Weatherhead Center Fellow and Directorate-General Taxation and Customs Union, EU Commission, Juan José García Sánchez argues that there’s a better way for the US to compete with China other than its current protectionist strategy.
by Juan José García Sánchez
While the US is moving its military presence toward the Asia Pacific arena, in an overt show of power, there’s another less conspicuous “war” underway against China: the trade battle over advanced chip technology. These high-end chips are the critical components for the technology of the future—such as self-driving cars, super computing, artificial intelligence, and sophisticated military equipment. Taiwan produces over 90 percent of the most advanced chips. The US wants to prevent China from buying these high-level microchips and from producing them locally.
This spring, the US won a decisive battle in its chips war: both the Dutch and Japanese trade ministers announced new export restrictions on semiconductor manufacturing technology going to China. The Dutch company ASML and the Japanese company Tokyo Electron are the second and third largest world producers of the machines needed to manufacture chips, and the trade restrictions mean that without access to these technologies, China will be unable to manufacture advanced chips in the foreseeable future.
President Biden launched this particular chips war in October 2022 with the introduction of export restrictions preventing China from purchasing advanced chips from the US. But to achieve the intended impact, it also needed the cooperation of the Netherlands and Japan—two key actors that control the machines that make the advanced chips. Otherwise, China would be able to purchase the machinery from them and speed up its plans to produce advanced chips.
This episode illustrates two key elements of US foreign policy: the US leverages its trade policy (unilaterally) to achieve geopolitical goals, yet it needs the cooperation of other countries to succeed. This is a contradiction. In this essay I will argue that the US can achieve its goals more readily through multilateralism: working with other fair-trading countries to achieve efficiency and mutual goals.
What is the geopolitical objective of the US trade policy?
The Trump administration launched the ‘America First’ policy to reindustrialize the country and ensure America leads in strategic sectors. It included major protectionist shifts like US withdrawal from the Trans-Pacific Partnership, the renegotiation of the North American Free Trade Agreement, and a trade war with China.
Biden’s trade policy is more sophisticated and less controversial but does not reverse the core elements of ‘America First.’ His industrial flagship initiatives, like the CHIPS and Science Act and Inflation Reduction Act include generous subsidy schemes to companies who manufacture in the US or build infrastructure using US materials. These measures are perceived by the rest of the developed world as incentives for their local multinational companies to relocate part of their production in the US in order to take advantage of these subsidies.
What motivates this policy?
In short, the US policies were a reaction to globalization. The social unrest created by three decades of hyperglobalization—increasing disparities between the educated and the uneducated, between rural areas and cities, between the wealthy and the poor—have created a large segment of American voters who are open to policies aimed at addressing the negative effects of globalization. Decades of industry offshoring, decreases of labor share in national GDP, and growing inequality have fueled social discontent and have jeopardized democracy in the US. The January 2021 insurrection on the Capitol symbolizes this malaise.
Additionally, stress on supply chains during the COVID-19 pandemic, China’s assertive trade policy, and the Russian aggression in Ukraine underlined the need to reassess the US trade policy. A new wave of protectionism didn’t need to be the political answer to this social demand; however, it is the prevailing choice in both the Republican and Democrat camps.
Another motivation for protectionism is the imbalance of trade relations with China. The West granted China advantageous terms for its accession to the World Trade Organization (WTO) in 2001 because it expected that China’s integration in global trade would promote the country’s democratization (the ‘Wandel durch Handel’, or ‘change by trade’ doctrine). The West was wrong.
Since 2001, China has transitioned from a developing to an upper-middle-income country. Despite this evolution, China argues that it should keep its WTO benefits as “the world’s largest developing country” while it maintains aggressive trade and industrial policies. The US argues that China subsidizes public companies in certain sectors until they have outpaced their foreign competitors and attained a dominant position in global markets. Even more problematic, China imposes forced technology transfers to foreign companies that operate in China. This situation adds to the political pressure in the US to cut ties with China.
Is the US overhauling its economy?
From the perspective of the Biden administration, the solution to both problems is changing the overall orientation of the US economy—i.e., leaning toward local industrialization and taking on all the consequences that come with a new economic model. Globalization has given the US a permanent supply of cheap goods in a never ending process of delocalizing production to geographical areas with lower labor costs and lower environmental and social standards. In a reversal, the American federal government wants to bring production back to the US, especially in strategic and high added value sectors. In theory, the US nurturing local industries in emerging sectors would undermine Chinese predatory policies, create a geopolitical advantage for the US, reduce social unrest at home, and increase the income of American workers—all at the same time.
If you accept these premises, the local content requirements of the Inflation Reduction Act (where a certain percentage of a product’s parts need to be US-made), the subsidies of the CHIPS Act, and the ban of advanced chips exports to China, among other measures, are sound decisions that bring jobs back to the US. Arguably, these measures also reinforce supply chain resilience and preserve an American technological edge against China in strategic sectors, while contributing to climate change mitigation by reducing the amount of goods traveling long distances.
According to this view, the Biden administration is reinforcing its protectionist measures by invoking the urgency of climate change, and the supply chain disruptions caused by the pandemic to obtain the political support required to reindustrialize the US.
This line of thinking has its opponents. Traditional US allies such as Japan and the European Union (EU) argue that this tack undermines both the American and their own national economies, because it forces all advanced economies to join a subsidies race launched by the US. If they do not offer equivalent levels of subsidies, they will see their own industries flee to America. In their view, this is a lose-lose situation.
Other countries’ trade policies
The alternative to protectionism is multilateralism—understood as coordinated, cooperative policies agreed upon, if not globally, then by large blocks of like-minded countries. Multilateralists propose dual trade and industrial policies. The champion of this line of thinking is, of course, the European Union.
On the one hand, countries that are willing to grant fair and open trade terms to their competitors should carry on benefiting from the deflation of prices generated by globalization. The only permissible exception should be the minimal level of trade distortion required to secure the supply of strategic goods—like semiconductors, medical supplies, batteries, or rare earths and minerals. This distortion should be limited to friend-shoring the production of the essential goods needed to avoid supply chain disruptions in the event of crises. Friend-shoring can take place inland or in neighboring countries, and offers the benefits of lowering transportation costs and making oversight easier.
On the other hand, multilateralist think that the international community as a whole should confront noncooperative countries that break international law. Countries that implement aggressive national industrial and trade policies (like China) should be subject to targeted tariffs, direct foreign investment bans, and exclusion from public procurements. Countries that execute aggression wars against other countries (like Russia) should be punished with sanctions that undermine their capacity to carry on with the aggression.
Multilateralists believe that global problems like climate change mitigation and supply chain resilience are addressed at a much lower cost through international cooperation and common evolution of technical standards.
For instance, in sectors like chips or electric vehicle (EV) batteries, the US and the EU could cooperate to ensure that at least one of the two attains the production capacity required to ensure supply chain security both in the US and in the EU. It is likely that, through fair competition, both parties would benefit from supply security and from industrial specialization in the sectors where they have the competitive edge.
Similarly, if enough countries adopt comparable greener production standards together, the industry will adapt without requiring individual government subsidies.
The obvious criticism of multilateralism is that it does not address some undesirable effects of globalization, like inequality increases and wealth concentration. Multilateralists argue that other policies, like education and taxation, are better suited to address these problems.
Finally, developed countries cannot replicate China’s trade policy, which subsidizes export products, protects its internal market, and undervalues its national currency. This is a predatory policy. Applied by too many countries, it would generate a spiral of retaliations that would damage the world’s economy.
Which trade policy, protectionism or multilateralism, is more efficient?
Multilateralism is more efficient than protectionism, especially when partners align on long-term goals. Consider the top US and European political priorities. The US and the EU have mostly common goals: they agree on mitigating climate change, addressing unfair Chinese competition, combating Russia’s invasion of Ukraine, increasing supply chain resilience, and providing prosperity to their respective populations.
Multilateralism works better regarding climate change because it reduces the cost of the transition to carbon-neutral technologies through coordinated regulatory alignment and industrial specialization. For example, if all advanced economies banned combustion engines by a due date, the automotive industry would adapt to produce EVs without states needing to subsidise EV purchases. If the same countries open their EV markets, their citizens will buy cheaper EVs from the most efficient producers.
Multilateral measures against unfair Chinese competition are more efficient and more difficult for China to retaliate against. For instance, in 2012 the European Commission launched an antidumping investigation on solar panels imported from China. At the time, Australia, Canada, or the US had similar antidumping investigations in process. Soon after, China retaliated with an antidumping investigation on European wine exports. Finally, in July 2013, China and the EU reached a settlement to the solar panels dispute, but the WTO process for this was quite long. Ultimately, China exported solar panels worth more than twenty billion dollars a year to the EU, and the Chinese industry replaced the European industry as the world’s leading producer. In the end, the Chinese solar panel industry prevailed.
If all countries contesting Chinese practices would have imposed antidumping measures at the same time, maybe the European industry would have survived. Of course, other countries without a solar panel national industry benefited from cheaper solar panels and did not act against Chinese dumping. But their national industries faced the same dilemma in other sectors, like steel. At the end of the day, everybody lost from individual antidumping proceedings against China, who emerged on top. Developed countries are increasingly aware of the need to reform the WTO to allow simpler, stronger, and faster retaliatory measures against unfair Chinese practices.
Similarly, the more countries that agree to multilateral sanctions against an aggressor nation, the more successful they will be. The more difficult it is for Russia to find an alternative supplier or purchaser, the more effective sanctions will be. There is evidence of a certain degree of circumvention of the sanctions adopted by the Global North against Russia. It’s too early to assess the impact of various boycotts on Russia, but the coalition taking action against it is significant and large.
Multilateralism also provides cheaper supply chain resilience, which has two very expensive pillars: increasing stocks and having multiple suppliers. Multilateralism reduces both. The COVID-19 pandemic provides a valuable example. Once European countries started cooperating with each other, they sent patients from the countries facing more COVID cases to the countries with less stressed healthcare systems, reinforcing the overall resilience of European healthcare systems faster and at less cost. Further, sharing the development and purchase of vaccines allowed faster and cheaper access to vaccines in Europe.
Efficiency of multilateralism
Let’s illustrate multilateralism’s efficiency with the example of the US-EU negotiations on the Inflation Reduction Act (IRA) tax credits for American buyers of electric vehicles. These tax credits are conditional to EV batteries being produced in the US, or in one of its free trade agreement partners, and to the EVs being assembled in the US. If the US had chosen to exclude EVs with EU batteries from the tax credits, it may have forced the EU into a subsidies race with the US. Fortunately, this was avoided.
Tesla is the first pure EV producer in the world by market capitalization. The second and third are Chinese, and the fourth and fifth companies are also American. The EU and Japan have large traditional automakers that are far bigger than EV companies and are transitioning towards EV production quickly. In late 2022, the US and Japan signed a critical minerals agreement that paved the way to extend the IRA’s tax credits to Japanese EVs. The US and the EU have announced their intention to negotiate a similar agreement. To prevent China from dominating the market, it makes sense for the US to coordinate strategy with the EU and Japan.
Conclusion
The benefits of multilateralism are clear: it creates more prosperity, favors economic specialization and regulatory cooperation, and provides all parties with more and cheaper goods without the need for subsidies. If the US, the EU, and other like-minded countries can coordinate their trade and industrial policies to achieve common strategic goals, such as the case of EVs under the Inflation Reduction Act, this is undoubtedly the scenario that will benefit their citizens the most. Multilateral coordination will also help advance the US’s long-term geopolitical goals. Therefore the US should keep moving in this direction, to evolve its strategy from ‘America First’ to ‘fair traders first.’
DISCLAIMER: The opinions expressed in this article are the author’s own and do not represent the views of the European Commission.
Contributor Bio
Juan José García Sánchez was a 2022–2023 Fellow with the Weatherhead Scholars Program. He is a team leader at Directorate-General for Taxation and Customs Union of the European Commission. His research interests include European integration; globalization; international trade; economic diplomacy; international free trade negotiations; customs procedures; and strategic economic autonomy.
Captions
- Flag of USA and China on a processor, CPU or GPU microchip on a motherboard. US companies have become the latest collateral damage in US-China tech war. US limits, restricts AI chips sales to China. Credit: William Potter, Shutterstock
- Taiwan is the largest manufacturer of the wafers needed to produce microchips, and of the types of wafers used to make the most advanced chips. As a service provider, Taiwan fills orders for these chips (or wafers) for companies from China, the US, the EU, South Korea, and Japan. Chinese companies do not have the capacity to develop high-end chips by themselves, so they need to buy them from other countries, even if they are manufactured in Taiwan. Taiwan continues to supply China, but could decide to change course if China increases military aggression. Credit: Buchholz, Katharina. "Advanced Microchip Production Relies on Taiwan." Digital image. May 22, 2023. Accessed June 29, 2023
- Taiwan’s largest chip manufacturer, TSMC is in the process of building a second giant manufacturing plant in Phoenix, AZ, an example of both the US incentivizing foreign investments in critical industries and also creating more manufacturing capacity and jobs in the US. Credit: Reuters, YouTube
- Graph of global market share of leading electric vehicle (EV) battery producers. Credit: Juan José García Sánchez. Source: 2023 April Global Monthly EV and Battery Monthly Tracker, SNE Research