Trump has secret allies in China in trade war

This article first appeared in The Edge Financial Daily, on January 15, 2019.
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IN his tariff war with China, US President Donald Trump has some hidden allies. Just about every complaint US trade negotiators raised in Beijing last week — not to mention their doubts about the sincerity of China’s concessions — are shared by Chinese entrepreneurs, who feel as underappreciated and unwelcome as their foreign counterparts. Their common enemy: the Chinese industrial state, an animus summed up in China by the lament “guo jin, min tui” — the state advances, the private sector retreats.

This reality underscores how tough it will be for the Trump administration to roll back a set of statist industrial policies that are rooted more in politics and ideology than economics. At the same time, it presents Trump with an opportunity — to leverage internal Chinese pressure to open doors both for international investors and a domestic Chinese constituency with a vital stake in playing by global trading rules.

In his efforts to ensure Communist Party control over every facet of Chinese life, Chinese President Xi Jinping has smothered the 
animal spirits of the country’s private businessmen, who account for more than 60% of economic output and 80% of employment. Even though the party welcomed capitalists to join in 2001, they’ve long had an uneasy relationship with state authority. Many have been caught up in Xi’s anti-corruption campaign, paying the price for a pervasive rent-seeking culture in which bribing officials was necessary to secure business deals, land and bank loans.

Some wealthy entrepreneurs are moving their money offshore because they fear their tainted earnings will be confiscated. Others are putting off hiring and investing as the economy slows. Fred Hu, the founder of Primavera Capital Group, compares their current mood to the years immediately following the 1989 Tiananmen Square crackdown, which were marked by “tremendous uncertainty, concerns and worries” about the future.

The fact is that the world needs Chinese private enterprises to succeed if China is to remain a driver of global growth. And, conveniently enough, their demands mirror those of multinationals: better access to services markets that are currently dominated by state monopolies in energy, finance, telecommunications and transport; better protection for their intellectual property; a reduction in the subsidies, cheap financing and other advantages enjoyed by the state sector; and a desire to be left alone by meddling bureaucrats.

No less than foreigners, local players would love to get rid of the party cells implanted in their companies. What’s more, a policy shift away from state enterprises, which dominate old-line industries, towards private businesses, which excel at innovative services, would help boost Chinese domestic consumption and reduce the household savings glut that shows up in external imbalances. It is these distortions that have destabilised the global trading order and sparked a protectionist backlash in much of the West. 

Xi will never willingly dismantle the state-led industrial structure he sees as key to the survival of the party. Privatisation of state enterprises is not on the table, even though they suck up 50% of all credit despite accounting for just 20% of GDP — a colossal misallocation of financial resources.

Still, there are two reasons to think that Xi may be ready to make genuine concessions. First, as the sombre headlines in Chinese newspapers make plain, the economic slowdown, exacerbated by trade tensions with the US, has stunned the Chinese leadership. Until a few months ago, the People’s Daily was bombarding readers with stories lauding “Made in China 2025,” a blueprint for Chinese high-tech supremacy, and boasting of a “China Solution” to global challenges. Moviegoers were treated to a documentary called “Amazing China” that extolled Xi’s accomplishments in science, technology and poverty reduction. Today, China’s industrial ambitions get scant mention in the media and cultural czars have pulled the propaganda film from cinemas.

If nothing else, Trump has got Beijing’s attention.

Second, cracking open Chinese markets wider to both domestic and foreign competition would be the surest way for Xi to revive China’s flagging growth. Private enterprises produce three times the return on assets compared to state companies and, as the providers of almost all new jobs, they’re critical to boosting consumption and weaning the economy off its reliance on credit-fuelled investment. The International Monetary Fund calculates that while China’s per capita gross domestic product (GDP), measured in terms of purchasing power, is similar to Brazil’s, its consumption per capita is comparable only to Nigeria’s. If Chinese consumed like Brazilians, their spending would double.

The government understands the need to appease the private sector. Since the middle of last year, it’s been trying to encourage banks to lend more to private companies. Its efforts have made scant progress, though, in large part because the traditional banking system simply is not set up to issue such loans. Meanwhile, the government, trying to head off a potential financial crisis, has been cracking down on the shadow banks where small firms used to seek financing.

The good news is that a comprehensive blueprint for economic reforms that would energise the private sector already exists. Five years ago, when Xi ascended to power, he unveiled a 60-point plan that pledged “to let the market play a decisive role in the allocation of resources”. Unfortunately, the document has been gathering dust ever since. Resurrecting those abandoned pledges in the name of rescuing private Chinese enterprises would give Xi the political cover to accede to some of Trump’s demands. A two-for-one bargain is available: China would be wise to take it. — Bloomberg