Is the WTO the Worst of Both Worlds for U.S.-China Tech Competition?

The World Trade Organization (WTO) was envisioned as a forum for countries to resolve sensitive trade disputes based on generally applicable rules without escalatory, unilateral measures. Such a forum could play a valuable role in mitigating the escalating tensions between the United States and China over the future of high-tech industries. Instead, the WTO has been largely sidelined in the face of potentially intractable issues. Among these is the problem of “CCP, Inc.”—the phenomenon of China’s economic model blurring the lines between the actions of state and private entities. China’s use of “government guidance funds” to subsidize strategic industries is an increasingly prominent example of this dynamic. The WTO may be unprepared to address these issues under current rules and Appellate Body jurisprudence.

U.S. Secretary of State Antony Blinken emphasized the importance of the rules-based order in his March meeting with Chinese officials in Anchorage, Alaska. The WTO will test that position as applied to U.S.-China economic competition. As the Biden administration reconsiders the role of industrial policy in the U.S. economy, it will need to ask whether the United States should follow WTO rules even if it believes they cannot be enforced against others.

The WTO Challenge

The WTO is a beleaguered institution. Languishing negotiations and simmering frustrations regarding the dispute settlement mechanism have led the United States to block the appointment of new members to the Appellate Body, bringing dispute resolution to a halt. The vacuum created by loss of faith in the WTO’s multilateral trade rules has been filled with unilateral actions, largely under national security auspices. In a Yale Law Journal article on national security challenges to the economic order, J. Benton Heath writes that this “presents an acute challenge for international economic institutions” like the WTO. It also raises serious questions about the costs of “decoupling” the U.S. and Chinese economies. As the National Security Commission on Artificial Intelligence warns, “dramatic steps to sever [U.S.-China] ties could be costly for Americans and reverberate across the world.”

In this context, the WTO’s malaise is unfortunate. A viable multilateral forum for managing the economic aspects of U.S.-China tech competition could play a valuable role in filling the gaps in national security tools. It could also provide a lower-stakes framework for resolving disputes. WTO rules under the Agreement on Subsidies and Countervailing Measures, for example, discipline subsidies that harm the economic interests of other members. Subsidies are routinely stated as an aggravating factor in the U.S.-China competition for superiority in high-tech industries. But skepticism regarding the ability of WTO rules to discipline “CCP, Inc.” may leave U.S.-China competition to proceed in more militaristic terms.

The Battle for Critical Core Technologies

China’s 14th Five-Year Plan coincides with the beginning of a “new development stage” (新发展阶段) in which the country’s leaders envision a transition from accumulating wealth to exercising power. For Chinese leaders, technology is a chokepoint in that process.

In January 2016, Chinese President Xi Jinping said that “although our country has vaulted to the second largest economy in the world, we are still not strong.” To the contrary, he said, “The problem is fairly obvious that we are bloated, complacent, and weak, and this is clearest in our weak innovative capabilities.” Despite progress in China’s overall technological advancement, he continued, “there has still been no fundamental change in the fact that our critical core technologies are controlled by others.”

The concept of “winning the battle for critical core technologies” (打好关键核心技术攻坚战) has become common in official policy pronouncements. The 14th Five-Year Plan makes “self-sufficiency” in this area “a strategic pillar of national development.” It is widely acknowledged that subsidies are key to these efforts. But not all subsidies are clearly “subsidies” within the meaning of the trade rules.

Subsidies With Chinese Characteristics: Government Guidance Funds

Just as the Chinese economy has evolved, so have the mechanisms of state support for strategic industries. When China’s reform process began in the late 1970s, the government controlled the economy through state enterprises that operated as administrative arms of the state. The government’s attempts at reform during the 1980s and 1990s presented a number of questions. Which state assets would be “corporatized” into commercial enterprises? Which of these corporatized entities would be opened up to private investment? To what extent should the government permit non-state ownership? In other words, the original reform question was whether and how to relinquish control over assets that were operating under state auspices.

The proliferation of new companies in high-tech industries has presented the Chinese government with the obverse problem: whether, to what extent, and how to influence the development of industries and enterprises operating under private auspices. The concept of “mixed ownership reform” traditionally meant permitting a certain level of private ownership of state firms. The first major state ownership reform plan of the Xi era, however, made mixed ownership reform a two-way street. Developing “mixed ownership structures” (混合所有制) now includes injecting state capital into key areas of the private economy. Subsequent government plans have reiterated this priority with respect to both state and private enterprises.

The government has injected state capital into the private economy using hybrid state/private investment vehicles called “government guidance funds” (政府引导基金) or “government investment funds” (政府投资基金). Although the government guidance funds have just recently become a major point of emphasis for central government planners, they are not an entirely new phenomenon. The earliest government guidance fund is commonly identified as the Zongguancun Venture Capital Guidance Fund, which was established in Beijing in 2002.

Guidance funds proliferated rapidly across the country after 2008, when the State Council encouraged subcentral governments to establish funds and experiment within certain broad parameters. In a pattern typical of Chinese industrial policymaking, this period of subcentral experimentation was followed by a reassertion of central government oversight around the beginning of 2015.

At a State Council meeting in January 2015, Premier Li Keqiang highlighted a policy of “establishing national emerging industry venture capital guidance funds” to support innovative enterprises in the early stages of development. The idea was to leverage government investment by “drawing in participation of private capital ... to form emerging industry venture capital guidance funds” in support of “early and mid-stage emerging industries and innovative startup companies.” The Ministry of Finance followed with two additional measures providing more detailed rules and policy guidance for fund establishment and operation.

According to recent estimates, there were 2,156 government guidance funds nationwide as of October 2020. Their fundraising targets exceed RMB 11.6 trillion, of which approximately RMB 4.3 trillion is already in place. Most of these funds have been established at subcentral levels of government, especially at the prefectural (shi) level, one jurisdictional step below provincial governments.

Guidance fund investment is focused in high-tech sectors. According to recent estimates, more than 60 percent of funds are focused on artificial intelligence (AI), big data, the “Internet of Things,” and other technology, media, and telecommunications sectors, with 25 percent in health care and 11 percent in other industries. Guidance funds have also been created to support investments in China’s military-civil fusion efforts.

These funds are explicit actors in China’s industrial policy implementation. As part of an AI industry action plan announced in September 2019, the Shanghai government established a RMB 10 billion AI industry investment fund. The plan is to expand it to RMB 100 billion by setting up subsidiary funds, while the parent acts as a “capital magnifier.” It aims to focus investments in areas including AI chips, sensors, AI algorithms, smart cars, robotics, big data and cloud computing.

These initiatives have been characterized as “marketizing” government investment. In reality, they allow the Chinese government to both subsidize the cost of capital and plant the seeds of ownership and control throughout the Chinese industries at the heart of U.S.-China competition.

Guidance funds are likely to do the opposite of “marketizing.” Rather than expanding the role of market forces, guidance funds exacerbate concerns that Donald Clarke raised more than a decade ago regarding the first wave of Chinese state-owned enterprise reform. He worried that “part of enterprise reform involves a magnification of the scope of direct state control through leverage” (emphasis in original). Given their expansive presence in the Chinese economy, this threat exists even if many funds are ultimately mismanaged or otherwise unsuccessful.

A Role for the WTO?

U.S.-China economic competition is increasingly viewed through the lens of conflict between democracy and authoritarianism. But there are less ideological concerns regarding the Chinese government’s efforts to extend its reach into the private sector and key high-tech industries.

Government guidance funds may one day finance the technological breakthrough that permanently alters the balance of power in the Indo-Pacific region. But before that happens, they are more likely to drastically misallocate resources and perpetuate economic imbalances that will be familiar to steel, aluminum and solar panel manufacturers around the world. Such distortions could prove problematic for U.S. firms making long-term, multibillion-dollar investments. In that sense, addressing the Chinese government’s market interventions is as much about prices and market share as it is about winning wars and defending the United States’s role in the world.

From the perspective of governments that play a less interventionist role in the economy, China’s government guidance funds have the hallmarks of harmful subsidies that should be amenable to redress under WTO rules. Entities that are partially owned and controlled by the state are channeling government financial support to strategic industries and enterprises pursuant to the government’s industrial policy priorities. Some U.S. industries, in turn, have asserted economic harm as a result.

Legal outcomes, however, are not always consistent with common sense. The United States, the European Union and Japan, for example, have taken the position that the Appellate Body’s definition of “public bodies,” a legal element in a subsidies claim, is too narrow to discipline the actions of quasi-state entities like guidance funds. They argue that new definitions are needed. In the WTO’s consensus-based system, however, it could be impossible to convince countries like China to agree to new rules that explicitly target their own development strategies.

Even if the United States were to prevail in a subsidies case, compliance would be challenging. China has long questioned the legitimacy of the rules-based order that the WTO once exemplified. The opening exchange between U.S. and Chinese officials during their recent meeting in Anchorage suggests that China may be unwilling to accept any efforts by the Biden administration to revive the “rules-based order” in managing U.S.-China tensions. When even like-minded allies seem incapable of resolving sensitive disputes through the WTO, pessimism regarding the institution’s ability to play economic peacemaker between the United States and China seems justified.

It’s Time to Decide

Industrial policy was anathema to the neoliberal orientation of U.S. economic policy after the Cold War. But it is getting a new hearing as part of the strategy to compete with China. For example, the Biden administration has issued an executive order regarding government action “to strengthen the resilience of America’s supply chains” in selected industries. The Semiconductor Industry Association has called for more “government incentives” for U.S. semiconductor manufacturing, and Congress has obliged in the 2021 National Defense Authorization Act. But the Biden administration’s flexibility in implementing policies like these could be limited to the extent that it feels obligated to do so in a WTO-consistent manner.

The Biden administration inherited a dysfunctional WTO, but it owns the next decision regarding the United States’s future in the institution. If the administration’s position in managing U.S.-China competition is that the rules-based order “is not an abstraction,” then the WTO would be a good place to start proving that point. This would include achieving incremental progress toward U.S. reform priorities and demonstrating that dispute settlement can be an effective means of managing sensitive issues.

If that proves unrealistic, the administration should communicate to agencies and stakeholders that the U.S. government will implement domestic policy priorities without regard to WTO disciplines. If the WTO is a “sideshow,” as some observers have suggested, and it is “game on” between the U.S. and Chinese governments, U.S. policy should at least benefit from the greater flexibility that comes with that posture. As long as the United States feels bound by rules that it cannot enforce when the stakes are high, the WTO may be the worst of both worlds.