China and America Should Strike a Grand Bargain

by Arvind Subramanian, Peterson Institute for International Economics

Op-ed in the Financial Times
June 6, 2013

© Financial Times


When Barack Obama and Xi Jinping meet in Annenberg, California, the desert air will vibrate with the rhetoric of cooperation. The reality is different. The two most important countries in the world are involved in economic skirmishes that could corrode the institutions through which the global economy functions.

When Xi, who is set to be president of China for the next decade, meets the next US president in a few years' time, the World Trade Organization (WTO), World Bank, and the International Monetary Fund (IMF) could all be in positions of irrelevance. This would be a disaster for the rest of the world's economies.

The way forward is for the United States and China to strike a grand bargain. It would require an exchange of power for purpose. In other words, Washington would give up power in these institutions in return for China taking on greater global leadership to preserve the system's real purpose—free and fair globalization. But first they will have to overcome an increasing level of mutual mistrust.

China has been the biggest beneficiary of the open global system. Nevertheless it resents the fact that its rules have been shaped by the United States. For example, America has not ratified changes in the voting arrangements in the IMF that would give China more say. The United States has been reluctant to countenance an increase in the lending capacity of the World Bank. As a result, China is creating parallel structures: the BRICS (Brazil, Russia, India, China, and South Africa) bank to rival the World Bank and regional trade initiatives such as the Regional Comprehensive Economic Partnership to parry American forays into Asia.

For the United States, mistrust stems primarily from China's military ambitions and its cyber espionage. And on the economic front, it comes from China's mercantilist exchange rate policy, closed financial and foreign exchange system, toleration of intellectual property violations, and the continued prevalence of its state capitalism. In the American view, China takes advantage of the openness of others while remaining relatively closed itself, a combination that is inconsistent with global leadership. This perception has led the United States to pursue initiatives such as the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP), free trade talks with Asia and Europe respectively. These promote liberalization but they also discriminate against China.

What would the grand bargain consist of? The United States should work to increase the power and influence of China in multilateral financial institutions, such as the IMF and the World Bank, to parity with that of the United States and Europe. The United States, and especially an indebted Europe, should no longer have veto power in these institutions—but if they do, so too should China. The United States should actively promote the rise of the renminbi as an international reserve currency. Providing China is forthcoming, the United States should pause discriminatory initiatives such as the TPP and TTIP in favor of a new WTO-led liberalization initiative.

By way of contributing to sustaining the open economic system, China should offer to substantially increase the size of the IMF to provide collective insurance against global shocks. It should work towards a new multilateral round of trade negotiations (a "China Round") where it would constructively engage in opening its markets in return for partners addressing some of its concerns. This would be credible only if China were willing to take actions at home to open its financial and exchange markets and reduce the presence of state capitalism.

Why should the United States be willing to cede power? If China is empowered in existing institutions, it will have a greater incentive to preserve them. For example, if the renminbi were to become a reserve currency, China would be reluctant to jeopardize that by closing its markets to foreigners or expropriating property. If it has more say in the World Bank, it would be less inclined to pursue the BRICS bank. Multilateralism could help constrain China by defining norms of legitimate behavior. Such soft power is one of the last few weapons in the depleting arsenal of influence over China.

Why should China be willing to take on additional responsibilities when it has pressing challenges at home? Because the two are consistent. China's rebalancing strategy, from high levels of capital investment to rising consumption, requires a new bout of liberalization with reform of state enterprises and the opening of financial markets. This is also what outsiders want and an open trading system needs. Similarly, by contributing to a stronger IMF, China would be taking out insurance against global financial instability that would eventually be very costly for its own export-dependent economy.

The United States bequeathed an open, rules-based, multilateral economic system after the Second World War even though as a hegemon it did not really need it. Today, at a time of its relative decline, the United States needs that system as the best defense against a resurgent China. To do so, it must resist its instincts and embrace its interests—by giving power away.

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