Fight the Dragon
China is waging war on free trade.

(Imaginechina via AP Images)


The standard economic model treats free trade as obviously positive, creating prosperity for all participants. Conservatives, and most neoliberals, have embraced that view and consistently press for further liberalization while condemning as backward and reactionary “protectionism” any proposed obstacles to the free flow of goods and services. But the model is incomplete, and blind allegiance to it only weakens the U.S. economy and the health of the international trading system as a whole.

Rather than an easy win-win for all involved, trade policy presents a variation on the prisoner’s dilemma, the classic game-theory problem in which two people must choose whether to cooperate with or betray each other. Each has an individual incentive to betray, but responding to those incentives and betraying leaves both worse off than had they cooperated. 

So it is with the global economy and specifically with China and the United States, its two dominant players. As any economist’s model demonstrates, both nations will benefit from greater wealth if they build strong trade ties and open their markets to each other. But while the United States strives to cooperate by opening its market, China has chosen betrayal. It restricts access to its market, aggressively subsidizes its domestic producers, and shamelessly expropriates intellectual property, all while manipulating its currency and loaning the ensuing surplus of dollars back across the Pacific to the United States.

Just as the betraying prisoner goes free while leaving the cooperative one behind in a jail cell, China has produced unprecedented economic success at the expense of the United States. In 2009 it overtook the United States as the world’s largest exporter, in 2011 as the largest manufacturer, and this year it may be declared the world’s largest economy. The U.S. economy, meanwhile, will likely stagger in 2014 to its ninth straight year of less than 3 percent growth, after having experienced only one such stretch of even four years since World War II. Other open, Western economies face similar challenges, while other developing nations watch China’s success and dream of emulating it.

Fortunately, today’s challenge differs from a prisoner’s dilemma in one important respect: Rather than choosing a strategy once and living with the consequences, the players are in a “repeated game.” The United States need not allow itself to be taken advantage of forever, or assume that China and its followers are irrevocably committed to their course. To the contrary, America and her allies have the opportunity to make clear that they will no longer play on these terms, that they would rather take their ball and go home than continue to compete on a tilted playing field, and that it is the cheaters who must decide whether they will finally comply with the rules or be ejected from the game.

Forcing such a decision is not “starting a trade war” any more than committing to the defense of one’s borders constitutes an invasion. Indeed, far from being protectionist, threatening nations like China with severe trade sanctions is critical to ensuring a prosperous future for the global economy.

The international trading system is governed primarily by the World Trade Organization (WTO), an international body, created in 1995, with more than 150 member nations. In theory, the WTO guarantees that all nations engage in free trade under the same rules and receive reciprocal benefits from their trading partners. In practice, it does nothing of the sort.

The agreements covered under the WTO at the time of its formation provide only limited protection for trade in services and for intellectual property, the bedrocks of U.S. economic strength, and were always intended to evolve through subsequent negotiations. Unfortunately, no such evolution has occurred — in its 20 years the WTO has failed to take a single step forward on trade liberalization. Expectations have fallen to the point where a recent, unremarkable streamlining of customs procedures led the organization’s head to declare: “For the first time in our history, the WTO has truly delivered.”

Nor does the WTO provide an effective enforcement mechanism for those rules that are in place. It does not have the power to enforce penalties against nations whose policies defy existing agreements. Rather, after lengthy litigation and appeals processes, a nation wronged by another wins only the right to retaliate in kind — an approach to conflict resolution typically left behind sometime around kindergarten. Any such retaliation may then itself be the target of further litigation.

Prospects for future progress are no better. Any agreement would require unanimous support from all 157 nations — support that is not forthcoming from those that benefit from the existing weaknesses. In short, the WTO has become little more than an economic United Nations, an ineffectual debating society beholden to agendas running directly counter to the organization’s supposed purpose.

Since joining the WTO in 2001, China has ruthlessly exploited the free-trade system’s reliance on mutual trust and goodwill, wreaking havoc in the markets to which it gained access while bullying entrants in its own market. Its economic strategy falls within three broad and complementary categories: market distortion, intellectual-property theft, and currency manipulation.

Market distortion comes naturally to China, a Communist country with a barely market economy dominated by state-owned enterprises. While its WTO commitments establish the official tariffs it can impose on imports, they are unable to restrain it from placing importers at other insurmountable disadvantages when attempting to sell into the Chinese market. China designs regulations and establishes technical standards that its domestic producers can more easily meet, provides direct subsidies to give those producers a financial advantage, and slows the approval of foreign products. It establishes “local content” requirements that force foreign firms to set up shop within the country and enter into joint ventures with local companies, rather than manufacturing at home and exporting the finished goods to China. And it ensures that government procurement gives preferential treatment to local firms — no small matter in a state-run economy where the government is often the primary consumer.