Has the international economic order (ie essentially the US and the EU) used its system of international economic law to get China to do what the rich nations have wanted all along, or has China used the international economic order for its own ends?

International economic law is traditionally broken into three divisions – trade, investment and finance.

In terms of trade, one view is that China’s WTO accession forced China to recognize and enforce foreign IP rights, in a way that has benefited EU and US corporations.  Likewise, its accession has forced China to open up to foreign banks, and otherwise allow in foreign services firms, all in ways of benefit to the rich nations. On this view, the West got the best from China’s accession. 

The other view is that China chose to accede to the WTO so as to be able to restructure its internal economy. China’s leadership wanted to implement a whole range of major reforms, to which domestic resistance was always going to be substantial. WTO accession allowed the leadership to first sell to its people the economic benefits that would flow from WTO membership and, then, having done so, use the need to comply with WTO requirements as the justification for implementing a whole raft of reforms. On this view, China’s accession was a device to restructure its own economy without fomenting disabling social unrest and dissent.

So who used who?  My vote is that while the West gained much from China’s accession, China gained more. As is often the case with China, Western commentators interpret China’s actions through the prism of their effect abroad and on China’s international relations, mistakenly thinking that China is primarily focused on its foreign agenda. Most Western commentators think this way, and most are wrong. China’s principal focus is internal. The biggest problems China faces are internal: corruption in  government, banks and major corporations and institutions, inequality, regional imbalances, etc.

In the area of investment, China opened up to foreign direct investment relatively early and liberally. It welcomed much FDI, especially in high technology industries. The tax and other incentives it offered were relatively generous. Again, to the unsophisticated Western commentator, it appeared that China was desperate for foreign capital and was basically willing to forego most of the tax revenues from most FDI projects to get it. Again this was a misapprehension. China was very keen to acquire something, but it wasn’t foreign capital as much as it was foreign technology and managerial know-how.

At the time, I was one of these misguided Western ‘experts’. I spoke at a conference on China’s rise in 1994 and questioned why China, a nation with this vast pool of very cheap labour, was offering tax and other incentives to attract high technology investments, when high tech is typically capital intensive and China at the time was capital poor. I thought what China needed was lower tech, more labour intensive, industries. History has proven me wrong. Nations that sought to industrialise through the traditional route of promoting textiles, clothing and footwear industries because they are low tech, labour intensive, and require relatively low levels of capital, are still industrializing. None have approached the performance of China. China took the long view. It could see where it wanted to be in 20 years time – as the high technology, higher value added, factory for the world, and it was willing to set policy frameworks to achieve that end, even at the expense of shorter term growth.

In addition, China was actively preferring foreign direct investment (FDI) over foreign debt because it knew FDI cannot flee readily in times of instability. So, for instance, at the time of the Tianamen Square incident most US corporations removed their US executives from the country for a number of months, but they couldn’t take their bricks and mortar investments in factories and the like back to the US. In contrast when the Asian Economic Crisis struck East Asia (apart from China) in 1997, the foreign capital quickly fled back to its countries of origins, and it was this withdrawal of foreign funding that made the crisis so severe.

As with trade, China appears to have made the right calls when it came to investment. It preferred investment in sectors that would give its workforce the skills to engage in higher value added manufacturing in the longer term. And it preferred equity investments over debt, because equity is far less destablising in times of trouble.  

And finally to finance where, more even than with trade or investment, China has marched to the beat of its own drummer.  For the past 20 years, the EU and US have been pushing for China to open up even more to their banking institutions, to allow in foreign capital, and to allow the renminbi to float on international markets. China has resisted most of these demands. Foreign banks have been allowed in when, and on the terms, that suited China, and only in limited ways. Foreign capital has been allowed in only in tightly controlled ways. The renminbi remains undervalued, substantially, and China’s export performance continues to ride high on the back of its undervalued currency.

The holy trinity in international finance is that a country can have two of (i) access to international capital markets, (ii) control of its interest rates, and (iii) control of its exchange rate. But it cannot have all three. In other words, if you need foreign capital, then you can set your interest rates but then the market will set your exchange rates (as Australia does). Or you can set your exchange rates, but then the market will set your interest rates. But you cannot set both interest and exchange rates, if you need foreign capital, because you typically then won’t get it in the amounts you need.

This is why China has never let in foreign capital in substantial amounts. By not becoming dependent upon foreign capital, it has managed to stay in charge of both its interest and exchange rates, and thus retain control of two very powerful policy levers over its economy.  Keeping interest rates artificially low for decades has preferred Chinese manufacturers and other industries who benefit from access to cheap capital, at the expense of Chinese citizens, who receive very low returns on their savings. And by keeping its currency artificially undervalued it prefers Chinese export industries over Chinese consumers, who have to pay higher prices for imported goods than if exchange rates were set by the market.    

This manipulation of its exchange rate has been fundamental to the accumulation of China’s massive foreign exchange reserves (funded by its massive export earnings) which it has in turn invested heavily into US Treasury bonds.

So in the ‘who’s using who’ scenario, while the rise of China has certainly benefited the West economically, China, to my mind, has consistently and skillfully called the shots.  China has adroitly used all three limbs of the international economic order to benefit itself more than the developed world.