Former Chairman of Morgan Stanley Asia Stephen Roach: The Sino-American Trust Deficit

The recently concluded Strategic and Economic Dialogue (S&ED) between the United States and China was a major disappointment. It lacked strategy at a time when both countries face formidable challenges on many fronts. And what passed for dialogue was a series of speeches and tightly scripted talking points. Most significant, it failed to address an increasingly corrosive trust deficit that poses the most serious threat to Sino-American relations in 25 years.

Conditions were tough heading into the talks. The US Treasury was complaining yet again about the Chinese currency, which had depreciated by 2.4% against the dollar in the first half of 2014, after having appreciated by 37% over the previous eight and a half years. The US State Department and China’s Ministry of Foreign Affairs were engaged in a war of words over mounting territorial and sea-lane disputes in the East and South China Seas.

But the darkest clouds were on the cyber front. Two months before the S&ED, the US Department of Justice indicted five officers of the People’s Liberation Army (PLA) on 31 counts of charges ranging from computer fraud and hacking to identity theft and economic espionage. In response, China suspended its participation in bilateral military exchanges on cyber threats. Meanwhile, revelations of the pervasive scope of US cyber-espionage activities reverberated from Capitol Hill to Berlin, giving rise to legislation aimed at controlling America’s largely unchecked National Security Agency and casting a pall over the all-important US-German relationship.

Charges and countercharges on the cyber issue have focused primarily on motives. The US has been quick to distinguish between commercial and military espionage. But for China, this distinction rings hollow.

Chinese officials see little difference between the cyber threat posed by the NSA and that posed by the PLA, especially given that America’s cyber intrusions have also been aimed at foreign companies, trade negotiators, and international leaders – all of whom are directly or indirectly engaged in commercial activity. In the end, moral hair-splitting is less important than the blame game itself – a visible manifestation of the deepening bilateral distrust wrought by a destructive phase of Sino-American codependency.

Against this backdrop, it was hardly surprising that the S&ED produced so little. Cyber exchanges between the two militaries were not restarted, and negotiations over a bilateral investment treaty – a mutually beneficial rules-based framework that would go a long way in opening up both countries’ markets to increasingly globalized US and Chinese companies – were particularly disappointing. A year ago, there was an encouraging breakthrough on the investment treaty; this year, there was a setback, as the launch of explicit negotiations over which industries would be exempt – the always contentious “negative list” – was deferred until 2015.

The problem with “kicking the can down the road” is that the road is leading directly toward the upcoming US presidential election cycle – a time when the debate over China always intensifies. Add to that a polarized and dysfunctional Congress, and the timeframe for concluding a US-China investment treaty is beginning to appear eerily reminiscent of the decade-long process that was required for Chinese accession to the World Trade Organization in 2001. That would be bad for both countries, as each now faces urgent economic challenges.

I was in China during the week following the S&ED, and official circles were abuzz about the new growth opportunities of services-led rebalancing. There was also clear recognition of meaningful progress on this front, with China’s tertiary sector (services) growing more rapidly than its secondary sector (manufacturing and construction) for the third year in a row – sufficient to make services the Chinese economy’s largest sector for the first time.

And there is plenty more to come. At around 47% of GDP, China’s embryonic services sector remains well short of the 60-65% share that a middle-income economy typically possesses.

At the same time, Chinese officials understand that further progress toward a services-led economic rebalancing will stall without the talent, systems, experience, and scale of global multinational services providers. And who better to provide what is needed than the US – the world’s largest and most competitive services economy. Given that the US has experienced yet another year of weak performance, one might have thought that this growth opportunity would have resonated on the American side of the S&ED table.

The failure of both US and Chinese leaders to recognize the mutual benefits of an investment treaty is disturbing. Going slow on such an obvious “win-win” reform suggests either that each country attaches little importance to its growth imperative or that they are unwilling to address that urgency by coming to grips with the increasingly insidious trust deficit that divides them.

I suspect that it is the latter. Leaders on both sides understand their countries’ growth challenges. But neither seems willing to address the intensification of distrust that has arisen during the past year from the cyber issue. Here is where the blame game belies the obvious: Both countries hack, and both have lost control over their hackers. Moreover, cyber-hacking itself is growing at an exponential rate in today’s interconnected world. In other words, the cyber blame game is pointless.

Acceptance of shared responsibilities in coming to grips with cyber tensions is essential if the US and China are to re-engage on the other geostrategic and economic challenges that they both face. The failure of July’s S&ED was a red flag, yet another indication that the bilateral relationship is headed in the wrong direction. Staying the course is not an option.