Abstract: At the recent forum on "China's Opening-Up Pattern in a New Century", former PBC governor Zhou Xiaochuan discussed two topics: the need for China to further open up to prevent a return to cold war-style international trade, and the global value chain.
I. OPENING-UP SHOULD BE PROMOTED AGAINST THE EMERGING TIDE OF REGRESSION TO THE COLD WAR-STYLE INTERNATIONAL TRADE.
1. Opening-up should be promoted without a Cold-War mentality.
At a time when China is firmly committed to opening up to the outside world, a Cold War mentality of de-globalization and increased trade controls are emerging in the world, a setback that threatens to return world trade to the Cold War state.
This regression is not a choice of China. Taking a global perspective, President Xi Jinping has stated unequivocally that China will strongly support globalization and opening-up. Despite the complicated international situation, China will open up further and at a higher level.
President Xi also emphasized the importance of participating in WTO reform, applying for accession to the CPTPP and DEPA, and fully implementing the RCEP, which has now officially entered into force. These are all evidence of China's efforts to actively open up. Moreover, we advocate multilateralism as a means to promote open trade and investment.
However, protectionism and unilateralism resurfaced after Donald Trump took office. Tariffs and embargoes have been used by the United States to launch a "Cold War" in economy, trade, finance, and talent. We have heard new terms like "de-globalization," "new Cold War," "decoupling," "bifurcation," and "new COCOM." Some banded together with their allies and advocated the formation of blocs to jointly carry out sci-tech blockades and financial sanctions. Some of these practices are becoming more prevalent, generating negative energy for the global economy. This is a significant challenge to which we must respond.
Although China actively promotes opening-up, there are regressive forces at work in the international arena. Overall, there is some uncertainty about future trends, which is largely determined by the attitude of Western countries, especially the United States. We would prefer not to see such a reversal, but the situation is likely to deteriorate.
Is a "new Cold War" on the horizon? What would global trade look like in the event of a "new Cold War"? We are hesitant to use the phrase "new Cold War," but the negative factors do share some characteristics with the "Cold War." I'd like to use this opportunity to review the trade landscape that existed during the previous "Cold War." And what can we learn from that? It will be helpful to investigate how to keep global trade and investment from devolving into a "Cold War" mode to better deal with this negative energy.
2. Global trade during the Cold War
The global trade during the Cold War had four features.
The first is that there were three major blocs. After World War II, Western countries led the signing of the General Agreement on Tariffs and Trade (GATT), while the Soviet Union and socialist countries in Eastern Europe pulled together the Council for Mutual Economic Assistance (CMEA). A few countries were engaged in both, such as Czechoslovakia which was among the founding members of GATT when it was launched in 1947. Later, several other countries such as Mongolia and Vietnam also joined the CMEA, but China didn’t. Both blocs endorsed international division of labor and global trade, but via different mechanisms, yet there was hardly any trade or investment between them.
This left the other developing countries or the third-world countries, some of which were once colonized by Western countries, wondering if they had to pick a side. Many of them didn’t want to, and so they initiated the Non-Aligned Movement, while in the field of trade they organized the Group of 77 and launched the United Nations Conference on Trade and Development (UNCTAD). Back then, the Group of 77 and the UNCTAD mainly addressed trade inequality between developed and developing countries: the machines and equipment that Western countries exported to these developing countries were very expensive, while their export of primary products were severely underpriced. That’s why they came together for a new international economic order, to change the situation and enhance cooperation among developing nations. China participated in many of their meetings as an observer. But in terms of trade, the Group of 77 never had a fair-sized intra-trade volume to make any major impact.
Today, if the United States teams up with its Western allies and imposes control on trade and investment, it could drive the global trading system back to its fractured state in history. That’s not what we want, but we need to be aware of the possibility and keep up with changes. Meanwhile, similar to during the Cold War, many countries are unwilling to choose a side, but they also face practical problems with not doing so.
The second feature is the existence of the Coordinating Committee for Export Control (COCOM). Some referred to it as the Coordinating Committee for Multilateral Export Control, but more called it the Coordinating Committee for Export to Communist Countries. COCOM was established by Western countries, controlling exports in three areas i.e. military products, cutting-edge technologies, and scarce/strategic resources. The Committee once had over 10,000 types of products on its control list. Later, as global tensions eased, Western countries believed that military blocs and eastern Socialist countries no longer posed major threats to global security, and so the Committee was dissolved in 1994.
Today there isn’t any coordinating mechanism like the COCOM, but some westerners are planning for actions at the military and hi-tech fronts, or a new version of COCOM, as well as attempts at imposing control over scarce resources such as rare earth metals. China needs to do more in-depth research in this regard and be prepared.
The third feature is the arms race. A geopolitical move, it had three important economic implications: it was a race on technology and on economic strength, and it affected resource allocation in the national economy, i.e. whether resources were tilted toward building military capacity, or toward other areas such as improving people’s livelihood. On resource allocation, there is a balance in between. Well balanced, resources are soundly coordinated; poorly balanced, it will have significant negative effects, which in most cases meant arms taking up too big a share in resource allocation.
The fourth feature is a competition in terms of the currency for trade settlement. The Soviet Union had a planned economy, where distribution-in-kind rather than currency-based settlement prevailed, leaving finance in an unvalued position. Back then, the gold standard was gradually replaced by a dominating US dollar, which enjoyed overwhelming preeminence in cross-border trade settlement in the Western world despite the presence of other strong currencies such as the pound and Deutsche Mark before the creation of euro, and later a rising Japanese yen. In contrast, transactions among CMEA members were settled based on balance of in-kind transactions under centralized planning and the books recorded the balances. In name, they “paid” in rubles or Swiss Francs, but all members tended to overprice their export products, so rubles and francs only served as a unit of account. Any trade imbalance was credited to the account to be dissolved later.
Even after the Soviet Union collapsed and the CMEA was dismissed, China still recorded a balance in Swiss Francs for many years that couldn’t be paid in cash or written off. The absence of a strong local currency hindered transactions and resulted in an inefficient payment system, further eroding the faith of its members in local currencies. Meanwhile, long-term currency overvaluation has bred black markets for the currencies of Eastern European countries such as that in Zurich. In addition, there were barter trades and some of the transactions settled in US dollars, as well as compensation trading activities with the purpose of writing off the outstanding balance in previous CMEA books. In general, trade among CMEA members was neither convenient nor efficient. The weak position of CMEA currencies has made further room for the US dollar as the world’s dominant currency. Today, the global currency landscape has already changed. Going forward, China needs to attach greater importance to payment and settlement systems and the role of currency in its opening-up endeavors.
If we apply these four features to the discussion of the global value chain today, it would mean breaking up the existing value chain to form different blocs. That is what some call “supply chain bifurcation”.
In addition, another important historical development is the rise of the Four Asian Tigers. Different from the Group of 77 and the UNCTAD which stressed the inequality between developing and developed nations, the Four Asian Tigers focused on pursuing export-oriented development based on international trade while pressing ahead with their own market-based reforms (all of them had a controlled economy in the first place; some of them even had very stringent control). Their development model had important implications for the world economy later.
3. Several Takeaways
No census has been reached on the global trade pattern during the Cold War, but in general, most people believe that the fragmentation of global trade undermined efficiency and countries’ well-being; trade control caused by separation of markets was even more inefficient and costly. After the Cold War, a pattern marked by globalization, liberalization and facilitation of trade and investment emerged. At the current stage, the global economic and trade landscape has changed significantly. Global value chains have seen full integration which cannot be easily split. Countries have played their part in the global division of labor by leveraging their comparative advantages. Meanwhile, the interests of developing countries were specially taken care of. There are now some attempts to split up the global value chains or supply chains, which are not welcomed generally and received mixed reception.
Views are divided not only within the US but also among Western countries. For example, the Trump administration insisted on imposing tariffs on China’s exports and believed that the costs should be borne by the Chinese side, which defied economic common sense, harmed the interests of American people, and also pushed up inflation in the US. This shows that any economic response needs to be carefully evaluated to assess the costs and benefits. Without exception, China should also plan every move on a long-term and objective basis. This balancing game also depends on how things evolve in the next step, including how we do our job.
Under the current international situation, China should fully support globalization, open up wider to the outside world, advocate multilateralism, oppose protectionism and unilateralism, and promote WTO reform, as called for by President Xi. This requires sticking to the right direction and opposing regressive forces.
To this end, the key is to focus on long-term competitiveness. Success of a trading system relies on its competitiveness and efficiency in the long run, instead of strengths and weaknesses in the short run. In addition to trade, we should also pay attention to how to better integrate trade with major objectives of national economic development.
In terms of scientific and technological development, in the medium and long term, competitiveness of a country’s science and technology depends on economic and sci-tech systems rather than the launch of a few large projects.
With respect to military development, it requires strong fiscal capacity, and has to be aligned with technological advancement. In addition, military and civilian use needs to be integrated. If well integrated, some technological advancement can serve both military and civilian development. Otherwise, enormous public resources would be wasted and resources for civilian purposes squeezed as a consequence. In this case, despite the improvement of military strength, it will bring losses in other areas and affect a country’s long-term competitiveness.
As for talents, the competition is more intense. Talents are the most essential for the development of science and technology as well as military strength.
With regard to currency, we should take international currency competition very seriously. China has promoted the internationalization of the RMB in a timely manner. Particularly in the digital era, progress has been made in developing digital currency. After the dissolution of the gold standard, the US dollar became the dominant currency. However, if the US abuses systems related to settlement in US dollars to impose sanctions on other countries, in the short run the dollar can be used as a weapon, but in the long run, it will erode the status and credibility of the dollar, thus giving opportunities to the rise of other currencies. Therefore, currency competition is a long-term rivalry that is linked to trade.
II. RESEARCH ON GLOBAL VALUE CHAIN
The Global Value Chain Development Report 2021 is an important study with many insightful findings. However in-depth research on the global value chain is still needed.
First, how big is trade in services?
People used to say the world is round. In the 1990s, a book titled The World Is Flat: A Brief History of the Twenty-first Century was published, arguing that with the Internet, a large number of services became tradable. Statistically, two figures need to be looked at: first, the share of services in gross trade value (including intermediate goods); second, the contribution of value added in trade in services to GDP (excluding intermediate goods) or GNP. In the past, goods were deemed as tradable while services non-tradable. Within the category of goods, certain items were also non-tradable, such as electricity, which is goods itself but cannot be exported without a power grid, thus making it non-tradable.
Statistically, more services are now tradable yet the proportion is not large. Although the customs statistics cannot reflect precisely the figure of trade in services, as the measurement of trade in services is being improved, the result seems not to be too far off. While many services have become tradable, most of the major types of final services still cannot be traded. It is hard to fundamentally change the ratio of goods to services in trade. Despite the increasing share of the service sector in GDP (more than 50% in many countries and over 70% or 80% in some developed countries), even in the US, the ratio of total services exports to GDP is still relatively small.
Are there any other notable omissions in the statistics? Further research is needed. The Global Value Chain Development Report 2021 discussed services provided by joint ventures/foreign-owned businesses in the value chains, and service revenue in the form of capital gains. According to the statistical standard of GDP and GNP, the calculation of GDP based on the income approach includes the income of foreign residents, while factor income from abroad is counted in GNP. If the omitted income from trade in services is large enough, the difference is supposed to be observed by the discrepancy between GDP and GNP. However, when we compare countries’ GDP and GNP numbers, the difference is not noticeable. Further study may be needed to address this question.
Second, the omitted figure should be reflected at other places. From different parts of value chains we can obtain different answers to the question of how big the trade surplus/deficit between China and the United States is. Customs data predominantly cover the import and export of goods as trade of services does not go through customs, but the statistics of trade in services has improved, so we can have some general statistics.
Are the statistics accurate? I think the statistics for multilateral trade are generally accurate, even if that for bilateral trade, such as China-US trade, may be incorrect. By the income approach of the System of National Accounts (SNA), China imposes controls on the capital account which require all transactions in the capital account to be registered and checked. If the annual foreign exchange surplus is large after removing the capital account, there is a huge surplus in the multilateral trade balance. This was the case for some time in China during the global financial crisis, causing pressure on the renminbi to appreciate. From the perspective of Social Accounting Matrix (SAM), if trade in services is not accounted for in customs statistics, the missing value can be seen from the GDP calculated with the income approach. The above-mentioned method can very much complement the analysis from the perspective of value chains.
Third, can tax reform reflect the distribution of the value added in the value chains? In 2021, the G20 implemented tax reforms. One issue the reforms touched upon is related to the OECD's statement that taxes should be levied where value is created. Related to this issue is the 15% minimum corporate tax rate, which is intended to stop a “race to the bottom” in tax rates.
One of the controversies about taxation is whether the tax havens have taken a big advantage outside the value chains. Since the global financial crisis, the G20 turned its attention first to the tax havens (2009), then to the issue of tax base erosion and profit shifting (BEPS). According to the GDP calculated with the income method, the real income of tax havens is mainly service fees of local lawyers and accountants, and registration fees, etc. Capital gains there usually become investment in other places, so tax havens are merely a transfer station for capital flow. In this case, although taxes collected by Western countries are reduced, it can hardly prove that tax havens have profited at their expense. Moreover, these tax havens do not account for a large proportion in global GDP, so some believe there is no need to waste too much energy on them. This analysis is interesting as it shows that some capital does not belong to any country.
Of course, some capital income may be converted into personal income and deposited in private banks in Switzerland, so the G20 proposed the automatic information exchange pact in the follow-up measures, which mainly targeted these personal deposits, and dealt with them as tax evasion. China joined the pact as well and made a commitment. In general, it is necessary to estimate the approximate size of these tax loopholes. From the perspective of global value chains, many issues need rethinking and quantitative estimation.
Global Value Chain Development Report 2021 touched upon the issue of base erosion and profit shifting, as well as a new round of tax reform. The G20 and the OECD have proposed global tax reforms, which was applauded by a number of countries including the United States. This is easy to understand. But if one thinks about it carefully, s/he can find that the focus of the tax reforms is not on the digital tax, but the 15% minimum corporate tax rate. The tax reform may end the global tax race to a certain extent. However, the more important intention behind it may be to improve fiscal revenue of developed countries in the face of excessive fiscal deficits and excessive debt since the great financial crisis and the outbreak of the COVID pandemic. As for paying taxes at the place where value is generated, it is still a rough idea. We cannot be too optimistic about it at a stage where numerous problems in implementation are waiting to be addressed.
Fourth, multinational companies deserve more recognition. Taxation issues lead to the analysis of multinational companies, which is an important topic discussed in the Global Value Chain Development Report 2021. China's reform and opening up shows those multinational companies are a very positive force. Multinational companies have contributed a lot to the advancement of global manufacturing, value chains, and degree of economic openness. Meanwhile, we cannot deny that multinational companies also have flaws and abuse loopholes.
Since the global financial crisis, multinational companies have received much criticism. The United States has attempted to ask their companies to move production and manufacturing facilities back home, which reflects a trend of anti-globalization. When conducting studies on global tax reform and global value chain analysis, people need to avoid excessively attacking the multinational companies and underestimating their positive role and their voices. At the same time, we also see that many Chinese companies are growing into multinational companies, and the country has fostered some small and highly specialized multinational companies, a phenomenon that reflects China’s support for globalization and its active participation in global value chains.
Fifth, transnational digital platforms have brought challenges to the measurement of global value chains. The real challenge which deserves further research is measurement of the trade in services on multinational digital platforms. The digital economy involves a lot of trade in services. The various online services are difficult to calculate either by customs statistics, or foreign exchange statistics. It is because loads of services are free. How do businesses make money without charging fees?
One is from advertising, so more research is needed on how to measure the value of advertising, and how to collect taxes on advertisement. Second, platform companies that prepare to go public usually have a very high market value, providing opportunities to realize profits. Such income appear to be irrelevant to trade and value chains, but they have actually changed the trade landscape and service trade system which used to be based on cost accounting. Meanwhile, there are a large number of direct, indirect and cross subsidies, some of which are expressly opposed by the WTO. However, policy design with regard to the digital economy is not yet very clear, and answers are not readily available. I think this is the more important blow to value chain measurement.
This article is a translation of Zhou Xiaochuan’s speech at the 2022 Annual Conference of the Institute for the Service Economy and Digital Governance, Tsinghua University, held on January 10, 2022.It is translated by CF40 and has not been reviewed by the author. The views expressed herein are the author’s own and do not represent those of CF40 or other organizations.
