He Weiwen, a senior fellow at Center for China and Globalization(CCG).

Following weeks of trade tension between China and the US, US President Donald Trump said on April 24 that he will send a delegation headed by Treasury Secretary Mnuchin and USTR Robert Lighthizer to Beijing for talks. The move immediately received a welcome response from the Chinese Ministry of Commerce.

The escalation of China-US trade tension over the past weeks has caused great anxiety among the business community in both countries and the world at large. The USTR announcement of a 25% tariff on $50 billion of imports from China, based on its Section 301 investigation on Chinese practices on technology transfer, was met with a strong counter-measure from the Chinese government 13 hours later, with a 25% tariff on $50 billion worth of imports from the US. Also, China immediately referred the US 301 investigation and the tariffs to the Dispute Settlement Mechanism of WTO. President Trump then asked the USTR for an additional tariffs on $100 billion of imports from China. This only resulted in an even stronger resolution from the Chinese Ministry of Commerce to “fight to the finish”.

The trade tension extended to the technology and investment areas when the USDOC on April 16 banned US companies from supplying chips to ZTE for 7 years, and the FCC suggested on April 19 a ban on buying Chinese telecom products. Meanwhile, the US Treasury Department is busy finding a new legal basis to block Chinese high-tech M&A in the US.

301 Investigation and Tariffs Violate WTO Rules

There have been complaints from US business on China’s practices in tech transfer, IPR protection, and equal competition. These have been the subject of bilateral dialogues and joint efforts by both governments for years. They could well be handled under the bilateral or WTO framework.

The USTR Section 301 investigation report cited cases offered by the US China Business Council (USCBC), which comprises of the leading American multinationals operating in China. According to the USCBC China business environment survey 2017, 81% of member respondents said that they had no compulsory tech transfer problems in China, while 19% answered yes. Of this 19%, 67% said that the transfer requirement was from Chinese businesses, 33% said it was from the Chinese central government, and 25% said it was from the local government. The survey gave no concrete evidence on who forced which US companies to transfer what technology in what project. As a result, the Section 301 investigation report also failed to give any hard, concrete evidence. Even if we take that into account, it accounted for less than one fifth of total US companies, and the Chinese central government (no hard evidence here either) accounted for one third of that. Hence, it is a limited issue, not the representative of bilateral trade as a whole.

We could easily have those issues resolved at the WTO. The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) under the WTO covers issues of technology transfer, layout design of integrated circuits, patent, industrial design, and copyrights. It is based on recognition of all the international treaties under the World Industrial Property Organization (WIPO), and on three WTO principles: national treatment, most favored nation, and balanced protection. Hence, international rules and standards are there for practically all the US businesses.

However, the USTR did not follow that path. Instead, he launched the Section 301 investigation, in violation of the WTO rules. Clause 23 of the WTO “Understanding on Rules and Procedures governing the Settlement of Disputes” stipulates that: “Members shall…not make a determination to the effect that a violation has occurred [and] shall make any such determination consistent with the findings of the panel of Appellate Body report”. It means that only the WTO Dispute Settlement Mechanism has the right to determine if China is in violation of relevant WTO rules. The US, as a leading member of the WTO, signed the Understanding. In 1998, USTR launched a Section 301 investigation on the EU. EU then turned to the WTO, and the US lost the case. The USTR then promised not to resort to unilateral Section 301 moves any more.

Twenty years later, the USTR forgot its promise and made the same violation. Unilateral tariffs are banned under WTO rules, as tariff levels are set by multilateral negotiations, not by unilateral government decisions.

Multilateral Trade Mechanism under Threat

Having violated WTO rules, the USTR has gone further, forcing other countries to give the US “good bargains”. It used the steel and aluminum tariffs to this effect in KORUS renegotiation. South Korea agreed to increase the US automobile quota to South Korea to escape tariffs. If China makes this same mistake and negotiates with the US under pressure from tariffs and the Section 301 investigation, the unilateral violation would be legitimized, and the WTO rules would be useless. Then all the countries can do whatever they want to impose tariffs, or other restrictive measures. World trade would fall into chaos, creating significant risks in the world economy.

In 1930, the US adopted the Smoot-Hawley Act to considerably raised tariff levels across the board, which hit an average of 53.2% in 1932, to protect the American jobs. Then Canada, the UK, and France retaliated with equal tariff hikes. As a result, US exports shrank by 66%, and imports shrank by 62% from 1929-1933, and world trade fell by 66%. The US unemployment rate shot up to 30%, the opposite of what the Act hoped to achieve.

The USTR’s Section 301 investigation and tariffs have posed a major challenge to the authority and effectiveness of the multilateral trade mechanism established after the end of World War II. The current China-US trade tension is not only a bilateral showdown, still less a tech transfer issue, but a major struggle between unilateral protectionism and multilateral free trade.

Tariff Measures Targeting Made in China 2025

A close look at the tariff checklist leads shows it has nothing to do with the Section 301 investigation which addresses technology transfer and IPR, not products. The list includes iron/nonalloy steel semi-finished products, central heating boilers, textile printing machinery, cooking stoves, dishwashing machines, and sowing machine needless. No one would believe that China needs to force tech transfer for those very low-end items. Further down the list, the main categories include nuclear reactors and parts, marine purpose internal combustion piston engines, and aircraft. Not a single one of these was covered in the Section 301 investigation report. However, they fall within the ten focal industries identified in the Made in China 2025 plan.

Peter Navarro, Chairman of the National Trade Committee, abandoned all pretense when he said in a Bloomberg interview that “the target” of President Trump’s tariff order is certainly the focus industries in Made in China 2025. His remarks were later confirmed by the USTR.

China, as a sovereign state, has its legal right to development. The Trump Administration could dispute specific measures within Made in China 2025, but not the Made in China plan itself. China never challenges President Trump’s Tax Act, because this is a domestic issue of the US.

It would be naive to think that the moonshot tariffs and other tech restrictions could stop or slow down the Made in China 2025 plan. As the Chinese and American high-tech sectors are closely interrelated in the global supply chain which also spans Europe, Japan and the rest of Asia, any disruption will hit American high-tech companies as well. Apple draws 25% of its global net income from the greater China area, and the loss of the Chinese market could lead to 27,000 job losses and a stock market crash. Qualcomm even draws two thirds of its income from China. Its stock fell by 18% since the USTR announced the tariff measures. The seven leading American IT and telecom providers-HP, Dell, Microsoft, IBM, Intel, Cisco, and Unisys-got an average of 51% of their components from China during 2012-2017, according to a report requested by the U.S.-China Economic and Security Review Commission. Made in China 2025 will offer an even larger China market for world leading technology players. If they lose the China market, they can’t support the R&D in cutting edge technologies that’s critical to their future.

Made in China 2025 is open to America and the rest of world. As stated by President Xi Jinping, China will further open up its manufacturing and services as soon as possible. The Chinese economy will grow by an aggregate of 50-60% over the next 8 years by 2025, meaning a tremendous new market, new industries, and new services, far outstripping the potential in any other part of the world. The Trump Administration should encourage the American business community ride on China’s coattails.

WTO Rules-Based Talk the Only Solution

The upcoming trade consultation is a step in the right direction. However, it must be based on WTO rules, and within WTO framework, not the Section 301 investigation and tariffs.

President Trump has said that if no agreement is reached in the talks, the tariff measures will take effect by end of May as scheduled. In other words, the talk is under the shadow of tariffs. For President Trump, tariffs are a stick to use at the negotiation table, and trade war is a tool of trade policy. However, talking with China under a threat will not work. If the US tariff measures take effect, Chinese tariff measures will follow immediately, thus a trade war, a limited one, at least, will replace trade talks. The US trade team had better throw away any illusion that China would accept a moonshot agreement, giving up its Made in China 2025 plan. Only talks based on WTO rules can provide the common ground and common standard for both and lead to a balanced agreement. China and the US should strive for that end, which will be good for both countries, and for the whole world.