The U.S.-China Trade Negotiation: A Contract Theory Perspective
52 Pages Posted: 17 Oct 2019 Last revised: 31 Oct 2019
Date Written: October 14, 2019
Since the eruption of the Sino-US trade war, the Trump administration has been pressing for a rigid trade agreement that can bind China more credibly to its promises. This article analyzes three ingredients of transaction costs that are barriers to drafting, concluding, and enforcing a rigid trade agreement. First, the United States cannot predict every contingency that might occur during the execution of the trade agreement. The Chinese government retains residual control over its domestic laws and possesses vast discretion in enforcement. Second, it is very costly to enforce a rigid trade agreement. The bilateral trade agreement can neither be enforced by a third party nor will it be self-enforcing. As illustrated by the Sino-U.S. intellectual property right disputes in the 1990s, bilateral trade agreements are constantly renegotiated and the United State lacks the credibility to impose sustained tariff sanctions on China. Third, the cost of writing the agreement is very high. A rigid agreement is more visible to the Chinese domestic audience, who suspects that the U.S.’ motive for triggering the trade war is to contain China’s rise. Moreover, a rigid agreement appears imbalanced and easily invokes the long and painful historical memory of Chinese subjugation under Western powers. Accordingly, the Trump administration should not overestimate the benefit of writing a rigid contract while underestimating the price of dignity to the Chinese government in acceding to the U.S. demand. Given the futile attempt to write a rigid trade agreement, this article advocates instead for greater Sino-US economic integration, contrary to the Trump administration’s agenda to decouple the two economies. By allowing each country to hold the other’s assets hostage, economic integration can facilitate cooperation when trust is lacking. Therefore, integration is more conducive to promoting peace and prosperity in the Sino-US relationship than a rigid trade agreement.
Keywords: Trade, Contract Theory, Trade War, Intellectual Property, China, Nationalism, Hostage, Trust
JEL Classification: F1, M48, F02, K12, K33
Suggested Citation: Suggested Citation