The Level of Decoupling between China and the United States and Corresponding Influences / TEMVON

Simple estimation on decoupling (simulated based on SIEM)

(1) Static loss caused by chip decoupling

(2) China’s electromechanical products suffering from static loss in the world market caused by chip decoupling

(3) The influences of US’s increasing tariff on Chinese products

Abstract

For the United States, to maintain its good relationship with China is to strike a balance between national security and economic development.

The United States assumes that China is a potential enemy for the United States, so it will restrict the allocation of strategic resources to the Mainland China as it does to the enemy countries.

One of important military technologies is to ensure the accuracy of weapons. It is computer technology and information technology that determine the accuracy of missiles or UAVs, including obtaining information, information network, information processing, and taking actions according to information orders. Therefore, computer technology and information technology should be regarded as strategic ones.

The United States maintains a certain amount of large trade deficit, so that it can export dollars, obtain seigniorage, and make up for defense spending. If the deficit is greatly reduced, the seigniorage revenue will be only reduced, not to mention the benefit of the United States. However, Trump administration attempts to correct what they think is unfair by raising tariffs on Chinese products, which is aimless.

In general, raising tariffs on Chinese products does not punish those enterprises or enterprise groups that engage in unfair trade. 93% of China’s exports to the United States are provided by private enterprises and foreign-funded enterprises, but the means of unfair competition are mainly adopted by state-owned enterprises (SOEs).

Figure 1 share of China’s SOEs and non SOEs’ exports to the United States (as of October 2020)

In terms of intellectual property rights, monopoly market is not open and government subsidies and Internet have not provided access to the public, so enterprises can be dealt with as a unit. This is because those who violate the rules of fair competition in the market do not take the state as a unit, or the industry as a unit, but at most take the enterprise group as the unit.

With the modern computer technology and information technology, it is relatively affordable and easy to collect and process the information of specific enterprises and impose legal sanctions on illegal enterprises.

The reciprocity is the structural treatment of individual cases. The principle of reciprocity is to treat the other party in the same way as the other party treats itself, that is, “don’t do to others what you don’t want to do to yourself”, and it is also “if the other party is not treated equally, make it equivalent.”

For China, the best choice is to keep all the economic relations with the United States, including the purchase of high-tech products and technologies, the open access to financial markets, trade relations, and cooperation in education and scientific research.

If China and the United States are decoupled from each other, such as trade decoupling, the Mainland China will lose the US market and the huge international market of its allies immediately. Financial decoupling will cause great losses of resources and reduce the real valuation of the enterprises. If decoupling of high-tech products will cause many enterprises in Mainland China to stop production immediately, the decoupling of high technology education or technology cooperation will also cause the Mainland China high-tech enterprises to lose American resources.

The only thing that needs to be improved in the past trade relations between China and the United States is to adjust the asymmetric tariff to the symmetric tariff, that is, to reduce China’s tariff level on US imports (weighted average 6.3%) to the US tariff level on China (2.9%).

Figure 2 Weighted average tariff rates of China to the US and the US to China
Unit:%

The most important way for Mainland China to achieve the goal of anti-decoupling is to resume the path of marketization and rule of law, and follow the market rules, rule of law, and freedom of expression..

If it follows the market rule, rule of law and freedom of expression, Mainland China is sending the strongest “non hostile” signal to the world. Because these rules and principles are made for the fair settlement of disputes in peaceful means, they are non-violent and pose no threat to other countries. These signals will also affect US’s judgement on Mainland China and makes US view China as a rival rather than an enemy.

The development of strategic high technology depends on a set of institutional environments, namely, market system, rule of law and freedom of speech. One of the most important links is the mechanism for continuously generating innovative ideas, and the environment for innovative technology elites and entrepreneurs to stand out.

Take the US chip decoupling as an example. China will not be able to make up for this shortcoming at least in the medium term, that is, 5 to 10 years, or even in the long term, 20 to 30 years. This is because the production of chips requires an all-round institutional environment. First of all, it needs world-class universities and research institutions. The first principle is free expression, which takes a long time.

Chinese universities and scientific research institutions still pay attention to administrative departments. They have only carried out a certain amount of academic research, and the research topics are only limited. Due to the strict examination and approval system of private foundations, 90% of government research funds are used for applied research, and the application evaluation mechanism is unfair and opaque, so there is little innovation in the basic theory.

Threatened by the US restrictions on chip supply, the Chinese government issued a military order against the Chinese Academy of Sciences under the “national system” to overcome problems such as chip lithography. However, this government-led research and development method itself has many drawbacks. In the case of political ambiguity, the government’s allocation of scientific research funds depends more on power and relationship. Government funds will not be effectively allocated to people with the ability to innovate.

If China wants to establish a complete chip industry system, it is impossible to rely solely on huge investment in the medium term.

Like the United States, the principle of reciprocity is also the best principle for China to follow. It should be emphasized that the Chinese government should attach importance to the positive principle of reciprocity. The positive principle of reciprocity not only refers to the equal punishment of the other party’s unfair behavior, and its purpose is to force the other party to return to the rules of fairness; but also refers to the fact that one party should reflect on whether the other party’s action is reasonable and whether it conforms to the constitution. If so, it should not take revenge, but should adjust its own behavior.

The constitutional system of the United States not only stipulates the constitutional rights of citizens in the constitution, but also effectively protects the constitutional rights of citizens through the judicial system.

This means that if foreign governments or enterprises violate the constitutional rights of American citizens in the United States, they will be stopped and punished; if the United States government wants to punish foreign governments or enterprises that infringe on the constitutional rights of American citizens, they will also be stopped or suspended.The Americans, including the American media in the United States, will denounce things that Americans think violate the values of the constitution of the United States. This kind of condemnation will affect public opinion and the legislature of the United States. For example, the bills passed by Congress to punish those who violate human rights and the rule of law are not bills directly related to American citizens or the country. It was almost unanimously approved, which shows that the two parties in the United States are more consistent at this time, and there are fewer interest groups hindering them.

If the decoupling actions taken by the US government violates the constitutional rights of US citizens, citizens will also go to court.

There is a tradition of lobbying in the United States. If the US government’s Sino-US economic policies harm the interests of interest groups, the interest groups can prevent or restrict these policies through lobbying.

If the US government takes a large-scale decoupling action, it will have a more significant impact, and the damaged interest groups will also respond more fiercely. The lobbying activities of industrial interest groups are key to limiting the decoupling of the executive order of the US President.

As long as there is suspicion of violating US laws, US companies will not hesitate to take legal measures against competitors, especially those from overseas. Of course, their lawsuits may not be tenable, but this may be a means of competition. Especially in the United States, local American companies have a “geographic advantage”.

When foreign companies generally violate U.S. laws and regulations, the US Congress will also strictly require or impose sanctions on foreign companies.

The provisions of the Chinese Constitution on civil rights are similar to those of the US Constitution. However, the difference from the United States is that China’s Constitution cannot be directly cited in court trials, that is, constitutional rights cannot be effectively implemented.

However, a series of administrative laws in China, such as “Administrative Punishment Law”, “Administrative Reconsideration Law”, “Administrative Procedure Law”, and “Administrative Enforcement Law”, restrict the power of the administrative department and can be used in judicial process. The process may play a role in defending the Constitution and effectively restricting the executive organs.

China’s courts cannot be “free from administrative interference” as stipulated in the Constitution. One of the most serious forms of interference is to force the court to “not accept” administrative litigation filed by citizens. Therefore, the various “Administrative Laws” cannot actually be used in the judicial process. The rights of citizens stipulated in the Chinese Constitution are often not effectively protected.

The reform and opening up started in 1978 After more than 40 years of development, the Communist Party of Chinese (CPC) has formed a tradition different from that of Mao era. This can be called the “Deng Tradition”, that is, the reform and opening up. This tradition advocates marketization and rule of law, tends to the principle of freedom of speech, and hopes to gradually reform the political system.

This tradition has dominated China’s system reforms and policy formulations during the 30-odd years of reform and opening up, lifted restrictions on people’s economic freedom, motivated entrepreneurship and market vitality, and brought China’s miracle. The foundation of Deng’s tradition in the CPC has been deepened.

Reform and opening up is not only a concept, but also an expedient measure to improve the situation of the CPC. The impetus released from the transition from planned economy to the market economy and the improved resource allocation will continuously generate the wealth, which will also bring benefits to CPC officials. On the other hand, although they know the importance of the market, they tend to gain a larger share of the market, and thus have an anti-market tendency.

When it comes to the relationship with the United States, Deng Tradition is more inclined to understand the reasonable requirements of the United States, and changes the pressure from the United States into a driving force for domestic reforms.

However, SOEs are a very powerful interest group. They instinctively oppose the abolition of the privileges and monopolies of themselves. Because they and administrative officials belong to the same interest group that can exchange identities, they have very powerful political resources that will affect government policies and even international relations.

The Deng’s tradition and the power of special interest groups are integrated. On the one hand, Deng’s tradition and the discourse of reform and opening up still have a certain or even dominant position in the CPC, because this may be used to maintain the CPC’s image of continuing reform and opening up, and help ease the ideological tension with the United States and the Western world; on the other hand, monopoly group of SOEs and administrative abusive groups hold actual political power and conduct counter-reform and opening operations under the rhetoric of reform and opening up.

After the reform and opening up, private enterprises have made considerable progress. According to the National Bureau of Statistics, by 2019, non-state-owned enterprises accounted for about 73% of the industrial added value; non-state-owned enterprises accounted for 87% of urban employment, and provided more than 100% of new job opportunities. If we simply associate the proportion of employment with the proportion of GDP, knowing that the proportion of employment in the state-owned sector in rural areas will be lower, we can infer that the proportion of GDP created by the non-state sector is more than 87%.

Figure 3 proportion of SOEs and non SOEs in industrial added value

Figure 4 employment increment of SOEs and non SOEs in each year

The rapid development of non-state-owned enterprises since the reform and opening up is propelled by the market rules and the rule of law, as well as the property rights system. However, they often suffer from the exploitation of state-owned enterprise monopoly, the increase of tax rate, and the threat to their security and property rights by the administrative department and its officials. Therefore, they have the orientation to support marketization and rule of law, and oppose administrative abuse and state-owned enterprise monopoly.

Non-state-owned enterprises have always been relying on their own innovation and efforts to gain access to the US market. As mentioned previously, non-state-owned enterprises in Mainland China account for 92% of exports to the US; they also attach great importance to the patent system so as to develop their own technology and products. In 2016, the effective patents obtained by non-state-owned enterprises accounted for 97% of all patents.

SOEs have unfairly obtained various preferential treatments, subsidies and monopolies. They are unfair competitors in the Mainland China’s market, and of course they are also unfair competitors in the international market.

SOEs lack a mechanism to encourage innovation. They rely more on their monopoly on the domestic market and manage to grab the intellectual property rights of enterprises in other countries. Such monopolies do not want to see the IP system be further strengthened.

The so-called “administrative abuse group” refers to administrative departments that do not abide by the constitution and laws. They often violate the rights of citizens and enterprises under the banner of the government, manipulate the judicial department, and deprive citizens and enterprises of the right to justice. The abuse of police force suppresses the complaints of citizens or enterprises, and further violates the rights of citizens and enterprises, and seeks their own interests.

This administrative abusive group even created its own standards that are different from the Constitution and the law. For instance, they illegally determine a large number of residential houses that have been inhabited for 10-20 years as “illegal buildings” and proceeding in a brutal demolitions.

Since this interest group often violates the Constitution and laws, it does not want their unconstitutional and illegal activities to be exposed by the media and condemned by the public. Therefore, they support the suppression and monitoring of Internet public opinion, and oppose the freedom of speech.

Corporate executives, white-collar workers, small and medium-sized enterprises’(SME) owners, professionals and freelancers are the strong players in market competition. They benefit more from the market system, gaining higher income and accumulating a certain amount of wealth. They adapt to market rules and hope that property rights will be protected, so they tend to restrict the administration by the rule of law, and rely more on freedom of speech.

The Chinese government opposes decoupling measures, especially, to giving the access to foreign companies and individuals with more Chinese market demand. This includes lowering tariff rates, lowering restrictions on foreign investment, and opening up more Chinese domestic markets. Its purpose is to provide benefits to countries other than the United States in order to contain the United States.

An important achievement is that China signed the Regional Comprehensive Economic Partnership Agreement on November 15, 2020. Another important achievement is the Sino-EU Investment Agreement signed with the European Union on December 30, 2020. The agreement includes the protection of investment, respect for intellectual property rights, transparency of subsidies and improved market access conditions.

The US’s requirement to enter the Chinese monopoly market, cancel government subsidies and protect intellectual property rights will be opposed by state-owned enterprise monopoly groups and administrative abusive groups. However, as the Chinese Communist Party’s senior officials have declared that they will carry out these reforms, they may become one of the driving forces for reform in this field in China.

On the one hand, the CPC’s senior leaders not only sincerely follow Deng’s traditional ideology and use reform and opening up discourse, but also realize that marketization and rule of law can bring them benefits as a whole; on the other hand, they want to gain a larger share of incoming wealth.

The best choices that meet the interest of both China and the United States are shown as follows:
(1) The United States: Restrict strategic high-tech, and let others go; however, individual or structural sanctions should be imposed on companies that violate fair trade rules;
(2) China: Maintain all the original economic relations with the United States; the condition is to improve the intellectual property system, break monopolies, remove government subsidies from SOEs, and provide open access to (at least part of) the Internet. Furthermore, it is necessary to reduce the level of tariffs on American products based on that of the United States on Chinese products.
(3) Common points: Except for strategic high-tech, the rest should not be decoupled; Sino-US tariffs should be equal.

The global loss due to the decoupling of US-China chips ranges from US$393billion to US$1179 billion. Assuming an even distribution of production and consumption, calculated at 18% of the world’s GDP, the EU’s revenue will decrease by US$70.8 billion to US$212.3 billion, 18% of world’s GDP.

Figure 5 Trade of high tech products between the US ,China and the EU in 2018
unit: million US dollars

China is the EU’s third largest importer and the largest exporter. It is the second largest trading partner in general, and it has approached the scale of trade between Europe and the United States.

The EU and China have similar trade structures. As a unified trade and tariff unit, the EU is China’s largest overseas market for intermediate products, accounting for 16.48%; its intermediate products are also China’s largest overseas supplier, occupying 12.43%; significantly higher than the 7.38% and 11.7% of the United States. Therefore, seen from the data reflected in trade, China and the EU have a deeper international division of labor.

Figure 6 Distribution of China’s intermediate products market and supply place in 2017 Unit:%

Since the European Union does not have the same large-scale leading chip manufacturer as the United States or East Asia, the largest chip manufacturer in Europe, STMicroelectronics’ sales in 2019 is only about 9 billion US dollars. Regardless of the quality and quantity of chips, it cannot replace the United States or East Asia. Generally speaking, there are very few EU countries that can replace the United States in chip supply. Therefore, the decoupling of strategic high-tech between China and the United States will not directly bring much market to EU companies.

The average price of EU products is also 13.5% higher than that of China, and there is competition from East Asia, the United States, ASEAN, and emerging economies. The EU will not substitute much for the production of electromechanical products.

Since the EU is still a consortium of sovereign states, its legislation and decision-making procedures are complicated, and the unanimous consent rules or double-specific majority rules require high cost and time-consuming legislation and policy formulation. However, once a law or policy is formulated, it will be more effective and authoritative, and will have more bargaining power in negotiations with other countries.

The cultural traditions and institutional structures of EU countries are closer to the United States between China and the United States. Its values are in favor of market rules, the rule of law and the freedom of speech. As the Chinese government has done something that violates market rules, the rule of law, and the principles of freedom of expression, the EU’s overall judgment on China has changed, and it has gradually regarded China as hostile.

When the EU once again regards China as a potential hostile country, it will move closer to the United States in terms of strategic high-tech products, and will not export high-tech products that the United States prohibits from selling to China.

In order to achieve effective decoupling of China’s strategic high-tech technology, the United States will inevitably put pressure on the European Union. It will not allow EU countries to steal the market left by the US’s decoupling or allow China’s 5G equipment to enter the EU market. If the United States wants to have an effect on the strategic high-tech decoupling, it cannot allow EU countries to give access to China in the high-tech field. This includes not only high-tech products such as chips, lithography machines, AI, robots and precision machinery, but also it requires the EU to decouple from China in the fields of high-tech scientific research and education.

The decoupling of the United States from China should be limited to the decoupling of strategic high-tech fields. When the United States goes further, it will be concerned about the substitution of the European Union, thus restricting the decoupling to strategic high-tech areas that must be decoupled.

General conclusions about the degree of decoupling
(1) The common best choice of China and the United States: decoupling in strategic high-tech fields;
(2) Consider the status quo of the US system structure: the trade war may be suspended, sanctions on Chinese state-owned monopolies and sanctions on Chinese Internet companies that affect American public opinion, and sanctions on Chinese companies with intellectual property rights violations may be increased;
(3) Consider the status quo of China’s institutional structure: the market is less likely to recover, the rule of law and the freedom of speech in the short term, and the decoupling of strategic high-tech fields is inevitable;
(4) The United States adopts structural or case-by-case handling of China’s problems in market entry, intellectual property rights, Internet access, and government subsidies.
(5) The two sides can reach an agreement on tariff equality, that is, China will reduce the tariff on the United States based on the tariffs imposed by United States, and the two sides can further reduce the tariff to zero.

Full text in Chinese : http://sheng54.net/2021/02/26/%e4%b8%ad%e7%be%8e%e8%84%b1%e9%92%a9%e7%a8%8b%e5%ba%a6%e5%8f%8a%e5%85%b6%e5%bd%b1%e5%93%8d%ef%bd%9c%e5%8d%81%e7%bb%b4%e8%bf%9c%e6%99%af%e5%85%ac%e5%8f%b8%ef%bc%88temvon%ef%bc%89/

Author: flourishflood

Economist, Confucianist

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