The real problem is FDI
The finding that there is no casus belli for a classic trade war is confirmed ifone looks carefully at the complaints enumerated by the United States or at thedetailed report published by the European Chamber of Commerce in Chinasummarising the complaints from its over 1,600 member companies. This reportdoes make interesting reading because one does not find many complaints about‘trading’ practices, at least in the narrow sense (European Chamber, 2019). Themain complaint of EU enterprises in China is the perception of unfair treatmentby the Chinese authorities. The main complaint of the US government is thatUS high-tech firms are forced to reveal their technology and trade secrets. Anadditional common complaint is that, in many sectors, foreign firms are not permitted to hold a majority stake in joint ventures. The core of all these complaintsis thus not trade but FDI, and the situation ‘behind the border’, in the Chinesemarket. Measuring barriers to FDI is as difficult as measuring non-tariff barriers totrade. Barriers to cross-border investment can take many forms, such as limitson foreign ownership in certain sectors, different fiscal treatment for foreign-owned enterprises, or outright bureaucratic discrimination. The Organisation forEconomic Cooperation and Development (OECD) publishes a composite indicator of restrictiveness towards FDI (OECD, 2018). For China, this indicator
shows that, overall, the country is far less open than OECD countries, but that there has been continuous, albeit slow, improvement.
A further subtle distinction one needs to make is between barriers to new inflows of direct investment (i.e. investment with the implication that the foreign investor obtains control over the investment) and the treatment of enterprises that are under foreign control. In most OECD countries, a company incorporated in a different home country is treated in the same way as any other domestically incorporated company (this is called ‘national treatment’). But in China, there is a special regime for ‘foreign-invested enterprises’ (FIE). In the past, the purpose of this special regime might have been to protect foreign investors from an overbearing domestic bureaucracy. But today, there is a widespread perception that ‘foreign-invested enterprises’ are not treated fairly.
The complaints have come in light of the rapidly changing context in China itself. The real change might simply be that, in the past, the formal handicaps that foreign-owned enterprises faced were compensated by the eagerness of the provincial authorities to attract foreign investment. As long as provincial leaders were also judged on the amount of FDI they attracted, they would provide many incentives to outweigh the formal restrictions on FIEs. Today, there is less emphasis on growth in the evaluation criteria of provincial leaders, which means local authorities have less reason to provide incentives for FDI.
Moreover, the technology gap between Chinese and foreign enterprises is shrinking rapidly in many sectors. Restrictions on majority foreign ownership mattered little in the past when the formally majority Chinese partner (often owning 51%) had an incentive to acquiesce to the de facto control of a foreign investor who had superior technology or market access abroad. With technology on a more level playing field, it is the restrictions on foreign majority ownership that start to matter. This is also the reason why it is more appropriate to speak about a ‘technology' war’ than a ‘trade war’.