacturing to repressive institutions. Chinese workers have few rights and often labor under dangerous conditions, and the state relies on subsidies and cheap credit to prop up its exporting firms. This was not the comparative advantage that Ricardo had in mind. Rather than ultimately benefiting everyone, Chinese policies came at the expense of American workers, who lost their jobs rapidly in the face of an uncontrolled surge of Chinese imports into the US market, especially after China’s accession to the World Trade Organization in 2001. As the Chinese economy grew, the Communist Party of China could invest in an even more complex set of repressive technologies.

China’s trajectory does not bode well for the future. It may not be an outcast state yet, but its growing economic might threatens global stability and US interests. Contrary to what some social scientists and policymakers believed, economic growth has not made China any more democratic (two centuries of history show that growth based on extraction and exploitation rarely does). So, how can America put global stability and workers at the center of international economic policy? First, US firms should be discouraged from placing critical manufacturing supply-chain links in countries like China. Former President Jimmy Carter was long ridiculed for emphasizing the importance of human rights in US foreign policy, but he was right. The only way to achieve a more stable global order is to ensure that genuinely democratic countries prosper.

Profit-seeking corporate bosses aren’t the only ones to blame. US foreign policy has long been riddled with contradictions, with the CIA often undermining democratic regimes that were out of step with US national or even corporate interests. Developing a more principled approach is essential. Otherwise, US claims to be defending democracy or human rights will continue to ring hollow. Second, we must hasten the transition to a carbon-neutral economy, which is the only way to disempower pariah petrostates (it also happens to be good for creating US jobs). But we also must avoid any new reliance on China for the processing of critical minerals or other key “green” inputs. Fortunately, there are plenty of other countries that can reliably supply these, including Canada, Mexico, India, and Vietnam.

Finally, technology policy must become a key component of international economic relations. If the US supports the development of technologies that benefit capital over labor (through automation, offshoring, and international tax arbitrage), we will be trapped in the same bad equilibrium of the last half-century. But if we invest in pro-worker technologies that build better expertise and productivity, we have a chance of making Ricardo’s theory work as it should.