The world’s two largest economies are skirmishing around the brink of a global trade war. This dangerous development puts at risk the international trading system that underpins prosperity in the global economy and security in Asia.

The US administration’s “America first” agenda has brought uncertainty to the global economy. The risks have intensified in US President Donald Trump’s second year in office with tariffs slapped on steel and aluminium imports from around the world and launched large-scale protection against Chinese imports under Section 301 of the US Trade Act. The European Union, China and others are retaliating or preparing to retaliate.

A managed trade deal between China and the United States still could be the outcome, but it would be a distinctly second best one. Although it might be better than a full-blown trade war, it will involve measures outside of the rules-based trading order, such as so-called voluntary export restraints. That would have significant negative spillovers to other countries, diverting trade and investment in ways that diminish global welfare, and exacerbate political tensions. Nor would it help Trump achieve his stated aim of reducing the US trade deficit.

More than any other region, Asia relies on open markets and confidence in the multilateral system for economic and political security.

If Trump is intent on tearing up the existing global economic order, how might China and the rest of the world respond, preserve what works and fix what doesn’t work without major disruption?

Roberto Azevêdo, director general of the World Trade Organization (WTO), pleaded that the multilateral trading system, as embodied in the WTO, has been very effectively doing the job that it was created to do almost 70 years ago. “It has secured a foundation on which countries can base their economic planning with confidence — so much so that countries sometimes appear to take the stability and predictability of the trading system for granted in their economic planning," he said. But he also worried out loud: “It’s important to remember what we could stand to lose if the current tensions lead to an unmanageable escalation of tit-for-tat trade policy actions.”

“Imagine … if we were suddenly presented with a scenario where the system started to falter. If tariff levels were no longer bound at the historically low levels we see today, if we could not rely on members honoring their commitments, or if the system of settling trade disputes was to erode, the consequences would be dramatic. If, for example, tariffs returned to the levels before the multilateral trading system was created we would see trade flows fall by 60 percent, while the global economy would contract by 2.4 percent. That’s even bigger than the contraction after the 2008 crisis — the biggest crisis we’ve seen in the past 80 years.”

This threat is real, and all the countries which have such a big stake in it cannot stand by while the foundations of the global trade regime are torn apart by the maverick regime in Washington.

What can be done?

Some Chinese experts recommend that the Chinese government adopt a “tit-for-tat” strategy. This would be unwise — the priority is not to devise specific “trade war” policy instruments but rather to get the big strategic picture right.

China’s primary interest today is still continuing its economic development. China has progressed in and benefited from the open trade and investment regime. It is in China’s interest to maintain that international order, regardless of US actions today. The real meaning of development is to improve people’s living standards. China should remember this and never set the task of challenging or displacing the US as its ultimate motivation for economic development.

Facing US economic provocations, the Chinese government may have to retaliate from time to time. But it would best focus on continuing its own reform and opening up policies.

Since late 2017, China has introduced a set of policy measures to further open China’s financial sector to the world. And in early 2018, President Xi Jinping announced more ambitious reform and opening policy measures in four areas: relaxing restrictions on the entry of foreign firms in Chinese markets, creating a more attractive investment environment in China, strengthening the protection of intellectual property rights and proactively increasing imports. Implementation of these and other measures should surely help ease economic friction between China and the rest of the world.

The greatest threat posed by the US-China trade dispute in the near-term is the danger to China’s financial stability. The dispute creates economic and policy uncertainty in China, slows economic activity and worsens China’s external account balances. All of these could negatively affect investor confidence and increase financial instability.

China has common cause with its neighbors in responding to the Trump trade war threat. No actors are collectively more important in that response than those in East Asia, operating through ASEAN and the ASEAN-plus regional agreements that are already in place and can be consolidated quickly under the Regional Comprehensive Economic Partnership.

Asian economies depend on the open rules-based system not only for their economic prosperity but also for their political security. Asian countries need to stand firm in the face of the threat to the global trade regime. The dynamic of Asian growth depends importantly on remaining committed to the trade reform agenda, and encouraging entrenchment and deepening — including by China, the Southeast Asian economies and India — of the open rules-based international trading system.

Peter Drysdale is emeritus professor of Economics and Head of the East Asian Bureau of Economic Research at the Australian National University.The author contributed this article to China Watch exclusively. The views expressed do not necessarily reflect those of China Watch.

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