issue: Trade

The Hill: How the Obama trade agenda can advance progressive goals

Posted on by The Progressive Policy Institute

In the last month, protesters have camped out in the Washington office of Sen. Ron Wyden (D-Ore.) and have even flown a 30-foot blimp over his town halls in Oregon. The senator’s offense? As the ranking member of the Senate Finance Committee, Wyden is negotiating with the Obama administration and pro-trade Republicans and Democrats on Trade Promotion Authority (TPA)—legislation that would set requirements for new trade agreements and rules for how they’re considered by Congress.

Wyden believes that—if done right—new trade deals with Asia (TPP) and Europe (TTIP) coupled with strong enforcement can promote stronger growth and good jobs in his trade-dependent state, while also advancing important values like environmental protection, labor rights and an open Internet.

For the protesters, however, opposition to free trade agreements is an article of faith in their version of the progressive cannon.  Since the great NAFTA debate of the 1990s, trade has often been a polarizing issue among progressives. But key developments since then—the rise of China, the dramatic growth in digital trade via the Internet, and concerns about a long-term slowdown in U.S. growth—give progressives good reasons to think again.

Trade-skeptical Democrats should use the debate on Trade Promotion Authority to take a fresh look at President Obama’s far-reaching trade initiatives. As we’ve detailed in a recent Progressive Policy Institute report, open-minded progressives can find many examples of how the Administration is combining smart trade policy and progressive ideals to advance vital goals while strengthening both the United States and the global economy:

Tapping into Global Growth. Assuring that Americans have a fairer slice of the economic pie is easier when the pie is growing.

In the past, America’s middle class fueled growth in the rest of the world. Now, an exploding global middle class—especially in Asia—can return the favor. By 2030, Asia will add 1.2 billion new middle class consumers to the global economy. These global consumers will want to buy what America has to sell—from wholesome food and cutting-edge consumer products to modern financial services and health care.

Trade initiatives like the TPP can help America’s businesses and workers tap into growing global demand by eliminating high duties, discriminatory standards, and other significant barriers to U.S. exports.  And­—if combined with progressive initiatives in areas like education and training—growing trade can help support broad-based American prosperity.

Democratizing Trade. Trade agreements can also “democratize” trade by empowering small business and global consumers.

The Internet and services like eBay and FedEx make it increasingly possible for America’s small exporters to sell globally as easily as their bigger rivals. Small firms that export do well—with 20 percent greater productivity and 20 percent higher job growth than those that don’t. But an array of trade barriers—including high duties and fees and complex standards—still make it difficult for smaller exporters to compete.

U.S. trade negotiators are focusing intensively on eliminating small business trade barriers in the TPP and T-TIP. And they’re working to foster a robust trade ecosystem for small traders by promoting transparent rules, open electronic commerce, and strong protection for innovation. Opening up modern Internet-enabled trade can provide global consumers with greater choice, freedom, and economic power, as well.

Leading on Fairer Trade. Trade agreements like TPP and T-TIP help America lead coalitions of like-minded countries that seek a fairer global trading system in which abuses like exploiting workers, despoiling the environment, or blocking the Internet are not longer accepted means of competition.

Based on a 2007 deal initiated by House Democrats, U.S. trade agreements now include strong and enforceable rules that require trading partners to abide by and enforce fundamental labor rights and key environmental laws and agreements. TPP and T-TIP negotiations afford the opportunity to extend these—and other important progressive principles—to two-thirds of global trade. If America doesn’t lead, however, countries like China may succeed with a competing trade model—one that ignores values like worker rights, environmental protection, and an open Internet.

Updating Trade Rules.  New trade deals also provide the opportunity to update old trade rules and write important new ones.

Critics of NAFTA, for example, have long complained that its “side agreements” on labor and the environment contain weaker requirements that are neither part of NAFTA nor enforceable under that agreement. Negotiating with Canada and Mexico in the TPP can help assure that trade with America’s first and third largest trading partners is governed by strong, modern, and enforceable labor and environmental rules.

Additionally, new trade agreements can address an array of emerging challenges to U.S. trade, including State-Owned Enterprises that use government subsidies and special privileges to gain unfair advantages, and a growing list of barriers to innovation and electronic commerce.

Supporting a Progressive Growth Agenda. Finally, progressives can use a thoughtful trade debate to remind colleagues that trade is only one piece of America’s larger economic puzzle.

A new study by Progressive Economy concludes that trade is likely not a major cause—nor a major solution—for the serious problem of income inequality. The study notes that trade policy can make key contributions by, for example, driving stronger growth and reducing high duties that particularly impact lower-income Americans.  But, ultimately, solving America’s major economic problems will also require many domestic initiatives long championed by progressives, including better access to education and training, and investment in innovation and infrastructure.

When it comes to trade, not all progressive-leaning Americans are flying protest blimps. Indeed, according to recent polling, some 60 percent of Democrats and 65 percent of millennials believe that trade deals like TPP and T-TIP are “good” for America. It’s time for progressives to avoid reflexive opposition and take a fresh look at the U.S. trade agenda.

Forbes: Hillary Clinton and Trade: Not a Marriage Made in Heaven

Posted on by The Progressive Policy Institute

PPI senior fellow for trade and global opportunity, Ed Gerwin, today was quoted in a Forbes piece regarding Hillary Clinton and how Democrats approach to trade:

“The problem is there is a strain within the Democratic Party and the progressive movement that is of the view that support for any kind of free trade agreement is an absolute non-starter,” said Ed Gerwin, a trade expert with the Progress Policy Institute. “For these folks, it has become a part of their almost religious canon that you can’t support these FTAs.”

That’s counter-productive, he said, “because if that’s the attitude they take, then they lose all influence in the trade debate. People write off these hard-core anti-trade people because they’re not going to support you, whatever you do.”

Read the piece in its entirety at Forbes.

The Hill: Obama trade agenda

Posted on by The Progressive Policy Institute

PPI President Will Marshall was quoted by Kevin Cirilli in The Hill on the growing tensions in the Democratic party over President Obama’s trade agenda:

Will Marshall, president of centrist Democratic think tank the Progressive Policy Institute, said that “Democratic candidates in 2016 aren’t going to get into trouble for supporting” the trade agreements.

“Most voters understand that America can’t prosper in isolation and they have little interest in yet another reenactment of the long-ago battle of NAFTA,” he said.

Continue reading at The Hill.

Politico Pro: Report urges progressives to reconsider Obama trade agenda

Posted on by The Progressive Policy Institute

PPI Senior Fellow Ed Gerwin’s latest report was featured in a trade story by Politico Pro‘s Doug Palmer:

A new report urges progressive Democrats opposed to President Barack Obama’s trade agenda with countries in the Asia-Pacific to give it another look, arguing that trade deals support progressive goals in a variety of ways, including by helping economic growth.

“Trade-skeptical progressives … should take a thoughtful look at the details of the Obama trade agenda and how it might better position America in the modern global economy,” Ed Gerwin, a senior fellow at the Progressive Policy Institute, said in the report. “If they do, they’re likely to find important policies and initiatives for progressives to like.”

“A progressive society that is both prosperous and fair requires strong and inclusive economic growth. The Administration’s trade agenda can play an important role in assuring that America can tap into one key source of economic vitality — surging demand in key foreign markets,” Gerwin said.

The report comes as Congress is gearing up for action on trade promotion authority, also known as fast-track trade legislation because it would allow the White House to submit trade agreements to Congress for straight up-or-down votes without any amendments.

 

The Obama Trade Agenda: Five Things for Progressives to Like

Posted on by The Progressive Policy Institute

In his recent State of the Union address, President Obama went all in on international trade.

The Administration has already been aggressively pursuing the most ambitious set of trade agreements in decades—including potentially groundbreaking deals with 11 Asian-Pacific countries (the Trans Pacific Partnership, or TPP), and the European Union (the Transatlantic Trade and Investment Partnership, or T-TIP), as well as agreements in key sectors like services, information technology, and environmental products.

Now, to set the stage for eventual Congressional approval for these deals, the President has launched an Administration-wide effort to obtain Trade Promotion Authority (TPA) from Congress. Under TPA, Congress sets detailed priorities and extensive consultation requirements for U.S. trade negotiators, and agrees to follow special expedited procedures for agreements that meet these rules.

Congressional Republicans largely support TPA and the Administration’s trade agenda. There is less support, however, among Congressional Democrats, many of whom have doubts about new trade deals. And, because trade has long been a difficult political issue, it’s quite tempting for these trade skeptics to readily side with those who have consistently opposed trade agreements.

Download “2015.02-Gerwin_The-Obama-Free-Trade-Agenda”

 

The Hill: Shooting yourself in the foot

Posted on by The Progressive Policy Institute

What’s gotten into our European friends? Beset by slow growth, tensions over immigration and a rising fever of anti-Euro populism, some leaders are trying to deflect public discontent onto U.S. companies—a move that may turn out to backfire economically

The latest example comes from UK Chancellor of the Exchequer, George Osborne. He recently floated a proposed “diverted profits tax” on foreign companies doing business in Britain. It’s been called the “Google tax” and little wonder, since it’s clearly aimed at U.S. tech companies.

Osborne describes the idea as a way to foil tax avoidance strategies many companies use. That’s a legitimate issue. But what the Chancellor is proposing is a unilateral step that could torpedo the elaborate process the European Union and other governments already launched (through the Organization for Economic Cooperation and Development) to develop a common approach to tax base erosion and profit-shifting.

This gambit by the government of Prime Minister David Cameron, a Conservative who is forever extolling Britain’s “special relationship” with America, is unfortunately not an isolated incident.

Continue reading at The Hill.

Forbes: Net Neutrality at Home, TTIP Abroad. Moving Towards the Center?

Posted on by The Progressive Policy Institute

In an article on net neutrality and the Transatlantic Trade and Investment Partnership, Forbes contributor Larry Downes mentioned speaking at “Growing the Transatlantic Digital Economy,” an event hosted last week by the Progressive Policy Institute and the Lisbon Council:

Later in the week, I spoke at a program co-sponsored by the Progressive Policy Institute, the Lisbon Council, and the Georgetown Center for Business and Public Policy on “Growing the Transatlantic Digital Economy,” which reviewed efforts to bridge what have often been large gaps in policy that make digital trade between the U.S. and the E.U. difficult, including differences our respective approaches to competition, privacy, and communications infrastructure regulation between the two economies.

Read the full piece on Forbes.com

Anti-inversion legislation: A “boomerang bill”

Posted on by The Progressive Policy Institute

There must be a good word for legislation that produces exactly the opposite result that its supporters intend. I know, let’s call it a “boomerang bill.”

The anti-inversion legislation that Treasury Secretary Jack Lew advocated on September 7th is, unfortunately, a classic example of a boomerang bill.  It is intended to stop a feared tidal wave of corporate inversions–that’s a fancy technical term for when a U.S. company moves its headquarters to another country, often but not always for tax reasons.

In reality, anti-inversion legislation, at least as currently proposed, is likely to turn U.S.-based multinationals into hunted prey, selling out to foreign rivals. The proposed legislation basically draws up a roadmap for activist investors and foreign companies, showing them how to get access to the overseas cash of U.S. companies by buying them up and moving their headquarters out of the country.

How does that happen? Proponents of anti-corporate-inversion legislation are worried that the tax benefits of moving the headquarters of a U.S. multinational overseas are compelling–so compelling that if they allow a few companies to do it, a tidal wave will follow.

So to stop the flood, the legislation would require that any company that wants to “invert” show at least 50% foreign ownership in order to escape the U.S. tax system. That’s intended to stop companies such as Medtronic, which is planning to acquire the Irish company Covidien and move its headquarters to Ireland, while maintaining its existing operations in the U.S.

Now, there is much debate about whether Medtronic is making this move for strategic or tax reasons. But that’s not important.  The big problem is that the anti-inversion legislation does nothing to fix the underlying problem, which is the incredibly weird and broken U.S. corporate tax system.

Instead, the legislation encourages activist investors and foreign companies to work together to make takeover bids for U.S. multinationals with large amounts of cash outside of the country. No company, no matter how large, would be safe.

What’s the real solution here? America’s corporate tax system is broken, and you don’t fix a broken leg by applying a band-aid. For one, it has a higher corporate tax rate, 35%, than almost any other industrialized country.

Second, America taxes all income, foreign and domestic, of U.S.-headquartered companies at this higher rate, something almost no other country does.

Let me state for the record that I believe America is an awesome place to live and work. In particular, America’s history and culture as a wellspring of innovation makes it the best place to build a business in the world, bar none.  And I am gratified when I see foreign businesses open up factories, software labs, or R&D facilities in this country.

At the same time, I don’t necessarily like it when a U.S.-based company moves its headquarters overseas. Still, it’s a business decision, the same as when a foreign company takes tax breaks to open up a big plant, say, in Alabama or Kentucky.

The solution here is to fix the corporate tax system, not to enact a boomerang bill that will only make things worse.

 

Jobs in the Australian App Economy

Posted on by The Progressive Policy Institute

Is Australia ready for the digital economy? This is obviously a subject of great debate, intertwined with decisions about investments in the National Broadband Network and public concerns about data privacy. It is clear that some parts of the Australian digital economy, notably mobile communications, are quite vibrant. Two recent reports from the Australian Communications and Media Authority show the strength of this sector.

  • The number of Australians using the Internet via their mobile phone rose 33% from June 2012 to June 2013.
  • The number of Australians with a smartphone rose by 29% from May 2012 to May 2013.
  • Mobile broadband boosted Australia’s economic activity in 2013 by an estimated $34 billion (AUD).

In this study, we focus on one particular aspect of the mobile boom: The number of Australian jobs created in Australia’s ‘App Economy’. Australia has a large number of app developers—these are the people who design and create the apps distributed by small and large companies, nonprofits, and government agencies. Indeed, it’s astonishing how fast many companies have embraced the App Economy, hiring the workers needed to develop mobile applications at a rapid rate. We are seeing the creation of new specialties and new ways to interact with customers and employees.

But building a successful app is not a one-shot deal. Think of an app like a car—once built, it still needs to be repaired (in the case of bugs or security risks), updated, and maintained. And just as the automobile industry supports a large number of workers, from engineers to factory production workers to sales to service stations, so too does the App Economy support a significant number of workers.

An Australian company that does app development has to hire sales people, marketers, human resource specialists, accountants, and all the myriad of workers that inevitably make up the modern workforce. Finally, each app developer supports a certain number of local jobs. (The full definition of an App Economy job is found later in this study).

In this report we estimate that the Australian App Economy employed roughly 140,000 workers as of June 2014. The top state was New South Wales, with 77,000 App Economy jobs, but every state had some App Economy employment. Moreover, we note that Australia stacks up well against the United States and the United Kingdom when it comes to App Economy employment per capita.

Read the full memo – Jobs in the Australian App Economy

Does Ex-Im Bank Need a ‘Third Option’?

Posted on by The Progressive Policy Institute

Long dogged by claims of corporate welfare, the Export-Import Bank (Ex-Im) finds itself once again fighting for its survival. At 80 years old, Ex-Im has always won the fight. But this time, a “third option” of reform might just be what it needs — one that focuses on making the agency better, not closing its doors.

The Export-Import Bank is a government agency with a mission to support U.S. jobs through exports. The bank provides loans, guarantees and insurance to help U.S. exporters level the playing field against foreign competitors, in a world where 59 other countries provide export financing assistance. As a “lender of last resort,” each transaction must demonstrate “additionality,” where the export would not go forward absent Ex-Im Bank.

In the past, trade promotion by leveling the playing field has been argument enough for reauthorization. But now, the battle over Ex-Im Bank is about more than corporate welfare — it’s a face-off between the establishment Republicans and Tea Party conservatives.

Continue reading at The Hill.

A Fresh Approach to International Investment Rules

Posted on by The Progressive Policy Institute

Money makes the world go round. Although money flows are global, the rules governing investment are bilateral and regional. Cross-border investment is governed by a patchwork of over 3,000 bilateral investment treaties (BITs), regional and bilateral trade agreements (FTAs) with investment chapters, as well as the trade-related investment provisions of the World Trade Organization. While many states have signed international investment agreements (IIAs), they do not cover all states, investors, or categories of investments. Taken in sum, these IIAs have many problems, including:

  • The 3,000-plus IIAs vary significantly and do not offer clear and uniform guidelines to protect international investment.
  • Tribunals have no effective means of enforcing their decisions.
  • Some investors and states take advantage of the hodgepodge of rules to “game the system” through forum-shopping and other strategies.
  • Investors are increasingly challenging government regulatory or budgetary policies that reduce the value of their investments as “indirect expropriations.”
  • Citizens in the United States, EU, and other countries are increasingly critical of the balkanized, uneven investor-state arbitration process.

We believe it is time for a fresh approach to international investment agreements: one that builds a more universal, consistent, and accountable system. In this policy brief, we put forward three concrete steps that can promote and protect foreign investment, advance the rule of law, preserve the ability of governments to regulate, and link trade and investment.

Step 1: At the behest of the G-20, the WTO and international organizations with investment competence should establish a committee of experts to develop a code of norms and best practices. G-20 members should use this code as a template for future investment agreements and encourage all WTO member states to sign up.

Step 2: WTO members should set up an Investment Appellate Body to review and if necessary, override controversial arbitrations where the rights of investors or governments were inadequately protected. The Investment Appellate Body will stand beside the WTO’s Trade Appellate Body.

Step 3: To give the Investment Appellate Body teeth, one or more WTO member states should ask the WTO Secretariat to explore the feasibility of using trade policy to retaliate against states that fail to comply with its decisions.

Download the complete report.

Bloomberg: EU Risks Hurting Growth in Data Safeguard Effort, Study Finds

Posted on by The Progressive Policy Institute

Rebecca Christie of Bloomberg wrote an article covering PPI’s transatlantic conference and paper release in Brussels last week. The paper, Bridging The Data Gap: How Digital Innovation Can Drive Growth and Jobs, aims to measure the costs of data protectionism  and knee-jerk reactions to NSA revelations may hurt European economies. Michael Mandel, co-author and PPI’s chief economist explained:

A European Internet might sound like a grand, patriotic idea…But were it to take shape, it would harm few people or places more than Europe and Europeans themselves.

You can find the full article on Bloomberg’s website, here.

Bridging The Data Gap: How Digital Innovation Can Drive Growth and Jobs

Posted on by The Progressive Policy Institute

Seldom has the world stood poised before economic changes destined to bring as much palpable improvement to people’s lives and desirable social transformation as “big data.”

Breathless accounts abound of the huge amounts of data that citizens, consumers and  governments now generate on a daily basis in studies ranging from the French Prime Minister’s Commissariat général à la stratégie et à la prospective study on Analyse des big data: Quels usages, quels défis to Viktor Mayer-Schönberger and Kenneth Cukier’s seminal Big Data: A Revolution That Will Transform How We Live, Work and Think.

But the larger revolution will come not from the exabytes of data being generated on a daily basis, but through the vast advances in analytics that will help us convert this information into better lives, and better societies. Already, many companies are using the new information to offer more tailored products and services to customers; consumers are receiving more effective healthcare; clever administrations are cutting pollution and commuter transit times; people of all types are being entertained and educated in fascinating new ways; and entrepreneurs who seize the opportunity are helping raise North America and Europe from the longest economic recession since statistic-taking began.

Download the full report here.

Michael Mandel and Paul Hofheinz presented their paper today at the PPI & Lisbon Council joint event: New Engines of Growth: Driving Innovation and Trade in Data. 

Data, Trade and Growth

Posted on by The Progressive Policy Institute

We show in this paper that the architecture of the Internet dictates that current trade statistics significantly underestimate the magnitude and growth of cross-border data flows. As a result, the contributions of cross-border data flows to global growth and to small businesses are being significantly underestimated. This suggests that trade and tax policy should place more emphasis on maintaining cross-border data flows. Moreover, policies that discourage cross-border data flows, such as data localization and high tax rates on cross-border data, should be avoided if possible. Statistical agencies should explore adding data as a separate trade category, along with goods and services.

INTRODUCTION
The architecture of the Internet is designed as a “network of networks.” As such, one of its key attributes is making the passage of data from one network to another easy. So, when a user sends an email, views a video, or downloads a file from a website, the data may pass through a large number of different networks on the way from its origin to its destination, with the routing virtually transparent to the user.

This architecture has proven to be extremely flexible and powerful, both nationally and globally. Individuals, small businesses, and corporations with Internet access can easily access data of all sorts from around the world. Similarly, companies can efficiently and cheaply provide services such as email and web search on a global basis, in many cases without charge.

One sign of the Internet’s global success is the rapid growth of cross-border data flows. Cross-border data flows are growing far faster than conventionally measured trade in goods and services. According to TeleGeography, a consulting firm that keeps track of international data flows, demand for international bandwidth increased at a compound annual rate of 49% between 2008 and 2012.1 By comparison, the overall volume of global trade in goods and services, adjusted for inflation, rose at an average rate of 2.4% over the same period.

Continue reading and download the full report.

China’s Data Fog

Posted on by The Progressive Policy Institute

China recently released its January trade data, showing export growth of 10.6% and performing way above predictions – if you believe the numbers.  Many don’t.  After last year’s round of inflated figures, stories began to appear about just how businesses were cooking the books.  For example, some corporations were sending their goods on a “round trip” to Hong Kong and back, whereby a good produced in China goes “abroad,” to count as an export for tax purposes, and then is brought back to the mainland and sold at a premium because the same good is now also an “import.” Businesses being less than honest is neither a new nor a China-specific phenomenon — but as with every accomplishment the Chinese seem to be doing it bigger and more prolifically than most.

Exports aren’t the only quarter where domestically counted economic indicators have come under criticism.  Former Prime Minister Li Keqiang was quoted in a 2007 communique recently released by Wikileaks describing the data used to report China’s GDP as “man-made.”  In 2013, a Chinese university released a Gini coefficient estimate, a measure of a country’s rich-poor gap, at .61.  A short month later the Chinese government released their first official estimate in a decade coming in at 0.47 – where 0 is perfect equality and 1 is extreme disparities in wealth. (The U.S. for comparison is a middle-of-the-pack nation with a World Bank Gini coefficient of .45).  Foreign economists familiar with China labeled the official number, politely, as ‘optimistic.’

These examples highlight two related, but separate issues: Chinese economic data is manipulated at both the macro and at the micro level.  Government offices are incentivised to report good numbers and individual firms/households are incentivised to hide their wealth and keep it out of China.  Exacerbating the government’s stranglehold on numbers with any meaning is the aggressive harassment of investigative reporters.  Last December’s reporterpocalypse, whereby in retaliation for “biased” articles Beijing held up the visas for dozens of foreign reporters, was resolved only by United States Vice President Joe Biden’s direct intervention.  Even so, China has continued the trend of kicking out individual journalists with the banning of another New York Times reporter two weeks ago.  Of course, no one has it as rough as the Chinese national reporters, who are subject to intimidation, jail time, and annual mandatory classes on how to be a loyal “marxist” reporter.

Formerly, China’s data fog wouldn’t have much global impact.  But in an age of unprecedented investment, trade, and interdependence China’s behavior is a problem for actors worldwide.  U.S. current Foreign Direct Investment in China is a cool $51 billion, most of which is tied up in manufacturing and outside of finance.  American investors need to know the true quality of the environment in which they spend U.S. dollars.  Furthermore, globalization has led to the unprecedented integration of economies whereby governments need accurate data from abroad to determine domestic competitiveness.  Finally, as the 2007 financial crises demonstrated – failure in the number one (and presumably two) global economy has consequences far beyond a single state’s borders.

Can the US or other outside forces encourage transparency?  The fact is that the United States government has little to no political capital in Beijing.  When Chinese officials are approached directly by US counterparts, their “advice” is interpreted as at best, condescending and at worst, part of a massive beltway plot to keep China down.  This situation illustrates one aspect of a global sea change where the most effective ambassadors aren’t coming from the government, they are the corporations.

For corporations however, the need for accurate information is tempered by other considerations.  Companies operating in China have an obvious vested interest in staying on the good side of local/national authorities.  It’s hard enough to get things done even when you are courting, bribing and hiring the relatives of the right people.  But that doesn’t mean we should underestimate how much China wants to attract foreign business, and the leverage that this desire gives investors.  With the roll out of Shanghai’s new Free Trade Zone, Beijing has shown its hand.  The government desperately wants to shift the focus of China’s economy away from heavy industry and towards financial and service sectors – ideally with foreign role models around to “unleash diversity and competition.”

Encouraging transparency in China, the United States’ biggest trade partner and the number two global economy, is good economic policy and a smart business strategy.  Both official and commercial actors need to participate in lobbying for transparency.  In the end, the prospects of foreign businesses in China contribute to the development of the US and the global economies.  Governments and the participating corporations are responsible for pressuring China to do the right thing, and as their relative power shifts, pressure is best applied through multiple governmental and business channels.

 

Innovation from 9 to 5: China’s Economic Test

Posted on by The Progressive Policy Institute

China is investing more in R&D than the European Union, according to soon-to-be-released data from the Organization for Economic Cooperation and Development (OECD).  This milestone reflects a multi-pronged effort by Chinese policy makers to spur economic innovation. Other measures include incentives to lure foreign educated Chinese back home,  patent targets and subsidies, and a strong emphasis on market driven change and innovation across sectors in the recent national memo from President Xi.

The Chinese strategy of focusing resources on modernization has paid big dividends for the national economy and Chinese workers since Deng Xiaoping opened China to Nixon and the world in the 1970s. First heavy than light industry flourished under focused, deliberate state nourishment, leading China to its present status as the world’s second-largest economy. But this model of state-directed development faces new challenges as the standard of living rises and factories face competition from other countries with even cheaper labor, such as Vietnam and Bangladesh. Now that Chinese workers face threats to their job security, the government is asking: How can we innovate our way up the economic value chain?

The Chinese Communist Party has long justified its political monopoly by acting as the benign steward of transformative economic growth. But as growth rates flag, the difficulty of moving toward higher-valued added activities has presented the Chinese version of “it’s the economy stupid.” Unfortunately for President Xi Jinping, the party’s authoritarian ways are antithetical to the type of culture that has traditionally led to the entrepreneurial innovation the party seeks to develop.

Innovation is inherently disruptive. But the business environment, the legal environment, and societal pressures in China combine to foster businesses and businessmen who curry favor with officialdom and make few waves. Chinese schools feature rote memorization of the “correct” answers to any and all questions, stifling any instinct a student may have to think outside the box. Recently, the government officially endorsed a rehashing of ancient Confucian thought emphasizing obedience and deference to authority. Professors who ask China to follow its own constitution and develop rule of law get sacked.  Beijing would like to believe that it can suppress freedom of speech and thought, forego a genuine rule of law, and maintain strict political control, all while building a dynamic, modern economy. It has done an impressive job of organizing the economy around the imperative of “copy to catch up.” But it’s a lot harder to force people to be creative by decree.

After decades of following Western models of economic development, Chinese politicians now denounce the predetermined path in favor of forging a new “Chinese way” of combining free markets with controlled government. Ideally, China would develop an economy driven by a flexible, creative, innovative work force without transitioning to the classically liberal social and governmental structure traditionally necessary to cultivate that kind of human capital. The writing on the wall reads: “Be creative and daring! Only at work, never in any other capacity.”  China’s attempt to quarantine innovation underpins the success or failure of their targeted economic transformation and with it the fortunes of the CCP. It is dangerous to join the chorus of voices heralding China’s downfall since 1949, but this contradiction looks like a giant roadblock on the path forward.