Pressuring China on Subsidies vs. Pressuring China on Consumption

If I understand their views correctly, some of the more hawkish voices on China's economic practices see a link between the Chinese government's high level of industrial subsidies, on the one hand, and the low level of consumption by Chinese citizens, on the other. Under this view, action by the Chinese government to reduce subsidies would contribute to a shift towards higher Chinese consumption, which would help correct imbalances in global trade. Thus, what the U.S. and other governments should be pushing China for, these folks argue, is an overall rebalancing of the Chinese economy along these lines: Less production, more consumption.

Of course, subsidies aren't the only factor suppressing Chinese consumption, according to this view. Michael Pettis, with whom I sometimes spar over these issues, recently listed the following domestic policy areas in which China could make policy changes in order to achieve greater domestic consumption (subsidies are at the end of the list):

· Faster wage growth transfers income from employers to workers.

· Larger social transfers shift income from the state to retirees and the poor.

· Lower income taxes or consumption taxes increase the GDP share of household disposable income.

· Pro-union legislation, or the elimination of residency restrictions, transfers income from employers to workers.

· Stricter environmental protection transfers income from industrial polluters to local households.

· Reducing subsidies to manufacturing, infrastructure, or favored borrowers shifts resources away from producers and toward households.

After presenting this list, he stated: "Although these policies appear very different, they all accomplish a similar macroeconomic objective: raising the household share of GDP while reducing the producer share, thereby reducing the excess saving that ultimately manifests itself as current account surpluses."

Just to state clearly what I think will be obvious to trade policy experts, there is an important difference between industrial subsidies and the other items on the list: For subsidies, when China joined the WTO it agreed to abide by the obligations of the SCM Agreement and its Accession Protocol, whereas China did not sign on to an international agreement for the other items. As a result, there isn't much scope for governments to press China on the other issues. Obviously, any government can raise whatever issue it wants with any other government. But I'm not sure the Chinese government is going to pay much attention to what foreign governments have to say on these other issues. (I doubt the U.S. government would take action if it were pressed by other governments on all this). I suppose the idea is to impose some sort of sanction in order to pressure China, but I'm skeptical that China would respond positively to that.

By contrast, because China did sign on to an international agreement on subsidies, there is a clear avenue for others to exert pressure in a constructive way. China's record on compliance with adverse WTO dispute settlement decisions is decent, so why not try to enforce the rules on subsidies? The arguments I've heard against bringing WTO complaints here are not very persuasive. Yes, these complaints can take a while, but (1) if the complaints had been brought back in 2018 when the conversation around these issues picked up, we could have made a great deal of progress already and (2) if we don't start the complaints now, we could still be talking about all the same things in 2034. And the alternative approaches that have been used in the meantime haven't gotten us anywhere.

Turning to "the need to strengthen household consumption" (as Pettis puts it), while I think that Chinese government subsidies and other non-market practices are a real problem, the broader logic tying producer subsidies to household consumption is not as convincing. It's certainly possible that consumption would rise if Chinese government subsidies to producers were reined in, but the actual consumption outcomes depend on what exactly is done with the money previously given to producers. Would consumption go up a bit if the Chinese government transferred more money to retirees and the poor? Probably. But it's worth emphasizing that the debate over transfers to retirees and the poor happens everywhere, and is a very sensitive one in domestic politics. It's difficult to influence how other governments approach this, and my sense is that the views of the Chinese government about these policies are firm and not easily changed.

But that doesn't mean people should ignore the subsidies. While reducing subsidies to industry may or may not translate into much greater consumer spending, these subsidies do have a real impact on trade flows. As part of the effort to create a level playing field, it makes sense to enforce the rules on subsidies that every government agreed to. Thus, other governments should press China on complying with WTO rules on subsidies (and the behavior of state-owned enterprises as well). This shouldn't be particularly controversial, as it just means enforcing the international rules in this area. While there's no guarantee of a big payoff in terms of increased Chinese consumption as a result, it would help make everyone feel like the trading system is operating under terms that are fair.