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News Update
08-08-05, 15:24
CNOOC Episode Unites Protectionists and Hawks

By Kevin A. Hassett

Posted: Monday, August 8, 2005

ARTICLES

Bloomberg

Publication Date: August 8, 2005

After an uproar that seemed far out of proportion to the economic issues raised, China's state-controlled CNOOC Ltd., the country's third-largest oil producer, withdrew its bid for U.S. energy company Unocal Corp.

This was a blow to Americans who believe in free markets. Many more such blows may be on the horizon. Indeed, the CNOOC affair reveals a potent informal political alliance between pragmatic security hawks and the opponents of free trade.

Economists and security specialists see two different Chinas. I was reminded of this a few years ago, when I gave an economics lecture to students at a university in China.

During my talk, one student asked how one could square U.S. support of free trade with protectionist measures for politically important industries like the steel industry. I responded that the recently enacted steel measures were shameful, and that the U.S. government should be embarrassed.

The entire hall of 500 students burst into applause. It wasn't the kind of polite applause an economist might get after a nerdy lecture. It was the kind the Beatles used to get at airports. I have never seen anything like it.

Afterwards, I asked a Chinese citizen why the students were such exuberant free traders. He told me they weren't. They celebrated my comments because they had never seen anyone stridently and publicly criticize his own government before. They were impressed by my courage.

Political Realities

Of course, my remarks never struck me as courageous. In America, everyone gripes about the government. Not in China.

This anecdote provides a fairly accurate picture of China today. It is a country that can produce a room of English-speaking college kids with delightfully well-informed questions. At the same time, it's a dictatorship.

It's easy for most market participants to lose track of political realities, and to miss how oddly dissonant China's political and economic actions are.

Last March, for example, the National People's Congress made a show of approving--the vote was 2,896 to 0--an order authorizing the use of force against Taiwan under circumstances vague enough to allow action whenever the Chinese feel like it.

Such threats challenge defense and political analysts in the U.S., who worry that tough talk can turn into action. China's political rhetoric suggests that it would be wrong to let our guard down.

Protectionists' Allies

If economists get paid to cipher, foreign policy experts get paid to worry. The CNOOC move for Unocal alarmed many because of Unocal's connections to Asia, and the perceived threat that Chinese possession of these assets might introduce into the equation.

For example, my colleagues Thomas Donnelly and Melissa Wisner argued in an article in the Weekly Standard that China was, in part, after Unocal's liquid natural gas assets in Indonesia. Unocal, they said, plans to supply Indonesia's large natural gas refinery with 40 percent of its gas over the next decade, and this refinery supplies Korea, Japan and Taiwan.

In fact, Taiwan gets 60 percent of its liquid natural gas from Indonesia. Possession of this asset would, they argue, give China “another bit of vital leverage in its intimidation campaign against Taiwan.''

If China is going to talk as tough as it does about Taiwan, it shouldn't be surprised when political analysts respond the way they did in the CNOOC episode. But such responses create a very big problem for free traders in the U.S. They demonstrate that protectionists have a large group of influential new allies.

Small Threat

When the recent U.S. energy bill was amended to include a provision requiring a lengthy review period for the CNOOC acquisition, it became obvious how serious the new political alignment has become. There is a risk that many more political actions will be taken against Chinese interests in the future.

Even putting security issues aside, China has become the piñata of American politics. It is incorrectly blamed for just about every problem in the U.S.

The facts don't support the hysteria. While China has been growing quickly, compared with the U.S. it still has a tiny economy. According to the World Bank, China's gross domestic product, or GDP, was about $1.6 trillion last year. U.S. GDP was $11.7 trillion. U.S. exports in 2004 were, according to the Bureau of Economic Analysis, about $1.2 trillion. So while narrow sectors of the U.S. economy are undoubtedly harmed by Chinese competition, the total impact on our huge economy cannot be large.

Free Trade

Because the U.S. is about a third of the world economy, Chinese companies will naturally seek to acquire many U.S. assets as China grows. It will be harmful to U.S. economic interests if this integration is impeded. Taking CNOOC out of the Unocal auction will lower the price that U.S. shareholders receive for their company. Taking China out of future auctions will have the same effect many times over.

The Chinese government is undoubtedly a threat. Going forward, deviation from free market principles here in the U.S., however, will almost never be justified. Indeed, the U.S. foreign policy community should just ignore economic policy, for at least three reasons.

First, free trade is a powerful force for economic good, but it is politically unpopular. Proponents of free trade have fought an uphill battle for centuries to reach the partially free trade that we have today.

Punitive Measures

Throughout history, specific exceptions have often been used to undermine trade initiatives. If free trade principles are abandoned for China, they will be abandoned elsewhere. Any economic harm we do to China by impeding it will be as harmful to our own citizens as it is to the Chinese.

Second, our policies can't do enough economic damage to China to be politically meaningful. China is growing quickly because it started from such a low level of economic activity. It still has tons of catching up to do, and can do so simply by emulating developed nations.

China would still be one of the fastest-growing economies on earth even if the U.S. closed its borders to Chinese imports. A wealthy China might be more of a security threat, but nothing the U.S. can do (short of war) will materially slow the Chinese path to wealth.

Third, China is too small economically to corner the market in anything significant. If China truly were an evil empire, and set its sights on acquiring leverage over the rest of the world's nations through acquisitions, it would be unable to do so. If CNOOC tried to withhold Indonesian LNG from Taiwan, the Taiwanese could just purchase gas from some other country.

Respond Politically

Fortunately, the CNOOC episode is a relatively minor affair. There is a risk, however, that much more damage will be done in the future. A bill sponsored by New York Democratic Senator Charles Schumer that would impose trade sanctions against China unless it lets the yuan rise received a surprising level of support in the Senate recently.

Other punitive measures will undoubtedly appear, especially if manufacturing in the U.S. slows, and politicians start searching for scapegoats. Support for such actions from hawks will increase every time China rattles its saber.

China presents a genuine security risk in Asia. That risk should be responded to politically, however, and should not induce the U.S. to shoot itself in the foot.

Kevin A. Hassett is a resident scholar and director of economic policy studies at AEI.