China, the ‘surplus’ country in the trade war has accumulated financial claims against its “opponent”.
In march, US president Donald Trump enacted steel and aluminum tariffs aimed squarely at China. On April 2, China retaliated with tariffs on 128 US products. Trump then announced 25% tariffs on another 1,300 Chinese products, representing some $50 bn of exports. In response, China threatened 25% tariffs on 106 US exports (soya beans, cars, etc), to go into effect whenever the US tariffs do.
Yes, if these measures go into effect, it will amount to a trade war—one that the US is not likely to win. While economists generally argue that everybody loses a trade war, some defend Trump’s actions as a negotiating tactic to impel China to adjust its trade policies, such as the requirement that foreign companies share their intellectual property (IP) to gain access to the Chinese market. Yet, Trump does not understand the basics of such a negotiation: he thinks that a country with a trade deficit has the stronger negotiating position. In reality, the surplus country’s in the stronger position, because of accumulated financial claims against its “opponent”.
That is certainly true of China, which holds well over $1 tn of US Treasury securities. Of course, if the Chinese government dumped its US holdings, the resulting price decline would hurt both countries. But that doesn’t invalidate the point. China does not necessarily even have to sell to wield influence. With US debt expanding and interest rates on the rise, even rumours that the Chinese might stop buying Treasury securities could be enough to drive down US bond prices and accelerate the increase in US interest rates.
This would further undermine confidence in financial markets, which are already unhappy with Trump’s trade war, responding to every tariff announcement with a sell-off. But there are even deeper reasons to believe that China won’t give in to Trump. Both the US and Chinese tariffs will significantly hurt Americans. For example, Trump’s tariffs on steel and aluminum will force the US auto industry to raise prices for consumers as its major inputs become more expensive. China’s retaliation hurts other important US economic sectors, from agriculture to manufacturing.
While Chinese industries and consumers would also be hurt by a trade war, its leaders can overrule interest groups and stifle protests. In any case, public opinion will largely back retaliation against the US. The Chinese remember well the Opium Wars of the 19th century, when the China tried and failed to resist the British campaign to force it to open its economy to opium and other imports. The so-called Unequal Treaties that emerged from that campaign were part of China’s “century of humiliation,” the transcendence of which is as important to modern popular Chinese consciousness as the word “liberty” is to Americans.
Overcoming the legacy of humiliation is possible only if China doesn’t back down in the face of trade bullying. Add to that Trump’s reputation for flip-flopping, and the odds that China would bother making a deal seem small.
Even if China decides to concede something to Trump, it would not be meaningful. For example, in response to Trump’s demand for a reduction in the bilateral trade deficit, China could export less merchandise to the US directly, instead routing products through Taiwan and other countries, where some final assembly could take place. The result would be economically meaningless; but so is the concept of the bilateral deficit itself, as Chinese exports to the US contain a high proportion of intermediate inputs produced elsewhere.
What really matters is that China’s current-account surplus has been falling since 2008, and now stands at a relatively small 1% of GDP. The US’s external deficit is growing, but that is the result not of trade policy; it stems from Republicans’ fiscal policy, which is blowing up the budget deficit and reducing national saving.
As for Trump’s complaints about China’s IP “theft,” there are some valid grievances on this front. But addressing this issue requires technical expertise and negotiating skill, not blunt threats based on inadequate knowledge. Crucially, it would also require cooperation with other partners who have similar grievances with China, ideally including pressure applied through rules-based institutions like the World Trade Organization.
Trump is pursuing the opposite strategy, arguing that neither multilateralism nor bilateral negotiations work with China. Yet such tactics have helped to compel China to allow a 37% appreciation of the renminbi in 2004-2014 and to crack down on counterfeiting of US merchandise and theft of US software.
In any case, the shortcomings of existing trade institutions do not justify resorting to aggressive and ineffective unilateralism. That did not work in the 1980s, when Ronald Reagan’s so-called Voluntary Export Restraints on Japanese goods ended up benefiting Japanese firms, rather than the US, which was better off after they were removed. Nor did it work in 2002, when George W Bush imposed steel tariffs that cost many more jobs than they protected.
Trump may also want to avoid the WTO because the US doesn’t win all of the cases it brings there. But it does have a 90% success rate. And it is not as if the US has never violated international rules; its recent moves amount to clearer violations of those rules than the Chinese policies to which they respond.
Although China may offer Trump some face-saving gesture, substantive concessions are unlikely. Trump’s war will do nothing to improve the US’s external balance, output, employment, or real wages. No amount of gleeful photo ops, self-congratulatory tweets, or triumphant Fox News reports change that.
Copyright: Project Syndicate, 2018 www.project-syndicate.org
The author is Professor of capital formation and growth, Harvard University