An unpredictable US presidency and the consequences for US-China relations

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Good afternoon. First, I would like to thank the Shenhua Group for this invitation to speak here this afternoon.

I will divide this talk into three parts:

“Main Trends of President Trump’s China Policy.”

“Trump’s Energy Policy and its Consequences.”

“A Roadmap for the Future of the Relationship.”

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1 Resetting China Policy from Candidate to President There is no doubt that China’s economic rise has changed and will continue to change geo-politics but there are differing views within the US about how the administration should respond to this rise and China’s increasing integration into the global order. In particular, we are seeing a divergence of opinion about how threatening this might be for US preeminence. Views have reached what David M. Lampton refers to as a “tipping point”. He noted “our respective fears are nearer to outweighing our hopes than at any time since normalization.”

There are two disjunctures that underpin this uncertainty and how the Trump administration responds to them will determine the approach of the administration.

First, for the first time in a couple of centuries, the largest economy in the word is not Western and will be under a leadership that does not share the same consensual values and political structures as the West. This, of course, has led to analytical pieces in the US that suggest shifting policy focus away from engagement to hedging and even challenging and containment. This approach

is much more in line with the comments of candidate Trump and President Trump before the Mar-A –Lago meetings between the two presidents.

However, for the first time the world’s largest economy will not be the country that enjoys the highest standards of living and quality of life. China will contain large pockets of poverty and is operating an economic policy that the leadership states needs to undergo significant change if the country is to move up the global production chain and avoid the “middle-income trap”. This perspective gives hope to the diminishing band of analysts who favor engagement and would have been closer to the policies of a Clinton administration and may be closer to where the Trump administration moves over time.

Second, there is a divergence of intentions and capacities in the Asia region that strongly influences US thinking. What appears to be emerging is a potentially dangerous bifurcation with an Economic Asia within which China is the central player and a Security Asia where the US remains the strongest player.

CHINA INSIDE-OUT®: An unpredictable US presidency and the consequences for US-China relations

Speaker’s notes prepared by Professor Anthony (Tony) J Saich for Shenhua Group talk held in Beijing on 12 May 2017

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President Trump has proved to be highly unpredictable and on occasion has favored economic nationalism over global engagement and has been highly critical of trade agreements. He declared NAFTA “the worst trade deal in history” and now has stated that he will not scrap it but wants to renegotiate it on terms more favorable to the US. At the recent G-20 meeting, the US blocked the usual inclusion of the phrase on “resisting protectionism”. And, of course, he has scrapped US involvement with the Trans Pacific Partnership as soon as he become President. He has made a string of comments critical of Chinese policies claiming currency manipulation, unfair trade practices, barriers to US investment, etc.

However, following the meeting with President Xi, Trump has adopted a much more positive view of the relationship and has shifted towards a policy position that is closer to that of previous US Presidents. President Trump has now said that he will not name China as a currency manipulator, something that, in any case, only Congress can do. They agreed to set up a higher profile framework for negotiations with the Strategic and Economic Dialogue replaced by the US-China Comprehensive Dialogue overseen by the two Presidents. There will be four pillars: diplomacy and security; economy; law enforcement and cyber security; and social and cultural issues. However, it will be led by Cabinet Secretaries. The Commerce Secretary has said there would be a 100-day plan for coming up with ideas on trade and investment. Last, but not least, it seems that the two countries are more willing to work on the challenge of North Korea’s nuclear development. In fact, President Trump has suggested that he is open to a more favorable deal for China should it be able to help resolve the challenge. I think this will be a key factor in determining the future of the relationship.

Clearly, within the White House there is a struggle taking place between the economic nationalists (Bannon and Navarro) and those with a more internationalist stance (Cohn and Ross). How this is resolved will impact significantly on the relationship.

Gray and Navarro in a piece in Foreign Policy argue that Trump’s policy should be two-pronged. First, never sacrifice the US economy on the altar of foreign policy by entering into bad trade deals like NAFTA, allowing China into the WTO and passing TPP. Second, pursuing peace through strength. They call for rebuilding the military, viewing the US navy as the greatest source for regional stability in Asia. This was reflected in President Trump’s initial budget proposal for a $12.5 billion increase in the military budget. However, Congress will have to pass this.

President Trump’s initial policy proposals will not be realized and his thinking about the economic relationship is misguided along two dimensions. As noted, he has already stated that he will not declare China as a currency manipulator. Indeed, it is likely that the Chinese currency will depreciate. Second, in January 2016 he called for a 45 percent tariff on Chinese goods but later said he would not do this. In fact, the President cannot do this, power resides with Congress and they would have been highly unlikely to pass this measure. Finally, should Congress have passed this measure, China would be able to levy large penalties against the US for legitimate trade retaliation, amounting to around $225 billion.

On other issues, first the administration’s views of trade and how China has been taking jobs from the US and is undermining US manufacturing shows a complete misunderstanding of the advantages of trade and what has been happening with US manufacturing. It is the case that US manufacturing is close to record levels and while it is true that employment in the sector has declined, little of the decline is caused by China’s activities and results from increases in productivity. As has been noted by a number of analysts, technology not trade is the determinant.

Since China joined the WTO, US exports to China have risen significantly and are continuing to rise and this has resulted in important job growth. From 1980 to 2016, US industrial output has risen almost 100 percent, with wages also rising. However, employment has fallen but this is part of a much longer-term trend that began well before China joined the WTO. The manufacturing share of US unemployment reached its peak in 1952 at around 25 percent and fell to 8 percent in 2016. This

From 1980 to 2016, US industrial output has risen almost 100 percent, with wages also rising.

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was offset by the rise in services. Other countries have undergone the same process. In Germany employment in the sector was 40 percent falling to 17 percent in 2015. Of course, China is now undergoing the same process as cheap end manufacturing moves out to other destinations such as Vietnam and Bangladesh. Again it is productivity not trade that is driving this process. A 2015 study by Ball State University claimed that around 88 percent of manufacturing job loss in recent years was caused by productivity growth. If these statistics are correct, it means that the calls by the Trump administration for protectionism will not bring these jobs back. Indeed, it may hurt US consumers by reducing choice and increasing costs.

A second misunderstanding concerns the possibility of implementing and the impact of sanctions on China to force it to act in a way that the administration would see as desirable. On occasion, there have been suggestions that the US could use economic sanctions to pressure China over North Korea. A study by the Rhodium Group in the US highlights the problem with such an approach. First, the stock of US investment in China is much greater than the stock of Chinese investments in the US. Second, and perhaps more importantly, US investments in China form an important component of the global supply chains and play an important role in distribution. By contrast, Chinese

investments in the US are incidental to the healthy functioning of the Chinese economy. Many are purchases of overpriced assets and are not strategic investments. This raises the legitimate question of who would win in such a trade war.

What will play a major role in determining the relationship will be cooperation on resolving the nuclear development of North Korea. While both nations want a nuclear free peninsula, there is a divergence in the bottom line of what is acceptable. The US probably does not care so much about regime collapse as a result of increased pressure on the North, whereas China fears that such an outcome would bring chaos to its borders, refugees flooding into China and US troops up to its border. The problem is that it is hard to see what combination of policies and pressure might bring about a successful and acceptable conclusion. It is clear that North Korea is a de facto nuclear state and I think it improbable that the leadership would be willing to accept any agreement that forced it to denuclearize. According to the Trump administration this is unacceptable, even though the President has stated that he would be willing to meet with Kim Jung-un, if the conditions were right. The danger is that if North Korea is accepted as a nuclear state, what is there to stop other nations in the region from also developing nuclear capabilities?

It is clear that military action is unacceptable and it is unclear that trying to increase sanctions will produce the desired effects. The US cannot rely on China to ramp up the pressure on North Korea to denuclearize. So, where does this leave us? Clearly, China and the US must cooperate. If a dialogue could be restarted that guaranteed North Korea peace and recognition by the US, would its leadership be willing to freeze its current nuclear program and allow IAEA inspectors to monitor the development?

The manufacturing share of US unemployment reached its peak in 1952 at around 25 percent and fell to 8 percent in 2016.

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President Trump and Old King Coal As you are well aware there is no Federal policy on energy, although the Secretary of Energy has some powers. This is why President Trump is reduced to pushing his policy via executive orders and trying to rearrange incentives that will affect the sector. Counter to this, the states are able to influence strongly incentives through their own actions. For example, while the Trump administration might try to loosen emission standards, California might push to tighten them. Given the size of the market in California, auto manufacturers will have to take this into account when producing new models.

One of President Trump’s main campaign slogans was that he would end the war on coal and that he would not only loosen controls over production but that he would bring back significant numbers of jobs. As with his initial policies towards China, he will be frustrated in the extent to which he can be successful. He has promoted the idea of energy independence and a key component of this is putting coal miners back to work. While there are opportunities as coal is still projected to supply 25 percent of America’s generating capacity in 2030, there are barriers, not the least of which is the abundance and cheapness of natural gas.

The administration wishes to move away from the Clear Power Plan authorized by the Obama administration and will rescind the guidelines published by the White House Council on Environmental Quality (August 2016) and the estimates of the social costs of carbon and other greenhouse gases will be overturned. The Executive Order signed by President Trump on March 28, 2017 contains three major elements that are intended to move policy towards Trump’s objective. First,

it instructs the Environmental Protection Agency (EPA) to review and effectively weaken the Clean Power Plan and methane regulations. This is not as easy as it sounds. It took many years for the original Plan to be guided through the political and legislative process and this new order is likely to be challenged as draft rules are put together and the administration will have to deal with public comments and almost certainly defend the new actions in courts. The Clear Power Plan was blocked in the Supreme Court in 2016 and the main provisions would only take effect in 2022. Thus, the process with implementing the new executive order will extend well beyond the time limit of the current administration.

Second, the order requests that the Environmental Protection Agency should ignore the government estimations of price for carbon pollution. Since the reality is that the costs are probably higher than the estimates, the administration has ordered the EPA to ignore or deny the existence of these estimates. Finally, and perhaps most importantly, the order ends a moratorium on new coal leases on public lands before a review is completed. However, it is unclear whether the lifting of this would have any real impact on either coal production or mining jobs.

To follow up on this, in late-April President Trump signed an executive order to reduce restrictions on oil drilling in the Artic and the Atlantic to “unleash American energy”. Although there has been a downturn in the oil market, he felt that this measure would create “thousands and thousands” of jobs. The Department of the Interior is instructed to come up with a new development for all the Federal waters off the US coast. This executive order is likely to run into the same implementation challenges as the earlier order.

So, the question arises as to whether the administration can fulfill its stated objectives. From 2011 to 2016, the coal industry lost some 60,000 jobs, leaving

The idea of energy independence and a key component of this is putting coal miners back to work

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just 77,000 working in the sector. It is not surprising that while the Dow Jones Index rose 69 percent between 2009-2014, the coal sector shed around 75 percent of its value. Some things might help such as a restructuring and refocusing of the industry. Too much investment has been sunk into not favored high-sulfur coal in the Appalachian region of the US. Technology improvements such as improved pollution scrubbing technology might help but not enough. There is also the hope that external demand could be stimulated. China could take more coal if it reduces dependence on North Korean supplies, for example. However, US coal production would cost more and also currently the coal that the US produces is of lignite and bituminous that is used mainly for power generation. As I understand it the coal that China imports from North Korea is anthracite that has the highest carbon content and the lowest impurities and this is used mainly for the manufacturing of steel and ceramics. Anthracite makes up only 2 percent of US coal production and it would require significant expansion in areas such as Pennsylvania to increase production. This might be considered by many to be an uncertain investment and it is unlikely that President Trump would put government funding into this.

Repealing the Plan and the other associated actions will not reverse the decline of the coal industry. The real debate is whether regulation or competition has caused the decline in the coal industry and the answer is the latter. Natural gas is cheaper and the US has around 80 years of natural gas reserves at the current consumption rates. Given this enormous cushion, it is not surprising that utility companies are building gas-fired power plants. In 2013, for example, over 50 percent of new power generating capacity was for natural gas, coal accounted for 11 percent and solar was even higher at 22 percent. In 2003 coal accounted over 50 percent of all US power generation but by 2015 it was down to around 30 percent. Indeed, in 2016 natural gas surpassed coal as the main source for US electrical power. This challenge from natural gas began already in the mid-1990s when “fracking” and horizontal drilling led to a boom in production that drove down natural gas prices.

If one adds to this the increases in productivity and the expansion of automation noted in the previous section, the policies are unlikely to increase significantly jobs for miners. President Trump may not be as happy as Old King Coal.

In 2003 coal accounted over 50 percent of all US power generation but by 2015 it was down to

around 30 percent.

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Plotting a Way Forward

Moving forward at the global level, I would separate the potential areas for cooperation into two aspects: reordering power in existing institutions and collaborating on new global challenges. It is easier to see potential ways forward at the global level of engagement than at the regional level. China enjoys its role in the G-20 and is a strong supporter of the UN.

There needs to be reforms to enhance China’s influence within the existing architecture but this will also need to enhance the influence of other emerging economies. With respect to the Bretton Woods institutions, there is no necessary logic any longer as to why the heads of the World Bank and the IMF should be drawn from the West. It should be on the agenda for representatives from other countries to be eligible. While the idea of a G-2 is not feasible, the two countries should work together to revitalize the G-20. As Kevin Rudd has written to make it genuinely the “premium institution for global

economic governance.” This would act as a complement to his idea that the East Asian Summit could play a similar role in regional affairs.

Where trust might be built to move forward more constructively would be in the realm of new areas of public goods’ management that require new policies, structures or collaborations where the countries in the region together with the US and China could take on joint ownership. In addition to US-China cooperation, other countries such as Japan and, increasingly India, would play key roles. It is difficult to assess whether a more isolationist Trump administration would be willing to engage. Moving forward, I would divide areas for cooperation and collective action into three categories: Global Commons, Global Engagement and Global Regulation. These are areas that have shown some progress and might provide more opportunities moving forward.

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Global Commons This would include categories such as climate change, fisheries and water shortages. The November 2014 agreement on climate change could provide a fitting example for progress. China and the US announced they would cut greenhouse gas emissions thus providing leadership in the run-up to the Paris Conference that adopted the draft agreement in November-December 2015, becoming effective in November 2016. This depends, of course, on the final outcome of President Trump’s deliberations on the Paris agreement. This does not look very positive at the current time. On April 14, Scott Pruitt, the head of the Environmental Protection Agency called for “exit”, claiming it was a bad deal for America. Should they decide to withdraw, then according to the terms of the agreement, it takes three years for a party to withdraw, followed by a one-year waiting period. By this time, there will have been another US election. Withdrawal would mean combined with the policy reversals proposed by the US administration, according to the Rhodium Group, the US cutting emissions by 14 percent by 2025 compared with 21 percent if the policies remained in place. Given the current global sentiment, withdrawal would leave the US very much an outsider in policy trends.

At the US-China Strategic Dialogue of June 2016, the two countries confirmed their national, bilateral, and international commitments to ocean conservation. The two countries pledged to continue diplomatic, law enforcement, and scientific cooperation to protect the ocean from the threats posed by global climate change, ocean acidification, unsustainable fishing, and marine pollution. The United States and China have essential leadership roles in ensuring the long-term sustainability and health of the ocean.

Global Engagement

This would include combatting infectious diseases, dealing with natural disasters and peace-keeping. On the question of infectious diseases there is already very good cooperation between the Centers for Disease Control of the two countries, especially after SARS in 2002-03. Additionally, there appears to be good cooperation on the issues of piracy and as noted before a litmus test will be the ability to cooperate on North Korea in order to bring about a successful resolution to nuclear proliferation. One area of progress would be an agreement on terrorism that clearly indicated that any attack on innocent citizens is unacceptable.

Global Regulation

Agreements on finance and trade could help supplement whatever the outcomes are of regional trading agreements. The most important question here is whether the two countries can move forward on a Bilateral Investment Agreement (BIT), again not surprisingly this has produced sharply different views in the US. However, perhaps if there is progress on North Korea, this might be looked on more favorably by President Trump. Those in favor argue that the agreement would establish binding rules covering the treatment of foreign investors and investments from each country. They would guarantee non-discriminatory access to the Chinese market and fair treatment of investments once they had been made. It would also restrict things such as the imposition of performance requirements, such as the amount of local product that had to be included. China has proposed operating with a negative list for investments, which would be more open than previous practices. By contrast, opponents stress that the US is already a major destination for investment and that the protections that a BIT agreement would provide for China in the US market will damage US firms. They claim that Chinese state-owned enterprises would, with state support, be able to undercut local producers. Given the importance of the two countries in the global financial system, greater cooperation would be beneficial not just in reforming institutions such as the IMF but also in working together to regulate global capital markets and on the value of the Renminbi and the possibility of its future internationalization.

Cyber security might provide another area for cooperation. It could use the September 2016 President Obama and President Xi announcements as a basis for further progress.

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It is clear that progress in Asia and globally still needs a strong US-China relationship at the core. However, it will require shifts in attitude on both sides. The US will have to accept it can no longer dominate in all fields and that its fortunes are inextricably linked to global concerns. China will have to adjust its outdated notions of sovereignty and accept that its actions do impact fundamentally on the domestic affairs of other nations, whether this is intentional or not.

Progress in these spheres might provide the incremental steps to build trust between the two countries. It might not provide such a grand vision as that of Henry Kissinger who has written of building a Pacific Community but incremental increase in trust might move us along this road.

Thank-you very much

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Disclaimer: The views and opinions expressed on this paper are solely those of the original author. These views and opinions do not necessarily represent those of XRG.

Anthony (Tony) J. Saich is an XRG-CDN Core Associate and Daewoo Professor of International Affairs, Kennedy School of Government, Harvard University based in Cambridge, Massachusetts, USA.