As trade talks between the United States and China resume this week, there is optimism that the world’s two largest economies can reach a deal to end their destabilizing dispute: With the Chinese economy slowing and President Donald Trump in need of some good political news, both sides face pressure to compromise. A settlement, if it happens, would probably calm jittery investors and remove some economic uncertainty.

But not so fast. A truly comprehensive trade pact will be difficult, perhaps even impossible, to reach.

That’s because many of the problems Washington wants resolved in China will require more than a few regulatory tweaks. The bureaucratic harassment, theft of intellectual property, and overt favoritism toward local firms that make doing business in China such a nightmare for American chief executives are caused by the very way the Chinese economy works. Changing them means changing China’s basic economic system. Beijing’s leaders cannot possibly achieve such an overhaul in the short term—assuming they even want to.

“It is going to be a very long haul to get the changes the U.S. considers to be required because that really would force China to fundamentally alter the way it organizes itself,” Arthur Kroeber, a founding partner at Gavekal Research and the author of China’s Economy: What Everyone Needs to Know, told me.

At its heart, then, the trade dispute is about far more than tariffs and deficits. It is a contest of two very different national ideologies. Though the Trump administration has deviated from this somewhat, the United States believes that openness—political, economic, and social—creates prosperity, resolves disagreements within society, and promotes the diversity that spawns innovation and progress. China—or, more accurately, its leadership—sees government control as critical to developing the economy, achieving social peace, and forwarding the best interests of the nation overall. Americans tend to think open, free markets that are operating in a fair regulatory environment produce the best economic results. Beijing, on the other hand, doesn’t trust market forces and instead wants the state to play a more direct role in achieving the economic outcomes it determines are necessary for the country.

The Trump administration is, rightfully, demanding a slew of reforms to Chinese practices it considers “unfair.” Washington wants Beijing to cut back on the subsidies and other financial support it lavishes on favored industries, to stop compelling U.S. firms to disgorge their commercial secrets, and to widen access to China’s lucrative home market for foreign companies.

But what is “unfair” in American eyes is simply a matter of daily business in China. Sure, China’s spectacular ascent was sparked by capitalist reforms that opened the economy to private enterprise and international trade and investment. Its economic system, which its leaders call “socialism with Chinese characteristics,” relies on a much heavier role for the state than any true capitalist could stomach, though. Large swaths of the economy remain well under the thumb of meddlesome state planners and bureaucrats, and their web of permits and restrictions. Many of the country’s critical industries, from automobiles to banking to microchips, are to a great degree in the grasp of state-owned enterprises or heavily supported by state aid, or both.

As a result, what Trump is demanding is extremely difficult to achieve: a “level playing field” for American firms. In fact, nothing of the sort actually exists in China, even for Chinese companies. The state has a nasty tendency to favor its own, with government-controlled businesses enjoying a smorgasbord of official assistance, including tax credits, low-interest loans from state banks, and other subsidies that give them an undue edge in local competition. That leaves private Chinese companies and entrepreneurs often facing the same kinds of hurdles to doing business that foreign ones face.

Zhang Chunlin, a specialist at the World Bank, recently argued that Beijing should adopt the principle of “competitive neutrality” for Chinese state and private companies. Doing so, he wrote, could require “separating government from the enterprise” and ensuring that regulations are applied evenly to all companies, no matter who the shareholders might be.

That would prove a tall order. Chinese bureaucrats are simply not trained to treat all comers equally and fairly. Even the most prominent Chinese companies suffer from arbitrary and erratic state intervention. Tencent Holdings, one of China’s premier technology companies, helplessly watched its stock price tumble last year after regulators randomly blocked a newly launched, and popular, video game.

Altering the current state-heavy system, from Beijing’s standpoint, also comes with risks. Without cheap credit and freebies, some state companies would be pushed to the wall, while a withdrawal of the help and protection Beijing offers certain companies and industries could set back the very sectors the government wants to develop.

The whole purpose of Beijing’s “Made in China 2025” program is to build up cutting-edge industries including robotics, medical devices, and eco-friendly cars, often with ample state support. A 2018 report from the Center for Strategic and International Studies in Washington calculated, for instance, that the Chinese government lavished more than $58 billion on the country’s electric-vehicle sector from 2009 to 2017, on everything from research and development to buyer subsidies; that represents an astounding 42 percent of the industry’s total sales. “Much of this commercial activity,” the report’s authors concluded, “would not exist without the heavy, visible hand of the state.”

Of course, China would not have to completely end all subsidies as part of a trade deal. With electric vehicles, the government is already phasing them out and allowing greater participation by foreign companies. But that’s happening only after some Chinese firms had already become solid competitors. “They are going to open up—when they’re ready,” Mark Newman, a senior analyst based in Hong Kong at the brokerage Sanford C. Bernstein, told me.

Getting what Trump wants, therefore, requires a shake-up of the entire relationship between state and business in China: thoroughly reforming the financial system, reprogramming the minds of bureaucrats to act impartially, and introducing some form of rule of law and a functioning court system so companies have recourse against state action.

All of this could benefit China in the long run. There is an argument that state largesse leads to wasteful investment that ultimately hampers innovation. But it is doubtful that the current regime of President Xi Jinping is willing to make such significant changes. Since coming to power in 2012, Xi has placed a premium on strengthening Communist Party control over the economy, and despite frequent rhetoric about “opening up” and free trade, he has shown few signs of resuming more liberal reforms that would diminish state dominance.

“Xi has clearly nailed his colors to the mast of a much more state-directed economy,” said Gavekal’s Kroeber. “I’m pretty skeptical that there will be significant movement by China on these large-scale structural issues the U.S. is talking about.”

None of this bodes well for the future of U.S.-China relations. The potential short-term downside to meeting Trump’s demands should not be an excuse for Beijing to continue its unseemly trade practices. But it does mean that whatever emerges from trade talks runs the risk of being no more than a small step in resolving economic tensions between Washington and Beijing. More worrying, their differences may never be fully bridged—only a wholesale change in Beijing’s thinking can avoid an economic showdown with potentially terrible consequences for these two great powers, and everyone else.

By MICHAEL SCHUMAN
The Atlantic

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