Trading With The Enemy

IF IT WASN'T CLEAR BEFORE, IT IS NOW: CHINA--NOT Japan--is our largest trade problem. This is not mainly because the trade deficit with China has exploded or that China has rapidly emerged as one of the world's largest and fastest-growing trading nations. The real reason is that trading with China raises basic issues of how, or whether, we can use trade to create a more prosperous and peaceful world order. We haven't faced such fundamental questions for almost half a century.

It's a myth to think that the United States trades only for economic advantage. We do that, of course, and most discussions of trade policy are couched in terms of jobs or competition. But since World War II, American trade policy has reflected a broader belief that growing international commerce would bolster affluent democracies, contributing to global stability. Countries would be cemented by mutual benefits. In the cold war, trade was a big weapon. Our policy was simple: we traded with our friends; we didn't trade with enemies.

While the Soviet Union survived, this policy sustained itself. The Soviet Union and its satellites wanted to be self-sufficient, just as we wanted them isolated. Also, their command-and-control economies were incompatible with the market economies around which global trade rules were organized. The cold war gave coherence to our trade policy. The end of the cold war and China's emergence onto the world scene have shattered that.

For starters, we don't know whether China is friend or foe. At the moment it is neither, but--as the recent war games near Taiwan remind us--the potential for conflict is real. Nor do we know how China's political system will evolve. Though totalitarian, it is less so than before. Similarly, we can't label China's economic system. It isn't the free market. Perhaps half of China's output still comes from state-owned companies. But the economy isn't completely command-and-control. Since the late 1970s private property and foreign investment have mushroomed.

The result is a situation almost unprecedented since World War II: large and growing commerce with a nation that could become a major adversary. In 1995 China was our fifth largest trading partner. More than 220 Boeing jets cruise across China. General Electric now sells $1 billion worth of power-generating equipment, light bulbs and plastics in China. Wal-Mart and Sears buy huge quantities of Chinese consumer goods. In 1995 China supplied 51 percent of imported toys and sporting goods, 48 percent of imported shoes and 24 percent of imported radios.

China is often said to be the "next Japan," and in some respects, the analogy is apt. It's conceivable that our deficit with China ($34 billion) could overtake that with Japan ($59 billion). And China, like Japan, is a mercantilist nation that twists trade to its own advantage. Reaching trade agreements is hard; getting them enforced is harder. When China agreed to crack down on pirated software and CDs, the agreement was often observed in the breach. U.S. companies claim they lose $2 billion in annual sales.

But the Japan analogy can be stretched too far. The trade deficit with China is larger in statistics than in reality. Huge parts of China's trade flow through Hong Kong; adjusting for that may reduce the trade deficit by a third, estimates economist Nicholas Lardy of the Brookings Institution. And much of the growth of Chinese exports reflects a shift of production. Factories for clothes, toys and shoes have moved from Taiwan and Singapore to China. Our deficits with these countries fall; the deficit with China rises.

What genuinely separates China and Japan, though, is politics. Since World War II we have not seen Japan as a security threat or as a political (as opposed to economic) rival. In the 1950s and 1960s our trade policy with Japan tried to bolster the then weak ally. With China, what we want is murkier. The practical question is how, if at all, we can use trade to shape China's behavior.

One idea is to punish China for human-rights abuses by withdrawing "most favored nation" treatment for its exports. This would probably backfire. True, China's sales to us (facing higher tariffs) would collapse. But China would retaliate against U.S. exporters and probably wouldn't change anything else. Sanctions under the Nonproliferation Act of 1994--aimed at nations that sell nuclear-weapons technology -- may also be self-defeating. (China is suspected of selling such technology to Pakistan.) The penalty is to deny U.S. exporters loans from the Export-Import Bank: this only hurts our exporters (China would find other suppliers).

But we may have some leverage. China's exports to us are about a third of its total; our exports to China are only about 2 percent of total U.S. exports. That makes China vulnerable to sanctions. Greg Mastel of the Economic Strategy Institute sensibly argues that violations of trade agreements should trigger selective retaliation against China's exports through higher tariffs; otherwise, China won't honor its agreements. Likewise, some policies (such as selling nuclear-weapons technology) that seem motivated by the quest for foreign exchange might be curbed by export sanctions that cost China foreign exchange.

To try more may be futile. We cannot avoid ambiguities and contradictions, because no one knows what China will become. We rationalize our enthusiasm for China's vast markets--and the attendant vision of well-paid export jobs--with the hope that trade will have liberalizing effects. Prosperity spawns a middle class and nourishes a taste for freedom. It could happen: rapid economic growth preceded more democratization in both Taiwan and Korea.

But there's a more troubling possibility. It is that as China develops economically, it becomes a greater threat on the world scene and that our conflicts--over territorial issues, the spread of nuclear weapons, arms sales and trade--intensify. Economic growth could feed China's nationalism and assertiveness as much as its democracy. The prospect is chilling.