Trump Didn’t Kill the Global Trade System. He Split It in Two.

Allies find relations modestly tweaked, despite the president’s rhetoric, while relations with China are entering a deep freeze

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When Donald Trump entered the White House on a platform of defiant nationalism nearly two years ago, many feared he would dismantle the global trading system the U.S. and its allies had built over the past 70 years.

He hasn’t. Instead, he is presiding over its realignment into two distinct systems. One, between the U.S. and its traditional, democratic trading partners, looks a lot like the system that has prevailed since the 1980s: free trade with a smattering of quotas and tariffs like those Ronald Reagan once deployed.

The second reflects an emerging rivalry between the U.S. and China carrying echoes of the Cold War. On trade, investment and technology, the U.S. is moving to undo some of the integration that followed China’s accession to the World Trade Organization in 2001.

There are two big questions hanging over this realignment. The first is deciding how far the U.S. is prepared to decouple from China. The U.S. has given China until March 1 to avoid higher tariffs by addressing complaints it discriminates against foreign companies and steals their technology. Mr. Trump is counting on a deal that avoids a trade war. But many in his administration and Congress don’t trust China to make the necessary concessions and would likely advocate a sharper break.

Deep Ties

The second question is whether the U.S. can persuade allies to join a united front to contain China. Other countries don’t relish the choice. Their economic ties to China are far greater than they ever were to the Soviet Union during the Cold War.

Nor are the ideological choices as clear cut. China isn’t waging an ideological struggle against the West as the Soviet Union did, and Mr. Trump, while enacting policies reminiscent of President Reagan, lacks Mr. Reagan’s commitment to alliances and free trade. Defense Secretary James Mattis’s decision to resign after Mr. Trump’s decision to withdraw troops from Syria underscores the president’s ambivalence toward international engagement.

Two years ago, it was easy to predict a grimmer fate for the global trading system. Mr. Trump campaigned as a protectionist willing to tear up trade agreements and raise tariffs to shrink the trade deficit and bring back factory jobs.

In his first week he withdrew from the unratified 12-nation Trans-Pacific Partnership. He prepared to pull out of the U.S.-Korea Free Trade Agreement (Korus) and the North American Free Trade Agreement. Earlier this year he imposed steep tariffs on imports of steel and aluminum, using a little-used national security law, and threatened the same for autos.

Today, Korus and Nafta have been replaced by updated agreements(one not yet ratified) that look much like the originals. South Korea accepted quotas on steel. Mexico and Canada agreed to higher wages, North American content requirements and quotas for autos.

These represent a step back from free trade toward managed trade, but they will have little practical effect: The limits on how many cars Mexico and Canada can ship duty-free to the U.S., for example, exceed current shipments. Mr. Trump hasn’t stopped threatening auto tariffs, but for now his officials have elected instead to seek broader tariff reductions with Japan and the European Union.

Meanwhile, the U.S. trade deficit that incenses Mr. Trump has grownduring his presidency, especially with China and Mexico, as a strong American economy sucks in imports. His exhortations to manufacturers to bring jobs back to the U.S. have largely fallen on deaf ears.

Douglas Irwin, an economist and trade historian at Dartmouth College, calls these results the “status quo with Trumpian tweaks: a little more managed trade sprinkled about for favored industries. It’s not good, but it’s not the destruction of the system.”

Mr. Trump’s actions so far affect only 12% of U.S. imports, according to Chad Bown of the Peterson Institute for International Economics. In 1984, 21% of imports were covered by similar restraints, many imposed by Mr. Reagan, such as on cars, steel, motorcycles and clothing.

This is testament to something Mr. Irwin has identified in two centuries of American trade policy: Both protectionism and free trade breed powerful constituencies invested in the status quo. Mr. Trump’s protectionist instincts go only so far when Congress, business and the national security establishment don’t share them.

Yet the status quo with China is crumbling. Businesses have grown disillusioned with China’s restrictions on their activities, forced technology transfer and intellectual-property theft, all aimed at building up domestic competitors at foreign expense. Meanwhile, legislators in both parties are alarmed at increased military assertiveness and domestic repression under President Xi Jinping.

Dan Sullivan, a Republican senator from Alaska, personifies these broader forces reshaping the U.S. approach to the world. Mr. Sullivan has followed the rise of China for decades—as a Marine sent to the Taiwan Strait in 1996 in a response to Chinese provocations; as an official in George W. Bush’s National Security Council and State Department; and for a time as Alaska’s commissioner of natural resources.When Mr. Xi visited the U.S. in 2015, Mr. Sullivan urged his colleagues to pay more attention to China’s rise. On the Senate floor, he quoted the political scientist Graham Allison: “War between the U.S. and China is more likely than recognized at the moment.”

Last spring, Mr. Sullivan went to China and met officials including Vice President Wang Qishan. They seemed to think tensions with the U.S. will fade after Mr. Trump leaves the scene, Mr. Sullivan recalled.

“I just said, ‘You are completely misreading this.’” The mistrust, he told them, is bipartisan, and will outlast Mr. Trump.

While delivering one message to China, Mr. Sullivan gave a different one to the administration and its trade negotiators: Don’t alienate allies needed to take on China.

“Modernize the agreements but stay within the agreements,” he says he counseled them. “Then we have to turn to the really big geostrategic challenge facing our country and that’s China.”

His was one voice among many urging Mr. Trump to single out China for pressure. Presidents Obama and George W. Bush sought to change China’s behavior through dialogue and engagement. Obama officials had begun to question engagement by the end of the administration. Last year, in its National Security Strategy, the Trump administration declared engagement a failure.

The Trump administration regards economic policy and national security as inseparable when it comes to Beijing, because China’s acquisition of Western technology both strengthens China militarily and weakens the U.S. economically.

“We don’t like it when our allies steal our ideas either, but it’s a much less dangerous situation,” said Derek Scissors, a China expert at the American Enterprise Institute whose views align with the administration’s more hawkish officials. “We’re not worried about the war-fighting capability of Japan and Korea because they’re our friends.”

Rating the Neighbors

The administration has yet to publicly explain its goals. In 1946, at the start of the Cold War, diplomat George Kennan made the case for containing the Soviet Union in his famous “long telegram.” The Trump administration hasn’t done anything comparable for China. One reason might be that administration officials are divided. Mr. Trump appears torn between wanting to halt China’s rise at any cost and hoping for “a big and very comprehensive deal” that lifts the cloud of a trade war.

Michael Pillsbury, a Hudson Institute scholar close to the Trump team who has long warned of China’s strategic threat, sees three plausible scenarios. At one extreme is a new cold war with drastically curtailed economic ties. At the other, the U.S. and China resolve their tensions, continue to integrate and run the world together.

Between those extremes, Mr. Pillsbury sees a more likely and desirable middle path—a transactional U.S.-China relationship of the sort that prevailed during the 1980s in which the two decide, case by case, when to do business and when to decouple.

Though administration officials haven’t publicly embraced such a policy, their actions conform to it, most clearly in their intensified efforts to find, publicize and punish wrongdoing by Chinese companies and state actors.

The U.S.’s request to Canada to extradite an executive of Chinese telecom giant Huawei Technologies Co., like an earlier case against smart-phone manufacturer ZTE Corp., is for allegedly violating Iran sanctions. The cases also have the effect of clipping the wings of Chinese national champions. Meanwhile, Congress this year expanded the administration’s authority to block foreign investments in the U.S., especially in technology, and stop exports that transfer U.S. technology abroad.

While the fate of U.S. tariffs on Chinese imports hinges on current negotiations, some companies, from Lennox International Inc., which makes heating and cooling systems, to shoe manufacturer Steve Madden Ltd. , said they are shifting supply chains out of China, further decoupling the two economies.

“Many companies are…pursuing a ‘China plus one’ strategy, in which current China production remains largely in place but the marginal dollar of new investment goes into countries with lower labor costs,” Dan Wang, an analyst at research firm Gavekal Dragonomics, recently wrote to clients.

The U.S. is stepping up efforts to draw its other trading partners into a united front to take on China. U.S. Trade Representative Robert Lighthizer and his EU and Japan counterparts have launched an effort at the WTO to crack down on China’s domestic subsidies and its technology-transfer requirements. The Group of 20 nations agreed at their recent summit to reform the WTO to address complaints it doesn’t adequately police China.

U.S. and domestic concerns have prompted Australia, New Zealand, Japan, Britain and Canada to restrict or consider restricting Huawei equipment in their telecom infrastructure, in particular for the next 5G mobile phone standard.

The U.S. is also seeking to wall China off from future trade deals. It insisted the pact replacing Nafta include a clause letting the U.S. quit if either Canada or Mexico signs a free-trade agreement with a “non-market economy,” i.e., China.

This realignment is fraught with risks—for the U.S., China and the broader global economy—beyond any short-term hit to growth.

The first goes to the heart of Mr. Trump’s goal. If his aim is to hold back China’s advance, economists predict he will fail. China’s innovative capacity has expanded dramatically. China now accounts for 18.6% of articles in international scientific journals, according to one study, and nearly a quarter of global venture-capital investment, according to another.

Indeed, some China experts fear that the U.S., by adopting a more adversarial approach, weakens China’s reformers and strengthens its nationalist factions, making conflict more likely. They predict China will intensify its pursuit of technological self-sufficiency.

Tom Linebarger, chief executive of engine maker Cummins Inc.,represents the Business Roundtable, which supports a crackdown on China’s discriminatory trade practices but not a decoupling of the two economies. “The only thing worse than an unlevel playing field is no playing field at all,” Mr. Linebarger said.

Persuading other countries to hold China at arm’s length will be harder than containing the Soviet Union. China accounts for 11% of world exports, whereas the Soviet Union in the 1980s accounted for less than 3%, not counting to Eastern Europe. China is 22% of Japanese imports and exports; the Soviet Union was less than 1%. Many of China’s close neighbors depend far more, economically, on China than on the U.S.

“The assumption behind some of the cold war, containment, decoupling rhetoric you hear rests on a fallacy—that such a strategy is deliverable in the 21st century given the integrated nature of the global economy and the role of China,” said Kevin Rudd, a former Australian prime minister who now heads the Asia Society Policy Institute think tank.

U.S. officials note that China’s aid, such as its Belt and Road infrastructure program, often saddles recipients with debt. Yet the U.S. offers no alternative, said Mr. Rudd.

Some of Mr. Trump’s trade policies undermine the united front he wants against China. He hasn’t sworn off protectionism against U.S. allies, promising to withdraw from Nafta even if its replacement isn’t ratified by Congress. His steel and aluminum tariffs, most of which remain in place, outraged such allies as Canada.

U.S. officials play down such frictions as easily worked out. Abroad, they are seen as more serious. Canadian ambassador to the U.S. David MacNaughton said he told U.S. trade negotiators that if Mr. Trump carried through on his threatened 25% tariff on Canadian autos, it would fundamentally change bilateral relations for the worse for years to come. In a letter accompanying Nafta’s replacement, the U.S. agreed not to levy the tariffs.

Even among advocates of decoupling with China, a recurrent worry is that the current administration isn’t up to the task. Said the American Enterprise Institute’s Mr. Scissors: “We can blow this. And if we blow it, we’ll get a world economy that’s poorer than it should be, with all the distortions and inconsistencies that come from unpredictable U.S. policy.”

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