Commentary
This is the second of two articles on the increasing risks of doing business with China, and how America and other Western-style democracies can move past it.
The Russia-Ukraine war has shown it is impossible to rely on trade with, or investment in, a country bereft of democratic norms, especially a totalitarian regime like China where the government controls business.
The dogmatic embrace of free trade, irrespective of the actions of the trading partners, a practice for much of the world since around 1990, has clearly endangered the global order.
We discussed the inherent and escalating risks to investors and businesses from continuing to maintain normal trading relations with China in this column. In this article, we’ll discuss some strategies that governments, businesses, and investors can use for moving beyond China as a base for manufacturing and investment, while maintaining it as a marketplace for goods from America and other democratic nations.
Doing so is important, not only from a business and portfolio risk perspective, but also for geopolitical and geostrategic reasons. The Chinese regime has repeatedly shown malignant, bellicose, intent toward democratic and Western-style governments, institutions, companies, and individuals.
The Chinese Communist Party’s (CCP) brutal suppression of Hong Kong’s pro-democracy protesters, its continuing bullying of Taiwan, its building and fortifying of man-made islands in the South China Sea, its hoarding of the global supply of personal protective equipment (PPE), and, at the outbreak of the CCP virus, imposing a travel ban within China while recklessly permitting travel abroad, to create a global pandemic, have shown that Chinese leader Xi Jinping and the CCP simply cannot be trusted to allow China to act reasonably in the community of nations. Their practices have made China an outlaw state.
A World Made New
Moving suppliers and investment out of China will require a number of steps, but all are achievable if democratic nations work together, much as they are working now to isolate Russia over its invasion of Ukraine.First, Western-style democracies need to vigorously embrace—and perhaps even amend–the World Trade Organization (WTO) rules that exempt member states from compliance in pursuit of health and national security concerns.
Article XX of the General Agreement on Tariffs and Trade, the legacy 1947 trade agreement now administered by the WTO, provides that where there is no “arbitrary or unjustifiable discrimination between countries where the same conditions prevail,” signatory nations can take steps “necessary to protect human, animal or plant life or health.”
An amendment would specify that member states can adopt robust industrial policy, at their sole discretion and without oversight from the WTO, that favors industries that are imperative for the protection of their own populations and their own national security, another exemption covered by GATT Article XXI.
Second, it’s important for financial institutions in democratic nations, including the World Bank, to work to finance and create robust national supply chain nodes in developing nations. Nations must agree to a unified industrial policy to do so, just as they agreed to WTO rules, the Geneva Convention, and other multilateral agreements.
Supply chains work much like the poem, “For want of a nail ... the kingdom was lost.” At the top, or tier one, is the kingdom; tier two is the battle; tier three is the horseman; tier four is the horseshoe; and tier five is the nail (and there are even lower tiers—blacksmiths, iron ore miners, coal miners—who fire the blacksmith’s forge, etc.).
As we saw with microchips, as well as car upholstery foam, interrupting the production of a final product, like cars at tier one, production is dependent on the lowest tier supplier that feeds tier one. And each of the lowest tier suppliers has its own chain of lower tier suppliers, and each of those has a lower tier, etc.
China’s command economy has been masterful at creating and integrating these supply nodes and maintaining them at any cost, even if they are not profitable, so long as they are necessary to maintain production of an important segment of its economy. (This follows a centuries-old similar practice, “Keiretsu,” that Japan had used to become the first “Asian Tiger” in the 1970s.)
This is not to say that each leg of the supply chain needs to be within the national borders of the tier one supplier. Required raw materials and labor costs will necessarily require some parts of critical supply chains to be in other nations’ borders and even overseas. But they will be moved to countries that respect international norms, such as India or certain countries in Latin America, or to countries that are, if not democratic, at least not belligerent toward Western-style political values.
Third, the democracies should deny China its comparative advantage from its blatant disregard of environmental concerns that most Western-style democracies observe. They should adopt the Carbon Border Adjustment Mechanism (CBAM), a measure that would, in effect, impose a tariff on goods produced in countries with a poor record of carbon emissions. It is currently under consideration by the European Union. But instead of charging the importer, the tariff should be imposed on the exporter, not the democratic country importer.
Democratic nations that have significant carbon emissions issues, but that have valuable productive capacity, like India, can be supported with technology transfers and World Bank loans and grants to clean up their carbon emissions and to supply them more natural gas to replace coal-fired generators and mills. If tariff rates are graduated to take account of their economic circumstances, the rates paid by these poorer, but democratic, nations are likely to be less than China. (India’s per capita income is about a quarter that of China.)
An aerial view of the coal-fired power plant in Hanchuan, China's Hubei Province, on Nov. 11, 2021. Getty Images
Fourth, exchanges around the world should require listed Chinese companies to adopt IFRS or GAAP, as appropriate to the exchange, in order to list their securities. This will not only make Chinese companies more transparent to investors and regulators, but also allow fairer competition for sector analysts, portfolio managers, and financial advisers. It’s a fundamental issue of fairness.
Finally, the democracies should agree to implement and follow the four principles of the International Labor Organization (ILO): The right to organize and collectively bargain and that prohibit forced labor, child labor, and discrimination in employment. China’s reported abuses of its workers, including the use of slave labor, are legion and should never have been tolerated by the international community in the first place.
Summary
The global economy requires the same kind of liberal, rules-based order on trade and investment that we expect of nations in their political and military dealings with each other. And while the world is now punishing Russia for violating them, it is likely just a matter of time before we are forced to do the same to China.For more than 30 years, Western-style democracies, and particularly the United States, have traded with China as though it was Canada. Russia’s invasion of Ukraine has now shown the enormous economic, geopolitical, and geostrategic risks that politicians, Wall Street, the City of London, and government policymakers around the world have taken by dogmatically embracing “free trade” without regard to their trading partners’ underlying political conditions or values.
Western-style democracies and their leaders should act now to start a five- to ten-year global initiative to inoculate their countries from those risks, in order to protect their critical national and health security products, to create alternative supply chains in more reliable nations, to penalize those nations that recklessly abuse the environment, to demand conformity with global financial reporting, and to adopt fair labor standards.
We should embrace those nations that conform as friends, trading partners, and allies. We should eschew and punish those that do not.
Read part I here.
Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.
