MITIGATING THE NEW COLD WAR: Managing US-China Trade, Tech .
MITIGATINGTHE NEW COLD WAR:Managing US-China trade,tech and geopolitical conflictAlan DupontAnalysis Paper 8May 2020
MITIGATINGTHE NEW COLD WAR:Managing US-China trade,tech and geopolitical conflictAlan DupontAnalysis Paper 8
Related WorksRowan Callick, The China Challenge (28 July 2019, OP171)Wolfgang Kasper, Does Western Civilisation Have a Future? (19 February 2019, PP17)
ContentsExecutive Summary.1Recommendations.2Chapter 1: The Trade War.4Endnotes. 11Chapter 2: The Tech War. 15Endnotes. 24Chapter 3: The Foothills of a New Cold War. 30Endnotes. 36Chapter 4: Mitigating the New Cold War. 40Endnotes. 48
AcknowledgmentsThis report has benefited greatly from the constructive and insightful comments of the four membersof my research reference group: former Australian Ambassador to the World Trade Organisationand head of the Australian Trade and Investment Commission, Bruce Gosper; techno-economist,hedge fund founder and former head of technology investment banking at Morgan Stanley, JulianSnelder; trade and industry consultant and former Executive Director of the Australia-Japan EconomicInstitute, Manuel Panagiotopoulos; and Asia Group Partner and former Principal Deputy AssistantSecretary for Economic and Business Affairs at the US State Department, Ambassador Kurt Tong.I am also grateful to Professor Aaron Friedberg, of Princeton University, for drawing my attentionto his coauthored report “Answering China’s Economic Challenge: Preserving Power, EnhancingProsperity”; and Dr. Charles Edel, a colleague and Senior Fellow at The University of Sydney’s UnitedStates Studies Centre for a long and helpful discussion about the Cold War. Finally, my thanks to mytireless assistant, Sam Heskett, for his research support and forbearance in reading, and amending,earlier iterations of this report.
Executive SummaryThis report concludes that the linked US-China trade,technology and geopolitical conflicts have precipitateda new Cold War. In an epoch-defining clash forglobal leadership, the world’s two major powers arewrestling for strategic advantage in an increasinglybitter contest to determine which of them will be thepre-eminent state of the 21st century. No matter howcleverly spun, a trade deal is not going to get therelationship back on track because both countrieshave moved from a framework of cooperation to oneof open rivalry and strategic competition.Beijing thinks Washington is bent on containingChina to prolong the declining power of the US whiledenying a resurgent Middle Kingdom its rightfulplace in the sun. US elite and popular views of Chinahave soured for different reasons. The previousgoodwill — which took decades to build — is rapidlydissipating especially within the once overwhelminglypro-China US business community. Americansincreasingly believe China is threatening US securityinterests, undermining its prosperity, interfering inits democracy and challenging its values. Anti-Chinasentiment unites an otherwise divided and partisanWashington, and will endure long after Donald Trumphas departed the White House.Preventing, or mitigating, worst case outcomes willrequire the US and China to accommodate eachother’s strategic interests. This won’t be easy becauseof diminished trust, their different world views, thesystemic nature of their confrontation and domesticpolitics. Neither Trump nor Xi Jinping have handledthe COVID-19 coronavirus pandemic well, so bothwill look to deflect criticism by blaming each otherfor the consequences. Although a simmering rivalryis more likely than a hot war, this is hardly cause forrelief or complacency. A second Cold War could beworse than the first, given the interdependence of theUS and Chinese economies, their centrality to globalprosperity and the proliferation of dangerous militaryand digital technologies.This report draws out the risks — and likelyconsequences — for a system already in a state of fluxas the transition to a post-American world acceleratesand the coronavirus wreaks havoc on the worldeconomy and international trade. A hard decouplingof global supply chains in the wake of the coronaviruscrisis would not only delay and complicate economicrecovery. It could also lay the seeds for a secondglobal recession, or even depression. A worseningof the US-China trade and tech wars would fracturealready-stressed supply chains, reduce internationalcooperation, reinforce protectionist tendencies andopen up new arenas of conflict and contestation.However, a managed decoupling is already underwayand is necessary to preserve the integrity of an open,robust trading system and a liberal internationalorder. This is not an attempt to isolate China ordeny it a position of influence in the world. ButChina’s leadership ambitions won’t be realised ifthey undermine democracies and the principles,rules and institutions that are intrinsic to fair andopen trade. Democracies need to consider commonapproaches to managed decoupling that still permitglobal engagement and open trade with one anotherand China, while facilitating reform of trade andtechnology governance.Structure of this reportThe report comprises four chapters andrecommendations. Chapter 1 examines the originsof the most serious trade dispute since the 1930sfrom both an American and Chinese perspective,focusing on the phase one trade deal, the increasing‘weaponization’ of trade and the implications for themultilateral trading system.Chapter 2 sheds light on the linked tech war, explainswhy industry policy has become a new Sino-USbattleground and assesses the probability of aBalkanised internet and decoupled global supplychains.Chapter 3 appraises China’s strategic challenge andthe US response, drawing out the parallels betweenthis era and that of the first Cold War. It concludesthat the real problem in the bilateral relationship isthe diametrically-opposed political systems and valuesof the two powers, compounded by their sense ofexceptionalism.Chapter 4 looks at possible solutions and proposesa nine-point strategy for reducing Sino-US tensions.No strategy can hope to resolve the myriad problemsafflicting US-China relations, no matter how astutelycrafted, or rigorously implemented. The aim here isto illuminate pathways to compromise and renewedhabits of cooperation by making an explicit effort tounderstand the causes of their differences and tosuggest ways of mediating them.A report of this length cannot do justice toall elements of the US-China conflict. Morecomprehensive accounts will no doubt include China’sambitious Belt and Road Initiative and ‘debt-trapdiplomacy’, as well as other important sources ofeconomic and geopolitical friction between the twonations — such as currency flows, investment rulesand China’s influence operations. Moreover, this is1
an unfinished story. Like all epochal events, it will besubject to conflicting interpretations and judgementsby analysts and historians as American and Chineseleaders attempt to shape events over time.more or less experience and skill, in order to avoidThe celebrated German statesman, Otto vonBismarck, believed that we can’t create or divert “thestream of time”, merely “travel on it and steer withis a modest attempt to provide a blueprint for actionshipwreck.”1 But shipwrecks can be avoided if farsighted and determined leaders are committed toproblem solving rather than provocation. This reportto help guide the world through the dangerous shoalsahead.RecommendationsThese recommendations, and their accompanyingarguments, form a nine-point strategy for managingthe risk of a new Cold War and are elaborated inChapter 4.Recommendation 1: Reduce strategic tensionsAvoiding a Cold War will require the US and China tostrengthen, not reduce, the many areas of cooperationthat once bound them, dampen down their hostilerhetoric and get serious about conducting a wholeof-relationship dialogue to identify pathways formanaging strategic risk. This dialogue should worktowards verifiable agreements that proscribe cybertheft of commercial IP and establish new rules forinternet governance that lessen the risk of cyberspace becoming the next domain of warfare. A frankdiscussion of the damaging consequences of a secondCold War should be a priority agenda item aimedat changing mindsets and risk reward calculations,prerequisites to reversing the dangerous trendtowards conflict.Recommendation 2: Reform or replace the WTOThe US and China need to support — and preferablylead — reform of the WTO. Despite its inadequacies,it would be better to fix the WTO’s problems bybuilding consensus for reform among its membersrather than leave the organisation or worsen its nearparalysis. The US should enlist the support of likeminded countries in a united front against unfair tradepractices by leading efforts to reform WTO rules. Butif the WTO can’t be reformed, then those countriescommitted to trade liberalisation may have no optionbut to leave the organisation and establish a fit-forpurpose multilateral trade regime that embodies thevision of a liberal trade order for a post COVID-19world.Recommendation 3: Strengthen internationalcooperation and middle power diplomacyAs they have done in the past, the US and Chinamust use the existing multilateral architecture tohelp resolve their disputes. Should they be unwilling2to embrace international cooperation, middlepowers should step up. Partnering with establishedinternational institutions, and drawing on the collectivewisdom of Asia’s premier multilateral institutions (theEast Asia Summit, APEC and the ASEAN RegionalForum), middle powers should use their influence anddiplomatic skills to warn the US and China that theirescalating rivalry has triggered a new Cold War andneeds to be mediated.Recommendation 4: Restore trust withConfidence Building MeasuresBoth major powers should draw upon their residentdiplomatic expertise and the wider internationalcommunity to develop a fit-for-purpose suite ofConfidence Building Measures to build trust and maketheir intentions and behaviour more calculable andpredictable. CBMs could be formulated bilaterally,or through established second-track institutionalarrangements that have the confidence of Washingtonand Beijing and a proven record of feeding wellformulated policy ideas into government. If necessary,new regional or international architecture could becreated to focus exclusively on the most tendentiousaspects of their disputes.Recommendation 5: Use preventive and backchannel diplomacy to manage conflictCBMs are most effective when they are incorporatedinto a broader, proactive approach to conflictmanagement known as Preventive Diplomacy,which can take place at the strategic or operationallevel and could help manage US-China trade, techand geopolitical differences. Preventive Diplomacyshould be supported by semi-official (Track 1.5)and non-official (Track 2) institutions and processesfor ‘back-channel’ diplomacy such as the Councilfor Security Cooperation in the Asia Pacific. Backchannel diplomacy has made a significant contributionto strategic problem-solving in Asia and shouldbe enlisted as a source of policy ideas, advice andtechnical expertise.
Recommendation 6: Apply managed decouplingto minimise disruptionRecommendation 8: Integrate economic andsecurity policyEvery effort must be made to keep decouplingwithin manageable limits to contain the damage tothe US-China relationship, supply chains and theworld economy. However, some degree of economicseparation is necessary to preserve the integrity ofan open, robust trading system and the freedoms,institutions and way of life that define the USand fellow democracies. Of the available choices,managed decoupling is most likely to achieve mutuallyacceptable trade outcomes without losing 70 yearsof trade benefits. But one size cannot fit all. Eachcountry will have to determine the appropriatebalance between sovereign capabilities and relianceon global supply chains.Economists, technologists and strategists must learnto work more closely with each other and bringtheir skills, disciplinary knowledge and perspectivestogether in a collaborative approach to problemsolving. Governments should be encouraged to createeconomic security divisions or groups in their keyministries and to put economics and trade at the heartof national security policy. New epistemic networksof think tanks should be established to deepen andcross-fertilise ideas for reducing trade, technology andgeopolitical frictions. US-China business groups andsecurity communities must come together to buildawareness of each other’s concerns, interests andthinking in order to build a powerful business-securitypartnership to create a wider constituency for change.Recommendation 7: Create a new architectureand rules for cyber and technology governanceUS-China dialogue is not the place to comprehensivelyaddress a cyber-tech agenda that requires urgent,global attention and stakeholder engagement. Thismeans mobilising the full suite of multilateral toolsat the disposal of the international community, fromCBMs to information exchanges, first and secondtrack dialogues and Preventive Diplomacy. Europe’sGeneral Data Protection Regulation is the closest aregulatory regime has come to an acceptable balancebetween openness, privacy and government control.It is a template for resolving differences betweendemocracies and authoritarian states over theprinciples, rules and norms that should govern theinternet and cyber-tech more generally.Recommendation 9: Establish an EminentPersons GroupA strategy without leadership is a car without a driver.An authoritative, resolutely impartial Eminent PersonsGroup could take a significant leadership role byproviding ideas and advice aimed at reducing USChina tensions and developing viable solutions to theproblems identified in this report. Its composition is asimportant as the messages carried. To be successful,the EPG would need the reputational clout to opendoors and be taken seriously by decision-makers. AnEPG established by a non-government organisationwould wield more influence and have greater impactthan one constituted by government. It would beespecially suited to the transnational dimension of theissues analysed here, which transcend the US-Chinarelationship.Endnotes1Otto von Bismarck as quoted in:Evans, Richard. “War and Peace in Europe from Napoleon to the Kaiser: The Wars of German Unification, 18641871.” Gresham College, February 4, er-thewars-of-german3
Chapter 1: The Trade WarThere is already a rich expert literature on theUS-China trade war.1 Much of it, however, fails toshed light on the underlying causes or the salientconnections between the two nations’ trade andstrategic ambitions. Trade analysts forensicallyexamine the impact of tariffs on international tradeflows and speculate about the prospects for acomprehensive trade deal, but they rarely considerthe geopolitical drivers of the conflict or their widerconsequences. Conversely, geopolitical experts tendto neglect the trade war seeing it as a second-orderissue or derivative of the more important strategicrivalry. These siloed views work against the holisticanalysis that is required to understand the mostserious trade dispute since the 1930s, one that hasalready morphed into a technology war.Origins of the trade warThe origins of the trade war can be traced to China’sentry into the World Trade Organisation in December2001, when hopes were high in Washington that WTOmembership would accelerate the communist nation’stransition to developed nation status but within a USdesigned and enforced rules based system.2 Chinasaw WTO membership as an essential step towards itsFigure 1.0: US Trade Deficit with China4long-term goal of raising living standards and givingthe country a seat in the decision-making halls of thefirst world.3Neither went to script. Believing that the US intendedto constrain its rise, China decided to become a rulessetter and work towards supplanting the US as theworld’s premier economy by exploiting Washington’spreoccupation with overseas wars and the 2008-09global financial crisis. Disillusioned US policy elitessoon began to accuse Beijing of manipulating WTOrules, encouraging large bilateral trade imbalances,hollowing out US manufacturing with an attendantloss of jobs and pressuring American companiesto trade off intellectual property in exchange foraccess to the vast China market. Towards the endof President Barack Obama’s second term, tradedisputes had multiplied in frequency and scope, withthe Obama administration openly identifying Chinaas a threat to the US in high-end technologies suchas semiconductors and artificial intelligence. Wheretrade and economic interdependence was once seenas mutually beneficial, by the time Donald Trumpwas inaugurated as the 45th President of the UnitedStates sentiment in Washington had shifted decisivelytowards the view that China was getting ahead atAmerica’s expense.4
Leveling the playing fieldTrump immediately ramped up pressure on China“to level the playing field” for US firms, a constantcampaign theme in the run up to the 2016 presidentialelection. The opening shot in the US-China trade warwas the US president’s March 2018 decision to levytariffs of 25 percent on steel imports and 10 percenton aluminum imports from a range of countries,including China. But the bilateral trade conflict did notreally get under way until 6 July when the US appliedpunitive duties of 25% on 34 billion of Chineseimports following the collapse of negotiations. Beijingresponded by imposing tariffs of equal size and scopeon US imports.5Washington’s concerns about China’s unfair tradepractices were set out in a special report by TheUS Trade Representative Office in the same year.The USTR complained that China had failed toimplement promises to strengthen intellectualproperty protection, open its market to foreigninvestment, allow the market a decisive role inallocating resources, and refrain from governmentinterference in private sector technology transferdecisions.6 Trump’s initial aim was to secureconcessions from China on better market access forAmerican companies and a reduction of the 375billion annual merchandise trade deficit with China.The US president argued that China’s trade practiceshad damaged American manufacturing and unfairlyrestricted US farm exports. “We are now making itclear to China,” Trump declared, “that after years oftargeting our industries and stealing our intellectualproperty, the theft of American jobs and wealth hascome to an end.”7Trump is not the first US president to demand tradereciprocity or use tariffs to force market entry.Economist Henry Ergas points out that “if there is aconstant in American trade policy it is the emphasison commercial reciprocity and the willingness to useevery means to secure it.”8 Former president and freetrader, James Madison, was a strong advocate forusing America’s trade muscle to unleash commercialwarfare against Great Britain in the ea
the risk of a new Cold War and are elaborated in Chapter 4. Recommendation 1: Reduce strategic tensions Avoiding a Cold War will require the US and China to strengthen, not reduce, the many areas of cooperation that once bound them, dampen down their hostile rhetoric and get serious about conducting a whole-
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