Trade in a World of Conflict: Russia, China and the WTO

By William Hawkins l September 8, 2008

Adam Smith lamented that “Commerce, which ought naturally to be, among nations, as among individuals, a bond of union and friendship, has become the most fertile source of discord and animosity.” He blamed the “ambition” and “jealousy” of government officials, merchants and industrialists for this state of affairs, a line that would become central to the classical liberal critique of foreign policy in the 19th century. England’s leading advocate for “free trade” in the 1840s, Richard Cobden, thought that international commerce was “the grand panacea” that would eliminate “the motive for large and mighty empires, for gigantic armies and great fleets.” In 1842, he stated: “It would be well to engraft our free trade agitation upon the peace movement. They are one and the same cause.”

History has not been kind to the notions of Smith and Cobden. “The idea that economics is primarily a non-zero-sum game is a favorite conceit of tenured academics. It has little connection with reality” argues Samuel P. Huntington, who then asks “Why are the economists out in left field? They are there because they are blind to the fact that economic activity is a source of power as well as well-being.”

An example of the interplay of geopolitics and economics has been provided by the border clash between Russia and Georgia. In the wake of Russia’s invasion of Georgia to protect two rebellious provinces, the United States put the brakes on Moscow’s bid to join the World Trade Organization. In an interview with German weekly Der Spiegel published Aug. 23, U.S. Commerce Secretary Carlos Gutierrez said, “The President has made it clear several times: until now, America was Russia’s advocate when it came to integrating the country into the global community….We welcomed and pushed forward Russia’s desire to join the World Trade Organization. That is all at risk now.” Earlier in the week, Secretary of State Condoleezza Rice told an emergency meeting of NATO foreign ministers, “We have to deny Russian strategic objectives, which are clearly to undermine Georgia’s democracy, to use its military capability to damage….and to weaken the Georgian state.” She urged NATO to “punish” Russia with sanctions.

On Aug. 28, First Deputy Prime Minister Igor Shuvalov told journalists that while WTO membership remains a priority, Moscow should step back from agreements that place an unnecessarily heavy burden on Russia. Two days earlier, Prime Minister Vladimir Putin had called for Moscow to renege on some commitments — particularly in agriculture — it had made during the accession talks. Putin also told a Cabinet meeting that he saw “no benefits” in WTO membership.

Russia has been on the WTO slow track since its accession process started in 1993, whereas Georgia has been a member since 2000.

One of the difficulties facing Russia in the WTO is how state monopolies such as Gazprom might be constrained. Moscow has been using Gazprom’s control of natural gas flows to Europe as a political weapon. Last year, the European Union sought to prevent Gazprom from taking over power networks in Europe. Under plans submitted by the European Commission, non-EU companies would be barred from owning a majority stake in gas pipelines or electricity power grids unless their home country signs a reciprocal agreement with the EU, a move that would break Gazprom’s monopoly. The EU currently imports 50 percent of its energy, with Gazprom supplying one quarter of the gas used by Europe.

A natural gas and two oil pipelines run through Georgia from neighboring Azerbaijan’s Caspian Sea fields, bypassing Russia and Iran to supply the West. The Caspian may hold the world’s third largest oil reserves. These pipelines are, however, within range of Russian forces.

There is a fundamental difference, both in economic effects and political outcomes, between trading with allies and adversaries. Princeton political economist Joanne S. Gowa, in her book Allies, Adversaries and International Trade, finds that throughout history trade patterns have been aligned with security alliances. She argues that it would be unwise to abandon the traditional practice of having “trade follow the flag” because interdependence is too risky with any government that cannot be trusted on political grounds. Gowa contends “power politics is an inexorable element of any agreement to open international markets, because of the security externalities that trade produces….trade enhances the potential military power of any country that engages in it.” Trade with an ally makes both parties stronger, whereas trade with an enemy creates what Gowa calls “a security diseconomy” where an enemy is being made stronger by trade and investment flows.

Such a security diseconomy can be seen in China, which joined the WTO in 2001. It was not until 1999 that the Chinese leadership decided to complete the accession process. This fit the outlook of President Bill Clinton who proclaimed just before embarking on an Asia tour that year, “perhaps for the first time in history, the world’s leading nations are not engaged in a struggle with each other for security or territory. The world clearly is coming together.” The accession talks were completed by President George W. Bush, hastened forward by the September 11, 2001 terrorist attacks. Bush wanted to settle matters with China so he could concentrate on the Middle East.

While understandable at the time, it was not the best long term assignment of priorities. As Der Spiegel business writer Gabor Steingart argues in his new book The War for Wealth, “The risk of terrorism is very real, and we must protect ourselves. But….It is the rise of India and China, not the goings on in the mountains of Pakistan, that will leave their imprint on this era. The war for wealth, a bitter struggle for a share of affluence, and the related struggle over political and cultural dominance of the world, are the real conflicts of the day.” He could just as easily have added the resurgence of Russia to the geopolitical mix.

One of the principle WTO benefits to Beijing was in creating the perception that China was a safe place for foreign firms to make long-term investments in partnership with Chinese firms and state enterprises. Beijing particularly wanted to create a favorable climate for high-tech firms to set up shop and transfer technology that would expand Chinese capabilities. Being based on the principle of political non-discrimination, the WTO also assured China continued access to the world’s export markets, the driving engine of Beijing’s rise.

The 2008 annual report by the Office of the Secretary of Defense (OSD) on Chinese military power found, “China harvests spin-offs from foreign direct investment and joint ventures in the civilian sector, technical knowledge and expertise of students returned from abroad, and state-sponsored industrial espionage to increase the level of technologies available to support military research, development, and acquisition. Beijing’s long-term goal is to create a wholly indigenous defense industrial sector able to meet the needs of PLA modernization as well as to compete as a top-tier producer in the global arms trade.” The U.S. trade deficit supports the expansion of Chinese industry, while the transfer of capital and technology improves its capabilities. Not only is American-based industry paying a high price as China strives to become the “workshop of the world,” but national security is at risk.

The OSD report also found that “Regime survival and the perpetuation of Communist party rule shapes the strategic outlook for China’s leaders and drives many of their choices. As a substitute for the failure of communist ideology to unify the population and mobilize political support, the CCP has relied on economic performance and nationalism as the basis for regime legitimacy.”

Russia’s resurgence, funded by energy exports, is doing the same to solidify Putin’s hard-line regime. Rising wealth has been attracting record foreign investment into Russia, which the government has been trying to direct so as to gain the benefits of outside innovation without losing control of the national economy. Last year the Duma passed a bill restricting foreign investment in “strategic” sectors, including most manufacturing, defense, the nuclear industry, the extraction of mineral resources and mass media. Any foreign private investor wanting to buy more than a 50 percent share of a company (or a state-owned firm wanting 25 percent) in any of the designated sectors must win approval from a commission composed of economic and security officials. Putin signed the law in May of this year. China has similar controls.

Russian President Dimitry Medvedev has said, “We are not afraid of anything, including the prospect of a Cold War.” Those in the West who are alarmed by such talk fail to realize that the so-called post-Cold War period was an aberration. The 1990s, like the years following the Napoleon Wars which gave birth to classical liberalism, were characterized by a vision of a new world of harmony that could not be realized. Russia under Putin has turned towards the east to align with China against American “hegemony.” Every country currently considered a rogue state by Washington now enjoys diplomatic, economic, and strategic support from Moscow and Beijing. Keeping Russia out of the WTO is not an issue that needs much debate. It is how to redress the adverse consequences of having let China into the WTO that needs serious thought.

William R. Hawkins, a former economics professor and Congressional staffer, is a consultant specializing in international economics and national security issues. He is a contributor to

SFPPR News & Analysis.