Statesmanship and creativity are needed as Washington and Beijing renegotiate a relationship that is too big to fail.

BY HENRY M. PAULSON JR.

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America’s Foreign Service officers are important voices for, and representatives of, our country abroad. Your hard work and diplomacy are vital to ensuring that America’s policies and priorities are understood by foreign leaders. I believe your work in China will be particularly important as the U.S.-China relationship will shape the geopolitical landscape for this century. I hope you find this article useful in considering this important bilateral relationship.

There’s a lot of finger pointing between Beijing and Washington these days. It is important to understand how the United States and China arrived at this moment of heightened tension. The drivers of the current downward spiral aren’t complicated.

First, we have diverging interests. On many issues where the United States and China should agree, such as North Korea, we often pursue divergent approaches.

Second, the United States and China disagree about important rules governing the international system. One example is maritime rights and customs—which brought our navies into a near-collision on the high seas last September.

Third, American and Chinese views are opposed in critical areas. For example, China and Russia argue for cyber sovereignty and the right of the state to control cross-border data flows. The United States and the European Union both reject those views.

Taken together, these and other drivers have fueled a new consensus in Washington that China is not just a strategic competitor, but very possibly our major long-term adversary. America’s long-standing “engagement” policy is now widely viewed as being of little use for its own sake. Nobody is arguing against dialogue. But nearly everybody is arguing that the results of U.S.-China dialogue and engagement have been poor.

Underlying tensions will persist beyond any single issue between our countries, such as trade, because the problems we face, and our divergence of views—even in the economic area— are broad. Unless these broader and deeper issues are addressed, we are in for a long winter in U.S.-China relations.

Economics, for Example

Let’s take economics. The United States played the decisive role in facilitating China’s entry into the World Trade Organization. Yet 18 years later, China still hasn’t opened its economy to foreign competition. It retains joint venture requirements and ownership limits. And it uses technical standards, subsidies, licensing procedures and regulations as non-tariff barriers to trade and investment. This is simply unacceptable. It is why the Trump administration has argued for change and modernization of the WTO system. And I agree.

But it also helps explain why so many influential voices in America now argue for a “decoupling” of the two economies. This negative view of China unites politicians from both left and right who agree on nothing else. Trade with China has hurt some American workers. And they have expressed their grievances at the ballot box. So, while many attribute this shift to the Trump administration, I do not.

These and other drivers have fueled a new consensus in Washington that China is not just a strategic competitor, but very possibly our major long-term adversary.

What we are now seeing will likely endure for some time within the American policy establishment. China is viewed— by a growing consensus—not just as a strategic challenge to America, but as a country whose rise has come at our expense. In this environment, it would be helpful if the U.S.-China relationship had more advocates. That it does not reflects another failure.

In large part because China has been slow to open its economy since it joined WTO, the American business community has turned from advocate to skeptic, and even opponent of past U.S. policies toward China. American business doesn’t want a tariff war, but it does want a more aggressive approach from our government. Even though many American businesses continue to prosper in China, a growing number of firms have given up hope that the playing field will ever be level.

Some have accepted the Faustian bargain of maximizing today’s earnings per share while operating under restrictions that jeopardize their future competitiveness. But that doesn’t mean they’re happy about it. Nor does it mean they aren’t acutely aware of the risks—or thinking harder than ever before about how to diversify their risks away from, and beyond, China.

The Risks Are Real

That brings us to the risks. Sadly, I think the risks of a new age of disruption are considerable. For 40 years, the U.S.-China relationship has been characterized by the integration of goods, capital, technology and people. And over these years, economic integration between the two countries was supposed to mitigate security competition. But an intellectually honest appraisal must now admit that the reverse is taking place. And economic tensions are reaching a breaking point.

After 40 years of integration, a surprising number of political and thought leaders on both sides advocate policies that could forcibly de-integrate the two countries across all four of these baskets. The integration of trade in goods could come undone— as supply chains are broken, especially for sensitive technology. Integration through cross-border capital flows will come under greater pressure as restrictions on Chinese investment take hold across big sectors in the United States.

Indeed, if this trend continues, integration of global innovation ecosystems may well collapse as a result of mutual efforts by the United States and China to exclude one another. Meanwhile, the integration of people, especially the brightest young students, could stall—as Washington potentially bans Chinese students from studying whole categories of science and engineering subjects.

If all this persists, I fear that big parts of the global economy will be closed off to the free flow of investment and trade. And that is why I now see the prospect of an economic “Iron Curtain”—one that throws up new walls on each side and unmakes the global economy as we have known it.

A U.S.-China Divorce?

But here’s the problem for those in the United States who advocate a U.S.-China “divorce”—decoupling is easier when you’re actually a couple. The United States can try to divorce; but what if others, especially in Asia, don’t want to follow suit? As a function of geography, economic gravity and strategic reality, I do not believe that any country in Asia can afford to divorce China, even if it wishes to. So in its effort to isolate China, America risks isolating itself.

But let’s also be clear that if Beijing wants to keep its relationship with the United States from spinning out of control, it’s going to have to look hard at some of its policies. Above all, China will need to rediscover the spirit of market-driven reform. 2018 marked the 40th anniversary of “reform and opening” in China, the remarkable transformation launched by Deng Xiaoping and other leaders in 1978.

The United States can try to divorce China; but what if others, especially in Asia, don’t want to follow suit?

It’s been a good run for China over these years. And it’s been an especially good run for China since it entered the WTO in 2001. Its $1 trillion economy in 2001 has become a $14 trillion behemoth today. Its $220 billion in foreign exchange reserves ballooned to a staggering $3 trillion.

But what China has lost, especially over the last decade and a half, is the bold impulse to reform that led leaders like Zhu Rongji to undertake significant changes to the state-led sector in the 1990s, as Beijing prepared for its WTO accession. Today, the prevailing view in the United States is that China is increasingly content to pursue its own standards, privilege its domestic rules, and erect rather than demolish walls for foreign competitors.

So I continue to encourage China’s leaders to pursue meaningful competitive and commercial reforms, and to do more to foster and protect innovation. The key to avoiding an economic “Iron Curtain” is for China to see its interest in making these reforms and changes. If China doesn’t move quickly, divorce is a real risk.

Considerations for Both Sides

While the current trajectory cannot be easily reversed, I offer these considerations for both sides.

For China: First, do no harm. For example, implement robust rules of engagement to prevent People’s Liberation Army Navy captains from undertaking the kind of maneuver that nearly resulted in a collision in the South China Sea last September.

Second, work constructively with America’s allies.

Third, be bold. Open your economy. Have confidence that your firms no longer need to hide behind a wall of government protection.

Fourth, be proactive in protecting proprietary foreign knowhow and end policies that compel technology transfer.

Fifth, work with the United States on its top strategic priorities, especially North Korea.

If the United States and China cannot find a way to develop a workable consensus, it will pose a systemic risk of monumental proportions.

As for the United States: First, dial down the rhetoric. Strategic competition is a fact. China does not pose an existential threat to American civilization. In the 243rd year of our great democratic experiment, we should have more confidence in America and the resilience of our system. We should prepare for the obvious challenges from China. But let’s not sacrifice those values that have made us the strongest, most competitive and most admired country in the world.

Second, enlist partners. And then, working in coalition with these partners, try to foster some workable understandings with Beijing. The World Trade Organization is perhaps the best example. It is in desperate need of an upgrade. So, China and the United States could be part of leading efforts to bring the WTO into the digital age.

In a similar vein, I wish President Trump would reconsider the withdrawal from the Trans-Pacific Partnership. A TPP 2.0 would offer a ready-made vehicle to shape the trade environment in which Beijing operates.

Third, negotiate with China and find frameworks to resolve issues.

Fourth, invest in America—big time. A strong military. A strong economy. Strong educational institutions. Strong investments in science and engineering. Openness to the world. Investment in alliances. Investment in security and economic partnerships on every continent, but especially in Asia and Europe. Getting our own policies right is essential to competing with China and to thriving in the 21st century.

New Framework Needed

If the United States and China cannot find a way to develop a workable consensus, it will pose a systemic risk of monumental proportions—not just to the global economy, but to international order as we know it, and to world peace. Both countries need an international system that functions, because international order is one of those things that is simply too big to fail. And so, the alternative is unacceptable. And that is why I am hopeful that statesmanship will prevail.

We are proceeding down divergent paths, and we are in danger of facing a long winter before we reach what may still be a rather patchy spring. But I believe a spring will come. So the questions are, how long will this winter last, and how much unnecessary dysfunction and pain will be inflicted along the way?

The answer will be determined by the capacity and willingness of leaders in Washington and Beijing to think creatively— and sometimes even disruptively. In 1972, our leaders established a framework for a world beset by Cold War and locked in ideological conflict. At various points, they’ve had to recalibrate. Today’s world looks nothing like the world of the 1970s, or of the 2000s, or even of the years when my friend [People’s Republic of China Vice President] Wang Qishan and I tackled the financial crisis in 2007 and 2008.

We’ve reached another of those consequential moments. And the stakes are higher than ever before. We must craft a new framework that works for today’s world, not the world of the past. And for that, we need statesmanship—wise and strong leadership in Washington and Beijing.

Henry M. Paulson Jr. served as Secretary of the Treasury from July 2006 to January 2009. Prior to that, he had a 32-year career at Goldman Sachs, much of it dealing with China. From 1999, he served as chairman and chief executive officer of the investment firm. Today he is chairman of the Paulson Institute, which aims to advance sustainable economic growth, a cleaner environment and cross-border investments in the United States and China.

An extended version of this article was presented by the author on Nov. 7, 2018, in Singapore at the Bloomberg New Economy Forum. To read the entire speech, visit http://bit.ly/Paulson-US-China.

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