What is the right strategic response to China’s unrepentant “innovation mercantilism”? One reason it has been difficult for U.S. policymakers to craft an answer that inspires confidence is that, viewed only in the present context, it has been too easy to believe the United States has never before faced such an adversary. But as Rob Atkinson argued in the fall 2020 issue of The International Economy, it has: Germany for the first forty-five years of the twentieth century.
Germany then was neither a free trader nor a protectionist—it was a “power trader” that used trade to gain commercial and military advantage over its adversaries. Likewise, China’s trade policy today is guided neither by free trade nor protectionism, per se, but by the power trade formula, with an overarching strategy and discrete tactics remarkably similar to Germany’s in its late-Empire, Weimar Republic, and Nazi eras. Understanding how Germany manipulated the global trading system in that period to degrade its adversaries’ capabilities, entrap nations as reluctant allies, and build up its own industries for commercial and military advantage—just as China is doing today—can point the way toward appropriate policy solutions to the China challenge.
One potential solution that will not be available as a practical matter is meeting China’s power trading strategy with an equal and opposite power trading strategy. The approach will need to be more nuanced than that.
In this follow-up article for The International Economy, Atkinson describes how the United States also practiced power trade for much of the Cold War era, but not to boost its economy (which it did in some cases and didn’t in others), but to achieve over-arching foreign policy goals, the most important of which was to assure global security and constrain the Soviet Union. But today, America’s relative economic and technological strength is so diminished from where it was even twenty years ago that power trade premised on leveraging U.S. economic competitiveness to achieve broad foreign policy goals is no longer sustainable. President Donald Trump understood that, but shifted not to a new form of power trade, but to protectionism. The Biden administration needs to renew America’s role as a power trader, but with a new focus of maintaining its relative lead, economically and technologically, over China. Doing so will require changes in the strategy and organization of U.S. trade policy.
Atkinson concludes that the United States should still embrace power trade, but with the overarching goal of increasing its competitive advantage over China. Making this shift will not be easy because many in the trade and economic policy establishments will deny that national economic competitiveness is even a valid concept, having concluded in the 1990s that it was a “dangerous obsession.”
Moreover, even when free traders have recognized the need for strong advanced technology industries, if for no other reason than national defense, many stipulate that free trade serves those interests because it not only maximizes U.S. GDP; it knits together other nations into a web of mutually dependent commerce, reducing the risk of conflict. This has long been the defense against responding to power trade with something other than one-sided free trade. As Hirschman wrote: “When derided as utopians or accused of a lack of patriotism, however, free traders have usually fallen back upon the argument that foreign trade enriches a country and thus helps its defense… in addition, free traders have tried to belittle the danger of dependence pointed out by their adversaries.”
But free traders would be correct if they were describing a world of two-sided free trade between the United States and its democratic allies. In such a world, where the United States is endowed with capital and skills, free and open trade would in fact not only boost U.S. GDP, but enable America to specialize in higher value-added production, helping U.S. national defense.
But that ideal world is far from what America confronts today. Many nations are quasi-protectionists, or rapidly moving in that direction, as we see today with Europe and its protectionist calls for “digital sovereignty.” Most U.S. competitors have put in place robust national industrial strategies targeting key industries, many of them consistent with fair market behavior, but many not. Moreover, with China behaving as an unrepentant power trader despite facing limited global resistance in recent years, a growing number of nations, including India, are emulating its mercantilist policies. The China model provides a powerful siren call for the many mercantilists around the world.
The lesson from China’s largely unchallenged rise has been that nations can flout international trade rules with little consequence. Prior to China’s rise, nations that wanted to indulge in mercantilist protectionism knew they were “sinning,” and they worried about punishment. Now the biggest sinner, China, denies it is a sinner, and casts stones instead at the American house of Donald Trump. And of course, China is a powerful, predatory power trader intent on gaining global dominance in most advanced technology industries. In such a world, two-sided free trade is not possible with a significant number of countries, and one-sided free trade for the United States means going onto the modern commercial battlefield armed with only a bow and arrows.
Moreover, conventional trade theory is still grounded in the concept that trade involves commodity-based industries like wine and textiles; examples Ricardo used to explain why trade was welfare maximizing for both parties. But for innovation-based industries, initial advantages can become sustained advantages as marginal costs of production go down, while network effects increase. And in those industries, predatory policies like subsidies and intellectual property theft can slowly starve foreign innovation-based competitors of the resources to invest in the next round of innovation. Indicative of this, World Trade Organization rules are stuck in the analog era of traditional twentieth-century trade in physical goods, with little to no progress on moving to the modern era with updated rules on intellectual property and services and digital trade. Moreover, U.S. trade theory and practice generally refuses to prioritize key industries as part of a new power trade policy, thinking “computer chips, potato chips; what’s the difference,” a quote attributed to Michael Boskin, head of President George H. W. Bush’s Council of Economic Advisors.
Hirschman rejected this view when he wrote, long before the rise of strategic trade theory in the 1990s, “The theory of imperfect competition has shown that this situation is only very rarely realized.” This is why he believed “international trade might work to exclusive or disproportionate benefit of one or a few of the trading nations.”
The theory of power trade also helps make sense of recent patterns of trade and globalization. In the linear framework of free trade versus limited trade, globalization is either increasing or it is shrinking. This has led some to argue that we are moving to a “post-globalization world” where “all countries are beginning to wall themselves off.” This concern is usually meant to refer to a global economy that is not like the one we thought we were living in with an inexorable movement toward tighter and tighter economic integration. But what these concerns are really getting at is that we no longer live in a U.S. power trading regime designed to bring and hold an alliance together. Rather, we are in a world of power trade, with constant thrusts and parries for advantage and protection, and one that the United States has no choice but to practice.