How the United States Uses the Trans-Pacific Partnership to Contain China in International Trade

The U.S. achieved an important strategic objective in its efforts to contain the People’s Republic of China (China) in global trade when the historic Trans-Pacific Partnership (TPP) was signed on February 5, 2016.11

The negotiations leading to the TPP have been called the most significant since the Uruguay Round of negotiations that led to the establishment of the World Trade Organization (WTO).22 Now open for ratification,33 the TPP is a vast free trade agreement covering the Asia-Pacific region and encompassing forty percent of world trade.44 The TPP promises “WTO plus” treatment—that is, trade privileges more favorable than those available under the World Trade Organization for all of TPP members, but not available for non-members, such as China.55 The TPP now stands ready for ratification by its twelve members: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the U.S., and Vietnam, with other countries, such as South Korea, expressing interest in joining.66 If the TPP gets ratified and becomes legally binding,77 it will be an unprecedented mega free trade agreement and could permanently change the course of international trade in Asia by shifting power to the U.S. and away from China.88 This possible shift can be seen in the glaring exclusion in the list of TPP members: China—the world’s second largest economy located right in the heart of the territory of the TPP—was not invited to join in the TPP negotiations or to sign the agreement.99

China’s exclusion from the TPP negotiations was no accident, but instead was a deliberate ploy by the U.S. to limit China’s growing global trade influence starting right in China’s own backyard.1010

The U.S. did not want China’s input on the terms of the TPP as is; rather, the U.S. wanted to dictate the terms of the TPP on its own, with the cooperation of the other compliant TPP members.1111 Now that the negotiations over the TPP text have been formally concluded and the ratification process has begun, China can join the TPP, but only under conditions imposed by the U.S. in the text of the TPP.1212 China will be allowed to join only by accepting all of the terms of the TPP as is, and is without any power to alter, propose revisions, or dilute any of its provisions unless approved by all the TPP countries, including the U.S.1313 Moreover, in order to join the TPP, China might have to undergo a humiliating process of submitting its terms of admission, essentially an application, to the U.S. Congress for review and approval,1414 a process that could take several years and could expose China to many additional demands by Congress that China must accept as conditions of joining the TPP. Congress might also relish the opportunity to use the approval process to scold and embarrass China in its conduct of international trade.1515

Creating an “anyone but China club”1616

was an express and aggressive objective of the U.S. in establishing the TPP. Although China was never a party to the TPP negotiations, China played a key role in the positions advocated by the U.S. In the words of one observer, “China is the ultimate target of every major U.S. proposal in the [TPP, a] ‘new generation twenty-first-century agreement.’”1717 One of the motives behind the TPP is to force China into accepting obligations that exceed those of the WTO.1818 Many politicians, trade unions, and businesses believe that China was able to reap the advantages of its WTO membership while paying little in return.1919 In exchange for the benefits of obtaining greater access to foreign markets, WTO members are required to reduce trade barriers in order to open up their own markets to other WTO members.2020 After it joined the WTO, however, China allowed many of its trade barriers to persist by ignoring many of the rules of the WTO.2121 For example, China gained trade advantages by continuing to subsidize its massive state-owned enterprises and by ignoring intellectual property rules.2222 In other words, some critics regard China as a free-rider of the WTO, reaping the benefits of the WTO while not playing fair through contributing in kind by following the rules of international trade.2323 The TPP can help to rein in China’s behavior by imposing rules that exceed WTO obligations, backed by the TPP’s own dispute resolution process that will have the bite of trade sanctions for refusing to comply with TPP obligations.2424 The TPP itself is compatible with the WTO, which means that TPP countries continue to be bound by the WTO2525 and that the TPP cannot be challenged by China under the WTO as discriminatory or otherwise unlawful.2626

Reining in or constraining China in international trade is achieved by the TPP through a number of specific trade provisions; the major provisions are the subjects of study in this Article. For the U.S. government, these various provisions of the TPP serve three important objectives, set forth below, which both threaten and constrain China. These three features of the TPP seem to put China in a difficult conundrum—China can suffer losses in international trade by refusing to join the TPP, or it can join the TPP and be subject to the humiliation of having to abide by rules written by the U.S. with the express intent of containing China.

First, the threat to China if they refuse to join the TPP is a loss of trade with the U.S. and other TPP members.2727

From an economic perspective, the TPP, like all preferential trade agreements (PTAs), is a double-edged sword in that it both creates and diverts trade.2828 PTAs increase trade among their members because intra-PTA trade faces fewer trade barriers.2929 For example, in the trade of goods, PTA members are allowed to offer “WTO plus” treatment, such as lower tariffs than the WTO rate (and ultimately zero tariffs) for goods traded from other PTA members.3030 This helps to increase the trade in goods among PTA members, as imports are less expensive, since, they come in at lower tariffs or even duty free,3131 than imports from China, which are subject to the regular WTO rate from TPP members.3232 Assuming that the quality of the imports is the same or similar, importers from PTA members would prefer to buy goods from other PTA members as opposed to non-PTA members because goods from PTA members are less expensive.3333 Therefore, if China does not join the TPP, China might suffer losses in its trade with the U.S. as well as other TPP members.3434 This could lead to the reduction of the record $365.7 billion trade deficit that the U.S. has with China as of 2015.3535 The ever-expanding U.S. trade deficit with China has proven to be an incendiary and bitter political and business issue in the U.S.,3636 fueled by beliefs that China is cheating in international trade.3737 The TPP could help to address these grievances by diverting trade away from China and directing trade toward other countries, such as Australia, that enjoy more friendly relations with the U.S.

Second, if China does join the TPP, China will be constrained because the TPP will erode many of the trade advantages that China now enjoys and is able to exploit under the WTO.3838

For example, according to many critics, China does not enforce laws relating to workers’ rights.3939 China has allowed its workers to toil long hours in unsanitary and dangerous working conditions with few rights to demand any changes.4040 Although China has high-level labor laws dealing with all of these issues, China does not enforce them, thus allowing labor abuses to continue without any consequences.4141 Aside from the social issues of human rights, the non-enforcement of labor laws reduces the costs to the employer of labor in manufacturing. Low labor costs allow China to charge lower prices for its goods that are exported to the U.S. The TPP will impose higher labor standards on China, increasing the protection for China’s workers and at the same time increasing the prices of its goods.4242 The TPP also creates a dispute settlement mechanism that other TPP members can use to compel China to either enforce these obligations or face sanctions under the TPP.4343

Similarly, China does not enforce environmental standards in producing its goods, leading to not only the degradation of the environment, but more importantly in the context of trade, to lower-priced goods.4444

Refusing to follow high-level environmental standards and continuing to use “dirty fuel,” such as coal-fired power plants, that pollute the environment, is a serious social issue. From a trade perspective, dirty fuel is a cheaper way to produce goods that can out-compete U.S. produced goods based on price.4545 The U.S. uses environmentally sustainable sources of power to manufacture goods.4646 Of course, using environmentally sustainable power involves the use of expensive technologies that result in higher costs that are passed onto the consumer of products in the form of high prices. China can charge lower prices because it does not use more expensive forms of production that are friendly to the environment. The TPP would impose environmental obligations on China that would force China to use manufacturing processes that are more environmentally friendly and expensive. China would need to raise prices for its goods and this obligation would help to even the playing field between the U.S. and China.

Other measures that China currently maintains are financial and regulatory support of China’s massive state-owned enterprises (SOEs) that benefit from myriad forms of state assistance and from discrimination against foreign companies located in China.4747

These SOEs are thus able to lower the cost of their goods or services that are provided in China and abroad and out-compete foreign companies located in China due to favoritism from the Chinese government.4848 The TPP is designed to neutralize the advantages that China enjoys from its treatment of SOEs.4949

Third, the TPP is a shot aimed squarely—by the U.S.—at China that lets China know in no uncertain terms that the U.S., not China, intends to write the rules of international trade for Asia and the rest of the world in the twenty-first century.5050

The U.S., with a few of its close allies in Europe and Japan, has essentially written the rules of international trade for the past seventy years since the end of the Second World War.5151 Recently, however, this paradigm has come under siege from China. In the past decade, China has entered into many free trade agreements that differ in fundamental ways from the U.S.-led rules of international trade.5252 In contrast with U.S. trade agreements, China’s free trade agreements have no meaningful provisions concerning workers’ rights, the environment, or SOEs.5353 Earlier this year, China established the Asian Infrastructure Investment Bank (AIIB) with a set of rules for international financing that directly challenges the U.S.-dominated World Bank and International Monetary Fund that have controlled international lending for the past seventy years.5454 The AIIB is a direct challenge to the U.S. in setting investment rules in Asia and other countries.5555 The TPP is the U.S.’s latest volley in the growing rivalry between the U.S. and China on who will write the rules of international trade for the twenty-first century.5656 How China responds to the threat and challenge of the TPP is an important development in this growing rivalry between the two largest economies in the world.

This Article will develop the themes set forth above by proceeding in three sections. Section II will discuss the nature of preferential trade agreements and their relationship to the WTO, and detail how PTAs both create and divert trade and the threat this poses to China if China refuses to join the TPP. Section III of this Article will examine how joining the TPP will neutralize key advantages China currently enjoys in international trade, including concerns related to workers’ rights, the environment, and state-owned enterprises. Section IV will discuss how the U.S. and China are locked in a fierce battle on who will write the rules for international trade in the twenty-first century and how the TPP appears to be a major victory for the U.S., assuming that the TPP is ratified by the U.S. Congress,5757

in this ongoing battle. Section V then concludes with some observations about future developments, including how China might respond to the TPP.

The TPP is a comprehensive PTA that not only liberalizes the trade in goods,5858

but also includes trade in services,5959 financial services,6060 telecommunications,6161 foreign direct investment,6262 government transparency and anti-corruption,6363 coherence in government regulation,6464 and technology transfer (intellectual property).6565 The TPP also has an effective dispute settlement system, modeled after that of the WTO, that is generally regarded as a great success in enforcing WTO obligations.6666 Similar to the WTO, the TPP’s dispute settlement system can authorize trade sanctions to enforce TPP obligations, which makes the TPP’s enforcement mechanism one of its key features.6767

In order to facilitate an understanding of how the TPP—or any preferential trade agreement—works, the following discussion will focus on the trade in goods because it is still the most fundamental and important channel of trade, far exceeding all other channels of trade (services, investment, and intellectual property) in monetary terms.6868

In addition, understanding how PTAs liberalize the trade in goods will also help in understanding how the PTA liberalizes trade in services, investment, and technology (intellectual property) as the same basic principles apply (with some variations) in all these channels. This discussion also explains the relationship between the TPP and the WTO, and why the WTO both permits and encourages preferential trade agreements like the TPP.

The twelve countries that are members of the TPP are also members of the WTO and are subject to the obligations of both organizations.6969

  Established in 1995,7070 the WTO remains the landmark and fundamental multilateral treaty that governs most international trade in the world today.7171 Trade in goods among WTO member nations (currently consisting of 164 nations, including all TPP countries) is governed by the General Agreement on Tariffs and Trade (GATT).7272 The GATT is one of the three major WTO agreements covering world trade. The other major agreements are the General Agreement on Trade in Services (GATS),7373 which covers services trade, and the Agreement on Trade-Related Intellectual Property Rights (TRIPS),7474 which covers trade in technology or intellectual property.

Of these agreements, the GATT has the longest and most venerable history, beginning in 1947, immediately following the Second World War.7575

Prior to the GATT’s promulgation in 1947, no international discipline existed to curb the power of countries to impose tariffs on imports at the border.7676 This meant that countries could impose tariffs at any level they pleased without violating any international legal obligations.7777 In the period prior to the Second World War, many countries imposed draconian tariffs as protectionist and nationalistic sentiments ran high.7878 In 1930, the U.S. enacted the Smoot-Hawley Tariff Act7979 , which imposed tariffs that averaged over fifty-three percent of the value of the products imported into the U.S.8080 Other countries also passed similarly draconian tariffs.8181 The purpose of these prohibitively high tariffs was to prevent trade.8282 Nations refused to trade and viewed each other with mistrust and hostility.8383 The protectionist and nationalist sentiments that swept the globe in the 1930s contributed to the eruption of the Second World War that inflicted catastrophe upon the world.8484 One lesson from the Second World War is that nations in economic conflict often fall into military conflict.8585

The GATT (1947) was intended to impose much-needed discipline on the use of tariffs in order to avoid the disastrous use of tariffs to create barriers to trade that engendered suspicion and hostility.8686

Under GATT Article II1(b), each nation, after negotiating and reaching agreement with all other GATT (and now WTO) members, will establish a GATT schedule, that is, a schedule for all tariffs that a GATT/WTO member will impose on imports from all other GATT/WTO countries.8787 Each nation’s tariff schedule is filed with the WTO and is attached to the GATT as an annex.8888 Under GATT Article II, each nation has an obligation to impose tariffs no higher than the tariffs in its GATT schedule.8989 In other words, the nation’s tariffs are “bound,” that is, subject to a ceiling created in its GATT schedule.9090 A nation that imposes a tariff that exceeds its GATT schedule is in violation of Article II of the GATT/WTO and will have to withdraw the tariff or face consequences under the WTO dispute settlement process, 9191 which has proven to be an effective dispute resolution mechanism.9292 After the initial tariff schedules were established as a result of GATT (1947), GATT nations then engaged in successive rounds of negotiations to further reduce tariffs in order to facilitate international trade.9393 The result of these negotiations has been an outstanding success.9494 Tariffs have been reduced significantly from the pre-GATT era as a result of the promulgation of the GATT and subsequent rounds of negotiations.9595

Due to common political and economic interests, some nations have sought to reduce tariffs even further than their GATT commitments.9696

Some nations, such as the U.S., wish to have free trade, that is, zero tariffs, on imports from important allies in order to reward friendly nations and to deepen existing political ties.9797 The issue that arises with such free trade arrangements is the limits imposed by Article I of the GATT9898 , the most-favored-nation (MFN) principle, a bedrock and sacred pillar of international trade. Article I(1) of the GATT reads in relevant part:

With respect to customs duties and charges of any kind imposed on or in connection with importation . . . any advantage, favour, privilege or immunity granted by any contracting party to any product . . . shall be accorded immediately and unconditionally to the like product originating in . . . the territories of all other contracting parties.9999

The goal of the MFN principle is to ensure that members do not offer special preferences to some countries while denying the same benefits to other WTO members.100100

In this sense, the MFN principle is really a principle of non-discrimination, as opposed to a principle of favoritism as the name might suggest.101101   A WTO member must extend equal treatment to all other WTO members and cannot discriminate in favor of, or against, any other WTO member.102102 In the context of tariffs, the gist of the MFN principle is that any GATT/WTO member that offers tariff preferences, including zero tariffs, to any other GATT/WTO member must immediately and unconditionally offer the same tariff preferences to every other WTO member.103103 Under the MFN principle, it becomes impossible to have a preferential trade agreement such as the TPP. The whole point of the TPP is that TPP members receive preferential treatment that is not available to non-TPP members. Under the MFN principle, such preferential treatment is discriminatory and a violation; a nation that extends zero tariffs to goods from another nation must immediately and unconditionally extend zero tariffs to all other WTO members.104104 How, then, is it possible to have preferential trade agreements such as the TPP under the WTO?

The answer lies in GATT Article XXIV:

4. The contracting parties recognize the desirability of increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties to such agreements. They also recognize that the purpose of a customs union or of a free-trade area should be to facilitate trade between the constituent territories . . . .

5. Accordingly, the provisions of this Agreement shall not prevent, as between the territories of contracting parties, the formation of a customs union or of a free-trade area . . .105105

The key language of Article XXIV is the first sentence of Article XXIV(5): “[T]he provisions of this Agreement shall not prevent . . . the formation of a customs union or a free trade area.”106106

This language has been read to create an exception to the other provisions of the GATT, including the MFN principle in GATT Article I. The result is that under a free trade agreement or a customs union, the MFN principle does not apply because, if it did, it would prevent the formation of a free trade area in contravention of the express language of GATT Article XXIV:5. Under this interpretation, free trade areas such as the North American Free Trade Agreement (NAFTA) and a customs union such as the E.U.—the two most prominent free trade agreements and customs unions—are permitted to exist as exceptions under GATT Article XXIV:5 to the MFN principle contained in GATT Article I. The TPP is also permitted to provide favorable treatment in all areas of trade, including goods, services, foreign investment, and technology trade without extending the same benefits to all other members of the WTO, such as China. Extending favorable treatment to TPP members while excluding benefits to non-members of the TPP, such as China, is perfectly legal under the GATT/WTO. Indeed, as noted earlier, the WTO encourages free trade agreements.107107 So regardless of any argument that China might make to the contrary, the TPP is consistent with the WTO.

The effect of excluding China from the TPP is that China, unless it joins, will be unable to enjoy the benefits the TPP provides to all of its twelve member states. The short-term goal of the TPP is to reduce tariffs among its members below their current GATT rates and, in the long term, to eliminate all tariffs in order to have a true free trade area.108108

As all TPP tariffs are reduced to below current GATT rates, members of the TPP enjoy “WTO plus” treatment for their goods because imports from TPP countries will enjoy better tariff treatment than they would under the WTO.109109 The economic effect of this preferential treatment is to increase trade and political cooperation among TPP member states.110110 This is apparent because imports that are subject to TPP tariffs are less expensive than imports that are subject to WTO tariffs. The lower TPP tariffs on goods from other TPP countries will be less expensive to the importer, which in turn will pass on the savings to the consumer driving up demand for the imports. This will result, in the long term, in an increase in trade among TPP members. This is how PTAs result in increases in trade among their members. Similar arguments can be made for other sectors, such as trade in services, investment, and technology. Although each area differs in some ways from the trade in goods, the basic concept of preferential treatment is the same—all areas of trade will increase between TPP members.111111

What might be less apparent is that preferential trade agreements also divert trade (and perhaps political cooperation) from non-members.112112

To take a concrete example, suppose that after the TPP takes effect, an importer in the U.S. has the choice between importing two substantially similar products either from China, a non-member of the TPP, or from Vietnam, a TPP member. Assume for the purposes of this hypothetical that the U.S. GATT rate for the product is five percent for all imports (including imports from China) but that the TPP rate for the same product from Vietnam is zero. If the products from China and Vietnam are similar in quality, a rational importer will choose to import the product from Vietnam.

Under the hypothetical five percent GATT rate tariff, an imported product from China with a price of $1 will cost the importer $1.05 with the tariff included and the importer will then pass the cost onto the consumer in the form of a 5-cent increase in price.113113

This might seem to be a trivial difference, but it is not. Suppose that the importer orders one million units of the product, which would not be unusual for any number of items used regularly by consumers, such as textiles (clothing). At this point, the GATT tariff on goods from China will cost the importer an extra $50,000 dollars to import as opposed to the products imported from Vietnam. In every highly competitive industry, even slight cost differentials can be decisive. Continuing our hypothetical, assume that the retail price of the product is $5; at this price point, the consumer will pay $5 for the import from Vietnam but $5.25 for the same product from China. This cost difference does not factor in the cost of a sales tax in some states that is usually assessed as a percentage of the retail price of the goods, which will further increase the price of the import from China. (Assuming a six percent retail tax, the import from Vietnam will cost $5.30 whereas the import from China will cost $5.67.) Assume further that the items are not sold individually but come in a convenient package of ten at the retail level because few consumers are likely to purchase the particular item one at a time. The consumer will pay $50 for a package of ten products from Vietnam but $55.65 dollars for the same package from China (including a six percent sales tax).

Over time, what will occur? As rational economic actors, importers and consumers will prefer to buy the imports from Vietnam, and the imports from China will go unsold. As a result, the importer will stop importing goods from China and import them from Vietnam instead. If we generalize this example to goods across many sectors, including high technology goods, the U.S. might be able to source goods across many industries from TPP countries instead of from China. Recall that Japan and Australia are also members of the TPP and other countries, such as South Korea, have indicated that they wish to join. This could give the U.S. many sources of goods comparable to Chinese goods in all areas, including high technology areas (for example, auto parts) but at a lower price because of the preferential tariff for TPP members. If China does not join the TPP, China’s trade with the U.S. and other TPP members will be diverted to other TPP countries and China could suffer a loss in trade opportunities.114114

Diverting trade away from China serves important U.S. interests at the present because of the heated political criticism and vehement populist anger over the ever-mushrooming trade deficit with China, which reached a record $365.7 billion in 2015. 115115

The breakdown of this figure indicates that in 2015, the U.S. sold $116.2 billion in exported goods to China while purchasing $481.9 billion of imports from China.116116 To place the trade deficit with China in historical perspective, in one year from 2014-2015, the U.S. trade deficit grew by almost $30 billion, a 6.6% increase.117117 In 1985, the U.S. trade deficit with China was $6 million;118118 the 2015 figure represents a growth of over 60,000 times in three decades. The U.S. trade deficit with China is much larger (by $230 billion) than the combined trade deficits of the next four largest U.S. trade deficits with a single country: Germany ($74 billion), Japan ($68 billion), Mexico ($58 billion), and Vietnam ($30 billion).119119 The U.S. trade deficit with China is nearly five times that of the U.S. trade deficit with Germany.

The negative consequences of the U.S. trade deficit with China can be understood through reviewing some basic international economic principles. When a nation experiences a trade deficit, it is buying more goods from its trading partner than it is selling.120120

  In other words, a nation with a trade deficit is spending more than it is earning from international trade.121121 In the case of the U.S., it is spending $365.7 billion more than it is earning from the trade with China, and China is becoming wealthier by $365.7 billion per year in its trade with the U.S., with the gap widening with every year. The long-term consequences for a nation with a continuing trade deficit are that unless other growth factors are present (for example, the sale of services, innovation in technology, the influx of capital through investment from foreign countries) the nation’s economy begins to shrink and may become mired in debt.122122

On the other hand, the nation enjoying the trade surplus will become flush with cash from revenues earned from trade, its economy will grow quickly and, in the case of China, become a global trading power.123123

China could use its earnings to buy more goods from the U.S. and reciprocate in the trade in goods, but China has chosen not to do so.124124 In China’s case, China is “hoarding”125125 by choosing to save instead of spend its earnings.126126 China saves its earnings by using those earnings from selling goods to the U.S. to buy more and more of the U.S. economy in the form of U.S. government securities, such as treasury bonds.127127 The debtor nation is trapped in a never ending cycle of an escalating trade deficit and increasing debt.128128 This is true for the U.S. as China is lending money to the U.S. by buying U.S. debt instruments (in other words, U.S. treasury bonds that pay interest to China and must pay the principal by a specific due date unless they are renewed).129129 The extra cash that the U.S. has available by borrowing from China means that the U.S. does not have to raise revenue through other more painful means such as increasing taxes on consumers or cut spending on government services.130130 The money loaned from China results in more consumer disposable income that is being used by U.S. consumers to buy more cheap goods from China, leading to an increase in the trade deficit.131131 The U.S. then needs to borrow even more (that is, sells more treasury bonds to China) to maintain its increasing levels of consumption and spending on government services. The U.S. seems trapped in a cycle of a spiraling trade deficit and increasing debt with China gaining more and more economic power over the U.S.132132 One way to deal with this cycle, that is, to reduce the trade deficit, is to buy fewer goods from China and to buy the same goods from another source, such as other countries in the TPP. This will allow the U.S. to reduce the trade deficit with China and still at the same time maintain or increase its level of consumption in order to satisfy consumer demand and avoid painful austerity measures.

A related hot-button issue that stems from the trade deficit in goods with China is that some U.S. companies are moving their operations overseas.133133

Chinese goods are popular with U.S. consumers due to their quality and low cost.134134 Some U.S. companies are responding by moving their manufacturing operations to China in order to take advantage of the low cost of labor and other lower costs in manufacturing.135135 These U.S. companies manufacture goods in China and then export them to the U.S.136136 However, the movement of manufacturing operations from the U.S. to China means that jobs in the U.S. are being lost and replaced by jobs created in China.137137 This is what is commonly referred to as “outsourcing,” a disliked and politically charged term that seems to immediately incite boiling anger and resentment in many people in the United States.138138 These negative sentiments towards China are exacerbated by arguments expressed by some politicians that the advantages enjoyed by China are not the result of greater efficiencies but by cheating through currency manipulation and low standards in labor, among other practices.139139

The virtue of the TPP is that trade will be diverted from China to other TPP countries, reducing the trade deficit with China and the outsourcing of jobs to China that so enrages some U.S. politicians and workers. The TPP countries will need to abide by the high standards set forth in the TPP so they cannot “cheat” in their trade with the U.S. as China currently does, according to China’s critics.140140

While the TPP could result in the diversion of trade from China to the U.S., the same holds true for all members of the TPP. The same arguments made earlier in this section apply to other TPP countries as well. All TPP members, such as Australia and Japan, now have an economic incentive in the form of lower tariffs to buy goods from other TPP members instead of from China. Exclusion from the TPP means losses of trade opportunities for China, not only with the U.S., but also with the entire membership of the TPP, which currently accounts for forty percent of world trade.141141

This creates a serious dilemma for China.

One alternative for China is to join the TPP and enjoy the advantages of lower tariffs and increased trade with the members of the TPP. This might seem to be an obvious step but here is where the U.S. strategy has created the other prong in the dilemma for China. In order to join the TPP, China must agree to the terms of the TPP, as well as any other terms that the U.S. Congress might demand as a price of admission to the TPP. China would also have to undergo a humiliating process of approval of its TPP entry by the U.S. Congress, which might relish an opportunity to criticize and humiliate China.142142

While it is unclear what demands Congress might place on China, a reading of the TPP illustrates how several key provisions are meant specifically to neutralize the advantages that China currently enjoys outside of the TPP.143143 Compliance with the terms of the TPP and other demands by Congress is the price of admission for China to get access to the preferential treatment reserved to TPP members.

One of China’s major advantages in trade that the U.S. sought to neutralize is China’s comparatively low cost of labor.144144

The average cost of manual labor in China is less than $1 per hour while the average cost in the U.S. is nearly $20 per hour.145145 China’s low labor costs lead directly to less expensive goods—a key appeal to the U.S. consumer and also a key factor in the growing U.S. trade deficit with China. Critics argue that China’s low labor costs are made possible by a disregard for workers’ rights, subjecting workers to intolerable and dangerous working conditions, long hours, and forms of coerced or forced labor.146146

The following provisions of the TPP related to workers’ rights were likely also drafted by the U.S. with China in mind as the main target.147147

Article 19.3 of the TPP provides:

1. Each Party shall adopt and maintain in its statues and regulations, and practices thereunder the following rights as stated in the ILO [International Labor Organization] Declaration: (a) freedom of association and the effective recognition of the right to collective bargaining; (b) the elimination of all forms of forced or compulsory labour; (c) the effective abolition of child labour and . . . a prohibition on the worst forms of child labour; and (d) the elimination of discrimination in respect of employment and occupation.148148

The reference to the standards of the International Labor Organization (ILO), contained in TPP Article 19.3, can be best understood in the context of the long debate about including labor rights in the WTO culminating in the declaration issued by the first WTO Ministerial Conference held in Singapore in December 1996.149149

At the time, a debate raged in the WTO on whether to introduce human rights in the GATT and WTO.150150 Although many attempts were made, none succeeded, due to the controversial nature of the subject of human rights.151151 The Singapore Ministerial Declaration ended the controversy once and for all by declaring that the ILO is the competent body to deal with labor standards.152152 The result of this decision is that workers’ rights are outside the purview of the WTO and within the jurisdiction of the ILO.153153

The most important consequence of the Singapore Declaration with relation to workers’ rights is that the breach of workers’ rights cannot be used to justify a trade restriction under the WTO.154154

Rather, the complaining nation must assert its claims within the ILO.155155 However, the ILO is a toothless organization with no real enforcement power.156156 Limiting recourse to the ILO means that breaches of workers’ rights in international trade are effectively unenforceable and will go unpunished. The significance of incorporating the ILO’s basic principles within the TPP is that the ILO principles become TPP legal obligations that are now subject to the TPP’s dispute settlement system. This means that a TPP member may be authorized to impose trade sanctions on another TPP member for breach of workers’ rights, now giving teeth to the ILO’s principles.157157 The TPP brings the ILO’s principles within an international legal regime with effective enforcement powers.

The TPP also adds two other significant provisions regarding workers’ rights. Article 19.3(2) states: “[e]ach Party shall adopt and maintain statutes and regulations, and practices thereunder, governing acceptable conditions of work with respect to minimum wages, hours of work, and occupational safety and health.”158158

Article 19.5(1) states: “No Party shall fail to effectively enforce its labour laws through a sustained or recurring course of action or inaction in a manner affecting trade or investment between the Parties after the date of entry into force of this Agreement.”159159 The major significance of these two provisions is that they bring domestic labor laws and regulations within the purview of the TPP and its enforcement mechanism. Like many countries, China has effective labor laws on its books,160160 but, according to critics, China fails to enforce these laws in practice.161161 Currently, the failure to enforce labor laws within China is subject to recourse within the ILO, an illusory remedy, or within China’s own domestic legal system. Within China’s domestic legal system, the complaining party lacks any recourse if China’s own internal domestic systems fail to enforce its labor laws, a common problem due to a number of systemic weaknesses.162162 Under the TPP, however, the failure of a TPP country to enforce its own labor laws now becomes a violation of the TPP and subject to the TPP’s dispute settlement mechanism.

The consequence of the TPP’s labor provisions is that once China joins the TPP, China will no longer be able to maintain factories that are dangerous and unsanitary.163163

Chinese factories can no longer require workers to toil through onerous and unreasonable hours, or subject persons to forms of labor that could be deemed to be coercive.164164 If China does not abide by the TPP standards, the U.S. can challenge China through the TPP dispute settlement system, with trade sanctions as a possible option. Currently, the U.S. and U.S.-based multinational corporations (MNCs) lack the ability to challenge China’s workers’ rights record in any forum other than the ILO or China’s own legal system, a mechanism that is not viewed as independent or impartial.165165

From a competitive standpoint, meeting the TPP’s high labor standards should result in an increase in labor costs and a corresponding increase in the price of imports from China. The labor provisions of the TPP were designed by the U.S. to neutralize one of China’s major advantages in trade—highly skilled and conscientious but inexpensive manual labor created by substandard working conditions.

The TPP incorporates a number of environmental provisions that are not available under the WTO. In the WTO, environmental concerns are linked to trade but only in an indirect and peripheral way by decisions of the WTO Appellate Body, which functions as a high court of international trade.166166

By contrast, the TPP explicitly ties environmental concerns to the trade in goods (as well as in the other channels of trade) in the text of the TPP agreement itself.

The extensive environmental obligations under the TPP are the subject of Article 20, with no parallel in the texts of the WTO. Most salient to the main themes of this work is Article 20.5, Protection of the Ozone Layer, which provides:

1. The Parties recognise that emissions of certain substances can significantly deplete and otherwise modify the ozone layer in a manner that is likely to result in adverse effects on human health and the environment. Accordingly, each Party shall take measures to control the production and consumption of, and trade in, such substances.167167

This TPP provision was likely drafted by the U.S. with the specific purpose of reining in China. Why? China is the leading producer of greenhouse gases that directly damage the atmosphere’s ozone layer.168168

In other words, China poses the world’s single greatest threat to the destruction of the ozone layer, and the key objective of TPP Article 20.5 is the protection of the ozone layer. Ozone depletion leads to global warming that could cause permanent and serious damage to the environment.169169 China continues to use a glut of coal-fired power plants—a source of greenhouse gases—as part of its plan of national development.170170 Not only does China’s use of so-called “dirty fuel” harm the environment, but these fuel sources create a competitive advantage. China uses coal-fired power plants because these plants are a cheaper source of energy than other forms that are environmentally sustainable. In the U.S., the use of coal-fired power plants has been replaced in part by different alternatives such as gas, solar, and wind power, but these technologies are generally much more expensive than coal.171171 Using cheap sources of energy, such as coal-fired power plants, leads to lower prices for goods produced in such plants and gives China an advantage in its exports. TPP Article 20.5 imposes a mandatory duty to protect the ozone layer through controlling the production of greenhouse gases (parties “shall take measures” to control ozone depleting substances).

Article 20.5 is only one example of many provisions in Chapter 20 that create greater obligations concerning environmental obligations. Other TPP provisions require protection of the marine environment from ship pollution,172172

the adoption of corporate social responsibility policies by companies operating domestically with respect to the environment,173173 the management of fisheries such that fishing does not lead to overconsumption of fish species,174174 and the control of the illegal trade in certain endangered fauna and flora.175175 All of these provisions will involve additional environmental responsibilities (and costs) for China at the international level, but this discussion has focused on Article 20.5 because it is intended to have the most immediate and serious impact on China in the area of environmental sustainability if China chooses to join the TPP.

Aside from the environmental benefits created by the TPP, and more germane to the thesis in this Article,176176

joining the TPP would also dull China’s competitive advantages in manufacturing of inexpensive goods. To be consistent with the TPP, China might have to abandon or limit the use of coal-fired power plants and use alternative and more expensive, but environmentally friendly, sources of power instead. Use of these more expensive alternative technologies will increase the cost of producing goods in Chinese factories and neutralize a major advantage that China currently enjoys in trade—cheap goods due to production methods using outdated and highly polluting technologies.

A third set of provisions in the TPP takes direct aim at China’s SOEs that receive many forms of financial and non-financial assistance from the State. In its 2015 annual report to Congress, the U.S. Trade Representative stated:

Many of the problems that arise in the U.S.-China trade and investment relationship can be traced to . . . the large role of state-owned enterprises and other national champions in China’s economy, which continue to generate significant trade distortions that inevitably give rise to trade frictions.177177

An SOE is a business enterprise that is an administrative unit of the State.178178

The State owns the SOE as opposed to ownership by a private person or group of persons.179179 China has a web of national policies to “incessantly strengthen” the “vitality”180180 of SOEs, considering them to be ingrained in the “lifeline of the economy.”181181 China’s plan is to create SOEs that are “national champions” that can dominate international trade.182182 Reflecting the importance of SOEs in China, all of the vital sectors of China’s economy are controlled by SOEs that have monopolies in energy, transportation (including air and rail transport), banking, electricity, water supply, and telecommunications.183183 Recently, China reported the existence of 144,700 SOEs, excluding banks, with total assets worth $13.6 trillion.184184 The world’s largest company by capitalization is Petro-China,185185 an SOE that ranks ahead of Exxon-Mobil on the 2015 Fortune 500 list.186186 China has three SOEs among the top ten largest companies in the world.187187 While other TPP countries also have SOEs, China’s SOEs are unique in the role they play in China’s economy, their size and financial strength, and the power they wield in China’s economy. The importance of SOEs to China’s national interests means that the State provides support to SOEs in myriad forms. This state assistance to SOEs comes at the expense of MNCs with operations in China.188188

MNCs doing business in China often claim that the Chinese government discriminates against them in favor of SOEs through three common practices. First, SOEs often prefer purchasing goods and service from other SOEs rather than MNCs.189189

Purchasing agents might prefer to purchase goods from sources they have dealt with in the past or from sales agents in other SOEs with which they have personal or professional relationships.190190 A more nefarious possibility is that purchasing agents working in SOEs may receive a kickback (as in, a bribe) from the sales agent of SOE that sells the product.191191

Second, MNCs claim that the Chinese government discriminates against MNCs under important regulatory regimes, such as the Anti-Monopoly Law (AML) and under various anti-bribery laws.192192

For example, MNCs argue that Chinese authorities apply the AML to benefit SOEs by blocking acquisitions of Chinese companies by MNCs or by imposing onerous conditions on MNCs such as requiring the sale of assets to SOEs in order to approve a merger or acquisition by an MNC of a Chinese company.193193 Chinese authorities use the AML to impose or threaten to impose heavy fines in order to force MNCs to reduce prices on their products while not subjecting SOEs to these pressures.194194 MNCs also argue that Chinese authorities are cracking down on MNCs under anti-bribery laws while ignoring similar conduct by SOEs.195195 Recently, Chinese authorities imposed a record $500 million fine on GlaxoSmithKline for bribing Chinese doctors and hospitals to prescribe its medications.196196 MNCs note that this record fine was imposed on an MNC while SOEs that engage in far more egregious conduct go unpunished.197197

A third common complaint is that China provides subsidies (financial contributions) to SOEs, a form of financial assistance.198198

The effect of a subsidy is that it lowers the operating costs of SOEs, providing a competitive advantage over MNCs in China. Subsidies to SOEs also provide a competitive price advantage by lowering the cost of the products when they are exported into the U.S. The lower price of Chinese goods provides them a competitive advantage over competing U.S. products.

The WTO has provisions that prohibit discrimination in the purchase of goods,199199

discrimination in the application of internal regulations,200200 and the provision of subsidies.201201 The WTO provisions, however, are general in nature applying to all forms of discrimination and subsidies, whereas the TPP provisions were drafted specifically with SOEs in mind and directly target illegal conduct by SOEs. The TPP provisions are designed to facilitate enforcement of specific obligations against SOEs.

The TPP addresses all three of these concerns raised by U.S.-based MNCs. Article 17.4 of the TPP requires SOEs to avoid discrimination in the purchase of goods and services by giving treatment to goods and services from other TPP parties treatment no less favorable than that accorded to SOEs.202202

Article 17.5 of the TPP prohibits discrimination in favor of SOEs in the exercise of regulatory authority.203203 Article 17.6 prohibits the use of “non-commercial assistance” to any SOEs related to the production of goods or the supply of services. As the context of Article 17.6 set forth below indicates, non-commercial assistance refers to assistance that is not available in the marketplace but is provided only by a government. In this context, assistance refers to:

i. direct transfers of funds or potential direct transfer of funds or liabilities, such as: A. grants or debt forgiveness; B. loans, loan guarantees or other types of financing on terms more favourable than commercially available to that enterprise; or C. equity capital inconsistent with the usual investment practice, including for the provision of risk capital, of private investors[  ] (ii) goods or services other than general infrastructure on terms more favourable than those commercially available to that enterprise.204204

A comparison of this provision with the provisions in the WTO Agreement on Subsidies and Countervailing Measures (SCM) indicates that the quoted text of the TPP set forth above closely tracks SCM Article 1, which defines a “subsidy” for the purpose of imposing a countervailing duty as an extra tariff imposed by the importing country on a subsidized import to offset the effect of the subsidy.205205

TPP Article 17.6 is specifically aimed at subsidies provided by China to SOEs whereas the SCM deals with government subsidies provided to all types of private businesses. The TPP is aimed directly at the type of subsidies that China is frequently accused of providing to its SOEs.206206 The direct consequence of Article 17.6 is that it provides the U.S. with clear authority to impose countervailing duties on subsidized imports from SOEs, neutralizing a major advantage that SOEs have in international trade. The imposition of the countervailing duty will reduce the demand for the imports by increasing their prices (as the importer passes on the increase to the consumer) and will make U.S. products more competitive relative to the now more expensive import. China will then be forced to either accept a reduced demand that leads to fewer imports or remove the subsidy.

Due to the outsized role that SOEs enjoy in China and in global trade, these provisions of the TPP were also likely drafted with China as the target. No other current TPP country has SOEs that approach the size and power of China’s SOEs or their dominance in international trade. Joining the TPP will make China’s most frequently complained of practices that benefit SOEs illegal and will allow the U.S. to directly challenge these practices in the TPP dispute settlement system.

The negotiation process for the TPP, which proceeded without input from China, may become a model for how the U.S. negotiates multilateral treaties in the future. If this appears to be an aggressive tactic by the U.S. to control a rival, this is exactly the intent. Discussing the TPP on May 2, 2016, President Obama stated:

[The TPP] would give us a leg up on our economic competitors, including . . . China. Of course, China’s greatest economic opportunities also lie in its own neighborhood, which is why China is not wasting any time. As we speak, China is negotiating a trade deal that would carve up some of the fastest-growing markets in the world at our expense, putting American jobs, business and goods at risk. . . . America should write the rules. America should call the shots. Other countries should play by the rules that America and our partners set, not the other way around. . . . The United States, not . . . China, should write them.”207207

Attempts by the U.S. to control China have not, of course, escaped China’s notice, and they underscore how the relationship between the two countries has increasingly become a fierce rivalry. The U.S. and China take starkly different approaches to international trade treaties, which benefit the interests of each country.

The recent approach of the U.S. in all of its international trade treaties is to link social issues such as workers’ rights and the environment to trade. This practice began with the North American Free Trade Agreement, which came into effect in 1994.208208

As part of NAFTA, the parties also entered into two side agreements: the North American Agreement on Labor Cooperation, which includes provisions linking trade to workers’ rights,209209 and the North American Agreement on Environmental Cooperation, which includes obligations linking trade to the environment.210210 In 2011, the U.S. ratified the U.S. Korea Free Trade Agreement (KORUS).211211 KORUS includes a reciprocal obligation to adopt the four basic principles of the ILO similar to the obligation created by TPP Article 19.3.212212 The State Department’s Model Bilateral Investment Treaty, which serves as a template for all future U.S. investment treaties, also contains provisions related to workers’ rights and the environment as well as provisions on transparency in government.213213 These developments indicate that the U.S. will link workers’ rights and environmental issues to trade in all future trade agreements. None of these U.S. agreements contain any special provisions relating to SOEs, another indication that the SOE chapter in the TPP was aimed directly at China.

By contrast, China’s trade agreements reveal a different approach. China has entered into recent bilateral free trade agreements with its partners, including Costa Rica (2011), Pakistan (2009), Peru (2009), Singapore (2009), New Zealand (2008), and Chile (2006).214214

On November 22, 2015, China signed a Protocol to enhance the China Free Trade Agreement with the Association of Southeast Asian Nations (consisting of Brunei Darussalam, Cambodia, Laos, Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam (collectively ASEAN)).215215 China is also negotiating the One Belt One Road agreements (so named after the historic Silk Road used in ancient times to trade with Europe) that will create unblocked road and rail access from China to sixty European countries.216216 China has many more free trade agreements that are being negotiated. The hallmark of all of these agreements is that they contain no provisions linking trade to workers’ rights and the environment. China’s agreements also contain no provisions that limit the trading rights of SOEs.

These two contrasting approaches concerning the linkage of social issues to trade reflect a fundamental difference in philosophy in the use of trade to create sticks and carrots on social issues and is a topic that is beyond the scope of this Article.217217

This Article has focused on the trade and economic effects of such provisions. From this perspective, linking trade to workers’ rights and the environment increases the costs of trade and is intended to neutralize the competitive advantages (that is, lower prices) that China now currently enjoys in international trade. According to the U.S. government, the TPP “level[s] the playing field for American workers and American businesses . . . [and] will help increase Made-in-America exports, grow the American economy, [and] support well-paying American jobs.”218218

The U.S.’s attempt to contain China in international trade through the TPP has left China with a dilemma: it can ignore the TPP and risk losses in trade opportunities, or submit to the TPP and the humiliating process of applying to the U.S. Congress to join the TPP. 219219

In the author’s view, China is not likely to join the TPP, to surrender itself to a humiliating defeat in international trade, and to acknowledge that China has been outsmarted by the U.S. The other alternative, losing international trade opportunities with nations that account for forty percent of global trade,220220 also does not seem acceptable. What will China do?

China may choose a third alternative—negotiate its own multilateral preferential trade agreements on its own terms with its trading partners in Asia and outside of Asia that will exclude the U.S. Indeed, China is now negotiating a rival preferential trade agreement in Asia called the Regional Comprehensive Economic Partnership (Regional Partnership).221221

By some measures, the Regional Partnership is more impressive than the TPP because the Regional Partnership covers nearly half the world’s population and four times the number of workers and consumers covered by the TPP.222222 A major difference between the two is that the Regional Partnership includes China—the world’s most populous nation—and India—the world’s second most populous nation and a growing economic power in its own right—while the TPP does not.223223 Countries that wish to preserve a good relationship with both the U.S. and China have joined both the TPP and the Regional Partnership with seven countries overlapping between the two agreements.224224 This overlapping membership will reduce the diversionary trade effect of the TPP if China chooses not to join, because these countries will still purchase Chinese goods, as these goods will still receive “WTO plus” treatment under the Regional Partnership, not the TPP. Just as China was excluded from the TPP negotiations, the U.S. was not invited to the negotiations for the Regional Partnership.225225 In addition to the Regional Partnership, China will undoubtedly continue to negotiate individual free trade agreements with countries that will not contain any of the provisions concerning workers’ rights, the environment, and SOEs used by the U.S. to contain China.

These recent developments in the negotiation of trade agreements underscore more clearly than ever that the U.S. and China see themselves as rivals, not allies, in world trade. Given their contrasting approaches to international trade, who writes the rules of international trade becomes paramount in the rivalry. The U.S. will seek to neutralize China’s cost advantages in international trade in all of its trade treaties and China will seek to preserve them in its trade treaties. No one should be surprised at this result. It is a political reality that nations enter into trade agreements that are in their best interests at the expense of rivals. The U.S. has entered into trade agreements that promote its best interests at the expense of China, and China has done the same at the expense of the U.S. This Article is a study of how the TPP promotes U.S. interests at the expense of China.

At this moment in history, whether the U.S. or China will write the rules of international trade is an open question. What is not open to question is that the stakes are high: the nation that writes the rules will likely gain supremacy in international trade and will become the leading power in global trade in the twenty-first century.