In 2017, the global economy witnessed the best year since the subprime crisis broke out in 2008 in the United States. That year, signs of economic recovery eventually appeared in most countries, giving impetus to global trade and short-term capital flows. 

In the first half of 2018, however, the situation reversed swiftly. First, the world economy that underwent a collaborated recovery last year headed to different situations. Among developed countries, the US maintained relatively high growth, while the euro zone, the United Kingdom and Japan saw a nosedive in their economies. 

Second, except for the US that continues a tightening monetary policy, China’s central bank has retuned its policy, and the euro zone and Japan postponed monetary tightening, which contributed to the appreciation of the US dollar. 

Third, geopolitical conflicts have intensified. For example, the US withdrawal from the Iran nuclear agreement directly jacked up the global oil price, bringing the new pressure of stagflation. 

Last but not least, intensified Sino-US trade frictions is estimated to weaken the spillover effects of the robust markets, like the US and China, on other economies, dampening the global economic recovery.  

From an objective perspective, few had foreseen how far the Sino-US trade disputes would go since they became acute this March. As to the reasons, the US hit a record high in trade deficits of goods, standing at $800 billion, in 2017, which drove the US government to launch a trade war to reduce the imbalance. However, the deeper causes are ascribed to the US fear of China’s technological progress and industrial upgrading, and moreover, the pressure from a rising China on the US economic hegemony. 

There is a voice in China that the trade war could be avoided if the Chinese government could have shunned confrontation with the US. It sounds rational, to some extent; but it underestimated the inevitability of the trade war. 

In retrospect, the US was alert for anyone able to challenge its world hegemony - no matter it was a rival country like the former Soviet Union, or an ally like the European Union and Japan - and spared no efforts to suppress it.

The most impressive case is none other than the US-Japan trade war starting in the 1980s. The Japanese government had no choice and signed the Plaza Accord in 1985, agreeing to cut its trade surplus through a large-magnitude appreciation. On the other hand, Japanese central bank kept a loose monetary policy, to counter the appreciation. The policy package blew huge bubbles in Japan’s real estate and stock market. When the bubbles burst, the economy was stuck in recession for three decades. 

China attracted the attention of the US government since it surpassed Japan in economic aggregate in 2010. Washington’s overall policy on China underwent drastic changes as early as in the Obama administration, represented by the Asia-Pacific rebalancing strategy and the initiation of the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership negotiations (China excluded). The strategic turn indicated that the US has shifted its attitude to China from “engagement” to “containment”. The current trade frictions are basically in line with the former administration’s strategy. 

The aforementioned factors show that the friction between China and the US are unavoidable, which will be demonstrated in other forms, if not in trade disputes. The long-term, deep-rooted causes mean that the possibility of addressing frictions through an agreement package is faint. 

Maintaining strategic resolve 

For the Chinese government, therefore, it’s imperative to take a deliberate manner to respond to the trade disputes. In general, China should step up the opening-up policy and resort to multilateral cooperative mechanisms. Domestically, the structural reform should be deepened at a preset pace, and systemic financial risks be prevented. 

In the past 10 years, the Chinese economy has achieved a remarkable progress, but the indexes on the efficiency of economic growth kept declining, including growth rate of labor productivity, total factor productivity, and rate of return on investment for private enterprises. In such context, China needed invest more resources to maintain a stable growth, which is definitely unsustainable. 

To boost the economic efficiency and the rate of return on investment in real economy, the Chinese government initiated the structural reform four years ago by reforming state-owned enterprises, reforming management rights for rural lands, taking financial reforms and opening the service sector to private capital. In practice, however, the financial reforms are faster than reforms in SOEs, rural lands, and service sector, which drove financial resources to the fictitious economy instead of the real economy, so incurring higher systematic financial risks.       

At the same time, the upgraded trade rifts has reduced China’s trade surplus and affected economic growth, as well as weakened domestic institutional investors’ confidence. Therefore, the Chinese government started to adjust macroeconomic policies in the second quarter of 2018.

Now China’s economy is facing a trilemma. In the context of an increasingly uncertain exterior economic environment, it has become even harder to strike a balance between risk control and steady growth. The pendulum of policies is slightly swinging to steady growth. But the government is also trying to avoid an excessive eased macro policy. Otherwise, the efforts on preventing systemic financial risks would be of no avail; even worse, China’s structural reform would be slowed down, suspended or even reversed.

Therefore, it is of paramount importance to maintain the focus of policies. Considering the inevitable Sino-US trade frictions and probable escalation, the Chinese government should put priority on steady growth before risk control and economic restructure. 

In fact, Chinese government should moderately tolerate a dip in growth rate, and continuously adhere to the track of risk control and structural adjustments, as long as there are no large-scale unemployment and systemic fiscal or financial risks. In other words, in order to sustain rapid economic growth, the Chinese government should position itself to continuously press ahead with the systemic risk prevention and control and the structural reform of the real economy, albeit the outbreak of Sino-US trade frictions.

In addition to speeding up domestic reforms, the Chinese government should also unwervingly open wider to the world. In the precondition of risk controls, the government could appropriately accelerate the process of opening up domestic financial market to developed countries like European countries and Japan, as well as institutional investors in emerging markets. On the other hand, China should further optimize the domestic environment of FDI, and offer national treatment to FDI enterprises. 

Moreover, the government should improve intellectual property protection, which will be conducive to importing advanced technologies for consideration payments and stimulating the domestic technological innovation. Furthermore, the Chinese government should safeguard legitimate rights and interests within the frameworks of multilateral organizations like G20 and WTO, and actively facilitate a new round of globalization of trade and finance.

Zhang Ming is a researcher at the Institute of World Economics and Politics, Chinese Academy of Social Sciences. The author contributed this article to China Watch exclusively. The views expressed do not necessarily reflect those of China Watch.

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