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The Real US Trade War With China

Multilateralism has a role to play in making America great again.

|April 18, 2018

By Phillip Orchard

During a meeting with farm-state lawmakers last week, U.S. President Donald Trump ordered his economic team to look into rejoining the Trans-Pacific Partnership. Trump withdrew the U.S. from the 12-nation trade pact on his first day in office, leaving it for dead as signatories wondered how to offset the loss of the ultimate trade carrot: unfettered access to the world’s largest economy. Improbably, the remaining 11 members found a way, signing a slightly slimmed down pact in March. And now Trump, just as improbably, is rethinking the value of the deal he repeatedly lambasted on the campaign trail.

Let’s be clear: For numerous political and technical reasons, the U.S. won’t rejoin the TPP anytime soon. But even Trump’s notional interest in the pact tells us two things about U.S. trade strategy. First, the political obstacles driving the U.S. away from its historical role as architect of the global trading system are by no means permanent. Second, the real trade war isn’t about the deficit – and this fight can’t be won without friends.

Politics by Other Means

When forecasting a trade war, as with a shooting war, it’s not enough to look merely at who can inflict the most pain, but also differing thresholds of pain. Even though the Chinese economy is far more dependent on the U.S. than vice versa, variables like political will also matter.

Though China is evolving into a dictatorship, it has a searing fear of unemployment sowing mass discontent. However, China has an immensely powerful president who doesn’t have to ask his legislature for permission to pass social measures to ease the pain of a trade war (nor for forgiveness if he deems it necessary to crush any sign of backlash). He also has an immense propaganda arm. It won’t be hard for Beijing to rally the nation around the flag and amplify the narrative that the government is merely doing what it must to stand up to the bullying Americans and take China to the promised land. The U.S., by comparison, has an embattled president grappling with a divided public, powerful lobbies and a slow-moving congress whose attention is fixed firmly on the upcoming midterm elections. Even in the best of circumstances, the fractiousness inherent to most democracies can make the politics of trade exceedingly tricky. This is why trade pacts require years of tortuous negotiations – even when broader strategic concerns compel leaders to commit political capital to seeing them through.

China is proving adept at the U.S. political game. According to Brookings, 82 percent of the counties expected to see job losses from Chinese retaliatory measures were won by Trump. Farmers, in particular, are squarely in Beijing’s crosshairs, with heavily exported U.S. crops like soybeans, wheat and corn facing 25 percent tariffs. This explains why farm-state leaders have been pushing Trump to reconsider TPP. The benefits of rejoining the pact likely wouldn’t be felt for years, but it would likely pry open tightly protected markets such as Japan’s to U.S. agriculture over time.

The difficulty of finding enough carrots to please an array of cantankerous constituencies in pursuit of the broader national interest is why much-maligned multilateral deals often end up making sense – and why presidents often flip-flop on trade. Barack Obama campaigned on overhauling NAFTA before concluding that TPP – which Canada and Mexico both signed, partly to offset U.S. demands on NAFTA – was the best way to update it. It’s why, at least in part, Trump is evidently warming to the trade pact. And it’s why the remaining 11 TPP members designed the revived pact to make a U.S. return as easy as possible. Whether or not the Trump administration moves in this direction, the world expects the U.S. to eventually re-embrace the notion that others have a role to play in making America great again.

It’s a Tech War, and the U.S. Needs Allies

The trade deficit with China is a sideshow, and so too are measures ostensibly meant to decrease it. The U.S. isn’t a major importer of Chinese steel and aluminum, for example, and the U.S. metals sectors – which already enjoyed strong protections – won’t be restored to their past glory by the U.S. tariffs that kicked in on March 23. Meanwhile, as Chinese consumer power has grown, so too have U.S. exports to the Middle Kingdom – by some 500 percent since 2001, with China accounting for 8 percent of all U.S. exports by 2016. General Motors sold nearly a million more cars in China last year than in the U.S. According to a study by Oxford Economics, the combination of U.S. exports of goods and services to China and bilateral foreign direct investment flows contributed to the creation of some 2.6 million jobs in the U.S. in 2015. The same study said cheap Chinese goods such as washing machines and solar panels (both of which were targeted with tariffs in January) have saved the average American household some $850 annually.

All this speaks to the broader issue at hand. The United States’ comparative advantage over lower-cost manufacturers like China is in high-tech goods and services. And the real Chinese threat to U.S. economic and strategic interests is that China eats into this advantage – and then uses its newfound economic heft to try to unravel the U.S.-led postwar order in the Indo-Pacific.

As part of its attempt to address enormous socio-economic challenges today – ones that may well make all this moot – China is laying the groundwork for its much longer-term goals. Underpinning the country’s economic rise over the past half-century has been low-cost manufacturing. But this has made China intolerably vulnerable to rising competition from its lower-cost neighbors, productivity declines as its workforce ages, and downturns in Western economies. This was exposed in 2008-09, when Chinese exports contracted sharply.

Thus, China needs to make a mad dash up the manufacturing value chain. Its blueprint is its “Made in China 2025” initiative, which outlines steps to leapfrog the U.S. as a technological innovator in the industries that will matter most over the coming century (for both commercial and military applications), such as semiconductors, robotics, aerospace, artificial intelligence, green energy and biotech.

The U.S. isn’t opposing China’s development goals reflexively – after all, there is ample money to be made for Western firms – but rather how Beijing is pursuing them. China’s systematic use of four practices, in particular, were cited by the U.S. as rationale for the punitive tariffs announced on April 4: pressure on foreign firms in China to enter into joint ventures with their Chinese counterparts and, in many cases, hand over invaluable intellectual property; laws that require foreign firms to license technology to Chinese companies on unfavorable terms; state support for Chinese acquisitions of overseas competitors in high-tech sectors; and state-sanctioned commercial hacking.

The U.S. is attempting to address the second issue – unfair licensing practices – through the World Trade Organization, and it’s increasingly using the Committee on Foreign Investment in the United States to block Chinese acquisitions in sensitive sectors. But deterring forced technology transfers is more complicated, since such preconditions are typically made informally (to avoid running afoul of WTO regulations), and private Western firms are free to strike whatever deals they think best suit their bottom lines anyway, with little regard for the national interest. Meanwhile, Beijing will never admit to supporting cyberespionage, and even if it did, such activities are exceedingly difficult to detect. Thus, the U.S. is stuck hoping that indirect measures, punitive tariffs in particular, will cause China to behave – and discourage other states from adopting China’s mercantilist tools.

The problem is that punitive measures are a rather ham-fisted means of recourse. This is, in part, because the U.S. does not have a monopsony on Chinese exports, nor a monopoly on the technology and industrial inputs China craves most. Though a trade war would be disruptive in the short term, over time, market adjustments would offset some of the loss of the U.S. consumer base for some Chinese goods. Commodities are fungible, meaning China won’t end up paying much more for inputs such as soybeans. And what China loses in access to technology from U.S. firms like Boeing, for example, it may still be able to get from Airbus. Finally, given the sprawling nature of supply chains today – with China often contributing to only a small percentage of the value of a finished good made with components manufactured elsewhere – tariffs are likely to end up hurting, perhaps as much as China, U.S. allies and partners that are central to broader U.S. strategic aims. Taiwan’s central bank, for example, estimated that a full-blown trade war between the U.S. and China would cut the self-ruled island’s gross domestic product by 1.8 percent.

To gain overwhelming leverage over China, the U.S. would need to limit Beijing’s ability to find substitute imports and markets, incentivize broader participation in the rules-based trading system, and shield U.S. consumers and allied economies from the fallout. In other words, the U.S. needs a multilateral framework that supports these aims – like TPP. Trump’s new chief economic adviser unwittingly made this case in February, when he called for a “trade coalition of the willing” to counter Chinese flaunting of international trade rules.

Cobbling together another TPP-like coalition wouldn’t solve these challenges overnight, particularly if it didn’t attract more economic heavyweights. But it would deepen adoption of the sorts of intellectual property protections that are key to the “knowledge-based” industries of the future, while making it harder for China to distort markets and tilt the playing field in its favor through alternative, Beijing-led trade pacts. Ultimately, it would pull countries more firmly into the U.S. economic and security orbit and assuage their doubts about long-term U.S. commitments, while weakening their vulnerability to Chinese economic coercion. Hence why South China Sea littoral states like Malaysia, Brunei and Vietnam were so eager to join TPP in the first place.

China is playing a long game here – and one that will demand more than tit-for-tat tariffs in response. Unless tariffs push China to the brink of mass economic and political instability – or unless China’s colossal financial risks do the trick on their own – Beijing won’t sacrifice its core national development goals for short-term relief. More likely, tariffs will merely reinforce Beijing’s view that dependence on foreign technology is a potentially crippling risk to national security. The White House’s nascent turn toward multilateralism, however half-hearted, is in recognition of this long-term strategic reality.