How Should We Frame the US-China Trade Conflict? Let’s Use Some Game Theory

How Should We Frame the US-China Trade Conflict? Let’s Use Some Game Theory

I think too much ink (or 0’s and 1’s) have been spilled analyzing Trump and his administrations actions on trade, specifically proposed tariffs on China.  For many reasons, not least of which way too much of this debate revolves around people’s hatred or love regardless of what he does, that any sense of how to frame this debate has been lost.

In this blog post, I want to frame why I am more sanguine about the Trump administration trade actions. Let me emphasize, for reasons I will get into in the next post (this is only Part I), I am not a fan of the Trump administrations actions, it is poorly planned, and unnecessarily extreme in its rhetoric. However, I do not think this will in anyway determine the outcome.  I am going to show you how I think about this trade dispute and as you will see is less about Trump, and more about the nature of the conflict.

Let us begin with a simple question, so we can start building a decision tree type structure, that will instruct us how to proceed. Should China be confronted with regards to its protectionism?  I say that outside of China, the pretty resounding answer would be yes.  The evidence on the problems laid out by the Trump administration is simply overwhelming and something you can easily witness.

The next question I believe that helps us proceed is to ask whether this is a technical or marginal dispute or a fundamental conflict? Let me give you an example. Europe and the US have had a long standing dispute over what constitutes unfair government support for Boeing and Airbus, that was largely resolved through the WTO, though it pops up from time to time.  Does Washington state tax breaks for Boeing constitute unfair government support?  Does financial support for Airbus development of new plane models by the EU constitute unfair government support? These are technical disputes between the EU and the US about what constitutes unfair government support for an industry rather than a rejection of the liberal system designed to increase transparency, fairness, and procedural justice.

I would make the argument that China represents, and honestly has not contested this point, that it wants to fundamentally do away with the liberal international order.  Specifically, with regards to trade and investment policies, it makes little attempt to even hide most of its violations.  It basically ignores WTO rulings against it and actively talks about it support for its companies.  The Chinese Communist Party has no interest in liberalizing its goods, services, and investment markets.  It has no interest in binding itself to foreign rulings against it.  I think the case is overwhelming that China trade and investment policies represent not just a technical or marginal dispute over a specific industry or good, but rather a fundamental conflict about the purpose and nature of the system.

This leads to a follow up question. What approach could any leader (even though we have Trump right now, let’s just take any leader using their preferred method) take that would persuade, either with carrot or with stick, China to join the international liberal order, specifically with regards to the trade and investment regulation?  Again, I think you have to conclude that no shift in strategic or stylistic approach is going to persuade China to alter its behavior or would only increase the probability slightly.

If we look at everything from currency management, to intellectual property, to non-tariff trade barriers over the last 20 years, we basically find a policy landscape that shows international influence has had effectively zero influence.  Make no mistake, Beijing craves the approval from international institutions, but rejects entirely the practice of the implied order.  For instance, Beijing applied great pressure to have the IMF include the RMB, despite rejecting in practice the requirements applied to reserve currencies.  For anyone to argue, well if we only tried a different approach, China could be persuaded to change their behavior, simply lacks any basis in reality and intellectual foundation.

Let us pause and recap our intellectual process so far. China needs to be confronted, it is a fundamental conflict, and there is virtually no evidence that a stylistic or strategic shift will persuade China to alter its behavior.  We can discuss Trump shortcomings ad nauseum, some of which I will do shortly, but this frames why I am more sanguine about Trump behavior. Let me emphasize, this does not mean I think it is optimal, well thought out, or that I support it, and many other things, but I am more ambivalent because of what happens if we assume Trump behaves in an opposite manner.

Let us assume, there is an alternate universe where Trump proceeds to the WTO filing a flurry of lawsuits on everything from IP to NTBs, checks every procedural box, follows every rule meticulously, engages in gentlemanly statecraft, and the US beats China before every WTO panel.  Now ask yourself: will that persuade China to alter its behavior?  In my estimation, this would only marginally increase the probability of China changing its behavior at best. China has shown time and time again, it will ignore even its own commitments whenever it feels like it.

Sports statisticians have developed a great statistic called “Wins Above Replacement”. It attempts to calculate the value a player brings to a team if they were replaced “for minimal cost and effort.”  In other words, if we brought in an unemployed free agent or the best minor leaguer, what difference would that make?  Apply this same concept to President Trump. Assume, we had Hillary Clinton, Bernie Sanders, Barack Obama, Mitt Romney, Jeb Bush, Bill Clinton, Ronald Reagan, Dwight Eisenhower, Franklin Roosevelt, or Condoleeza Rice or pretty much anyone you want within reason: how much would that add to the probability China changes its behavior? Like the perfect world in the previous paragraph, where every procedural and statecraft practice is followed perfectly, I think you have to believe that it would have little to no impact on China’s behavior.  In other words, even if you changed the leader and the method, would China alter its behavior? I would not assign a zero change in probability, but I would assign a very low probability to any change.

The point about framing this analysis is that for all the hand wringing about Trump, you can arrive at a pretty clear analysis of what are the highest probability outcomes pretty much ignoring who is the current President.  Let me emphasize, this is not a defense of Trump, but rather asking whether anyone would fundamentally alter current relationship with China and I think the weight of evidence indicates no.  The dominant strategy, to use a game theory term, is arrived at independently of Trump.

Too often, we assign achievement or failure of an organization to an individual, when in reality, individuals have much smaller impact than we believe.  People continue to tout a Presidents impact on GDP or the stock market when there is really no relationship. CEO’s and fund managers still rely vastly more on luck and random chance than skill above replacement.  The obsession with Trump, with all his faults, distracts from the reality of the nature of the conflict.

All this analysis invites the inevitable question then, why even engage in this conflict?  If you believe, unlike myself, that this is a marginal or technical dispute over a specific industry, product, or company, then Trump administration actions are a wild over reaction. I think most people fall into this camp.  If however, like myself, you believe China represents a fundamental threat to the liberal international order then Trump administration escalation can be supported, or at least understood, even if the specifics or execution are disagreed with.

The rapid escalation outside standard dispute resolution channels is understood or accepted if we believe that China’s behavior will not be addressed or changed with technical or marginal win.  Let me rephrase: if you believe China is fundamentally against the international trade and financial liberal order and will disregard any judgement against it, winning a technical or marginal judgement on a specific case is the definition of a pyrrhic victory. You will have won the battle while losing the war.  A fundamental refusal to abide by or even accept the rules of the game by a player will not change if another player appeals to the referee, represents a systemic and escalated threat.  That is what we are dealing with now.

Additionally, the longer the delay in confronting China about its systematic disregard for the rules of the international system, the greater the damage done in protecting the system.  We are not talking about a government disputing a specific measure, but the entire system.  The longer the confrontation about the nature of system is delayed, the more difficult it will become to prevent the Chinese Communist Party from fundamentally altering the liberal international system.

In respectable US foreign policy circles, it has become increasingly safe to talk about the reality that the US and China have entered into what amounts of to Cold War type of relationship.  If you believe the relationship between the US and China, whatever academic or popular term or historical analogy you prefer, is fundamentally in opposition, rather than a narrow or specific conflict over a technical dispute over financial aid to a specific industry, it is not a leap to at least tolerate the Trump administration actions.  If you believe an adversary represents that level of threat to the international liberal order, one has to consider fundamentally different methods than tools used for specific technical litigation.

We know that most of the analysis views the trade spat as representing a marginal or technical dispute rather than the fundamental conflict that it is.  For instance, analysis focuses on where will job losses be concentrated or how this will impact international supply chains.  Almost no work has framed against backdrop that China and the United States are in a Cold War with Beijing fundamentally opposed to the liberal international order.  The trade dispute is merely the pre-text for the reality of the conflict between the two major powers.

Finally, the reality is that there is no costless way to confront Beijing about its desire to systematically undermine the liberal international order.  Whether you impose tariffs or really any other form of punitive measures, taken after winning something at the WTO, or elsewhere, there is no costless way of confronting Beijing. You merely have to decide where, when, how, and why you want to impose specific costs. Framing those costs as a disruption of a supply chain on a marginal/technical dispute, the level of frustration becomes understandable. Set against the backdrop of a Cold War adversary bent on doing away with the liberal international order and that cost becomes at least understandable.

One of the greatest pieces of international relations theory that to me explained an enormous amount about post-WWII behavior was by ex-Obama official and Princeton professor Anne Marie Slaughter.  According to Slaughter, the US by creating international institutions and organizations that replicated US bureaucracy both included others into the decision making process, but also framed the discussions.  The WTO adjudicates trade disputes and the IMF is kind of like an IMF.  Furthermore, while a leading power, the US accepted that it could lose in forums like the WTO and other countries bought in to the system.

This is a lesson that Beijing has learned and is actively seeking to build a new international order that replicates its government-state system from China and the Communist Party.  From the AIIB where it insists on holding 51% of votes to Hong Kong where it appoints almost a majority of leaders then declares the system democratic.  Examples abound of how Beijing wants to remake the international order in its own image and does not believe it needs to be bound things as pesky as the law or commitments.  If a state refuses to accept the rule of law or adverse judgement in any forum, domestically or internationally in this case, you cannot expect purely legal order such as a WTO decision to change behavior.

Now what I think is important here and that using the line of logic, which taken individually and for the most part collectively, are at least semi to entirely uncontroversial opinions, we arrive at a dominant strategy that strongly/confronts pushes back Beijing’s systematic misbehavior and is not afraid to use political rather than legal means.  In other words, even if I do not consider who is in the White House, we have a dominant strategy to take a more confrontational approach vis a vis Beijing.

It cannot be stressed enough that this is no ringing endorsement or defense of Trump.  Rather explaining my view point that I am willing to tolerate Trump because while the Trump administration continues to make serious mistakes and commit unforced error after unforced error, I do not believe that is a determining factor in the outcome given Beijing’s predilection for not negotiating with anyone.  Independent of who is in the White House, I think you can see how easy it is to arrive at a strategy of strong confrontation with Beijing that relies on a variety of methods from political to legal and accepts there are costs that will be incurred in defense of the system.

Note: This is Part I laying out a line of logic of how to view the conflict. In Part II, I will lay out a course of action to better handle the China trade relationship and all the mistakes Trump is making. So before you flood my inbox with how I am a Trump apologist, wait for Part II