China should avoid a new economic Cold War with the United States, an influential economist has warned. Wei Jie, a professor at Tsinghua University’s School of Economics and Management, has outlined his vision of a settlement of the trade conflict between Washington and Beijing.

Later this week, US President Donald Trump and China’s President Xi Jinping will hold talks to end the dispute on the sidelines of the G20 summit in Buenos Aires.

Wei spoke in detail about the trade spat and the broader Chinese economy at Hupan University, which was co-founded by Alibaba founder Jack Ma, in Hangzhou, Zhejiang.

Below is a translated and edited version of his speech.

China’s economy has shown six serious phenomena since March:

1: A large number of small and medium companies are struggling with costs and capital, with some of them being shut down in June and July.

2: Increasing corporate debt defaults starting from state-owned enterprises (SOEs) and spreading to private firms and to listed firms. It seems a credit crunch chain is spreading.

3: Non-financial organizations have been in trouble, especially in July.

4: The stock market has seen a panic sell-off. The Shanghai Composite Index has slumped to 2,500 points.

5: Investors are desperately looking for safe assets.

6: Most Chinese are at a loss about China’s economic outlook and transparency has worsened since October.

That being said, China’s economic fundamentals remain strong. The above are signs that China’s economy is moving into an adjustment phase rather than a recession, a process that could take at least three years. These phenomena are triggered by five events, including de-leveraging, supply-side reform, shifting to a technology-driven economy, environmental protection efforts and the US-China trade war.

China did not expect the US to engage in a trade war at a time when the US economy was booming. We originally thought the trade war would not affect China very much, but the psychological impact was actually much stronger than expected.

If the US had begun its trade war a decade ago, China would have been doomed. In 2007, China was basically an export-oriented economy. The nation’s GDP was 27 trillion yuan (US$3.89 trillion), and exports represented 9 trillion yuan and contributed to over 30% of GDP. The trade surplus accounted for 11.3% of GDP.

The 2008 financial crisis made China realize that a nation with such a sizable economy should not follow an export-oriented model. Because of this, China started to reform its strategies and boost domestic demand.

Fast forward 10 years to the present. Last year, exports amounted to 15 trillion yuan and contributed 18% of China’s GDP of 82 trillion yuan. In the same period, the trade surplus represented 1.3% of GDP, compared to 11.3% a decade ago. That shows China has already adjusted its growth model.

A fully-fledged trade war or zero exports to the US would drag China’s growth down by between 0.2 and 0.5 percentage points. We could easily absorb that. But the psychological impact of trade tariffs has been much worse than we could have anticipated. Now, if the US were to announce any new tariff measures, China’s stock market would definitely fall dramatically the next day.

Overall, US-China economic ties have been stable for the last four decades. People are worried about the potential of another cold war, which could cause serious problems for the Chinese economy.

Industry upgrade

China should continue to upgrade its industry in 2019 and 2020 before it can enter a high-quality growth period. The Chinese economy is not facing a recession but a consolidation period. The country should continue to stabilize its financial system, maintain economic growth and continue to open up its market.

To stabilize its financial system, China should maintain a neutral monetary policy in order to avoid financial risks and support economic growth. It should also continue to de-leverage its banking system, maintain its forex reserve at above US$3 trillion and avoid a collapse in property and stock markets.

China should strengthen its protection of individuals’ personal safety and private property so that wealthy people will stay in the country to help contribute to the economy. The country should enhance its technological innovation by setting up research centers to serve the business sector.

China has to continue to open up. To achieve this, it has to properly handle relations with the US.

In the past, in order to buy time for economic growth, China pretended to be a little child in US-China trade relations. Now, we are already grown-up and cannot pretend anymore.

The US-China trade war marks a readjustment of bilateral relations, which is a sign that the old way of conducting US-China relations are gone. Neither side will return to the old status quo.

Some of the criticisms leveled by the US are correct. For example, we did provide subsidies to state-owned exporters. We should institute reforms.

Main principles

There are three main principles to deal with US-China relationships. First, China has to safeguard the core economic benefits of being at the forefront of the global supply chain. Second, China should reflect on the Trump administration’s criticisms about government-subsidized exports and SOEs, and push forward with internal reforms. Third, China should engage more with American companies and state governments and try to avert a cold war.

In fact, China missed out on a good opportunity in the wake of the 2008 financial crisis. It should have bailed out American corporations and become shareholders in US companies. Instead, we loaned over US$1 trillion to the US government.

Up to 180 American companies participated in the first China International Import Expo held recently in Shanghai. The Trump administration was lobbied by US firms to reduce the tariff on Chinese imports from 25% to 10% as the interests of companies such as these are at stake. This proved that China should avoid an economic cold war and enhance communications with US corporations and local and state governments.

It is critical that we properly handle bilateral relations with the US. We should avoid an adversarial relationship with the US due to trade issues. Instead, we should step up integration with the world’s most developed economy in various areas.

In fact, the US economy is facing various economic difficulties of its own. The middle class is struggling, while blue-collar workers have not seen a real increase in wages for nearly two decades. US government debt amounts to US$20 trillion, equivalent to its GDP. Taking these facts into consideration, an adversarial relationship with China would not benefit the US either.

Moreover, Beijing should step up efforts in promoting the Belt and Road Initiative (BRI). It has already figured out that China has to find new export and investment destinations in case the US bans Chinese imports altogether. Target regions include Asia, Europe and Africa as well as the Pacific Ocean and Indian Ocean regions.

Beware of failures

China must choose its strategy wisely and beware of the failures of Japan and Russia, who focused too much on the expansion of domestic demand and on an armaments race with the US, respectively. Contrary to Japan, Germany has successfully reformed its economy by enhancing its technology since it signed the Plaza Accord in 1985.

China must avoid a Cold War-like confrontation with the US. If it is too hard to deal with the Trump administration, China should approach the US business community or local and state governments. China must take the initiative to stick with the US, especially when the US tries to fight with us.