The Trade War we Don't Need and Can't Fight Properly

Bottom Line Up Front

Assertion

A trade war with China will accelerate ongoing economic changes in China to the detriment of U.S. economic strength and business interests at home and abroad. President Trump must reevaluate the consequences of punitive measures his Administration has threatened to place upon Beijing: such actions most certainly will not help make America great again.

Because

In 2013, China committed to a process of economic restructuring, a political promise that has yielded over 450 policies to date. While progress has been slow, a trade war will cause Beijing further economic pain.

Therefore

High interdependence in the U.S. and Chinese economies will ensure a trade war does not come without costs for both sides. The Trump Administration should instead opt for a litigious approach to China.

Executive Viewpoint

The United States and China have clear footholds in each other’s economies – and, more importantly, a combined 36 percent of the global economy between the two of them. A bump in the bilateral economic relationship would reverberate around the world. The Trump admin’s economic policies would negatively affect the operations of U.S. firms operating in China as well as those seeking to export to China. Moreover, it is unlikely that retributive economic measures by Beijing will help Trump bring manufacturing jobs back stateside. Such jobs are already moving elsewhere in southeast Asia (i.e., Bangladesh, Cambodia, India, or Vietnam,), back to the United States and Mexico, or are being  gradually automatized. Whether or not Trump acknowledges these realities is one question; more likely, his admin is operating on the belief that the large U.S. trade deficit with China makes Beijing a dependent, vulnerable economic partner. In fact, the relationship is one of interdependence. As a departure from decades of orthodox U.S. trade policy, there is little to gain and much to lose from declaring a trade war with the United States’ most important economic partner.

Background

Trump has made it clear that he seeks to punish and weaken China as America’s number one economic enemy. He has openly declared his intent to label China a currency manipulator, bring trade cases against China domestically or through the WTO, and utilize every “lawful presidential power” to end China’s illegal trade activities. In his inaugural speech, he signaled an intent to keep these promises with a call to protect U.S. borders from the “ravages of other countries making our products, stealing our companies, and destroying our jobs.” Trump’s rhetoric has rightly sparked concerns of a looming trade war. At a minimum, we should expect the admin to attempt punitive economic policies, such as the touted 45 percent tariff on all Chinese imports.

China has a number of obvious retaliatory measures available. Beijing could easily bar State Companies from business with Americans, limiting access to rare earth materials or other essential commodities, or stalling in efforts to combat intellectual property theft. These tangible steps will be complemented by a Chinese narrative that paints the United States as the villain – a narrative that could work against U.S. economic linkages in the broader Western Pacific region. A systematic vilification of Trump’s economic policy by Chinese officials and/or state-owned press would play directly into China’s hand of enticing regional partners to endorse a Chinese-led economic order through institutional arrangements such as the Asian Infrastructure Investment Bank (AIIB), One Belt One Road trade corridors, and the Regional Comprehensive Economic Partnership (RCEP).  These steps are all very easy to operationalize for Beijing, and very difficult for the US to respond to effectively in the near term.

Further, a trade war could not come at a worse time for Beijing. China is struggling to maintain an annual GDP growth between 6.5 and 7 percent, its politically-imposed target. Sovereign and corporate debt have surged to levels not seen in modern China, and businesses are experiencing defaults, low industrial profits, and weakening returns on investment. As Beijing has insisted on tackling these problems without risking too much economic growth, these policies have been implemented slowly, and amid bureaucratic uncertainty and competing economic visions.

Li Keqiang’s economic agenda of allowing the market to play a “basic” role in resource allocation was ultimately supplanted by Xi’s emphasis on tighter control and resolve that the market play a “decisive role.” Rather than slimming down State Firms as Li had hoped, Xi envisions a more central role for these firms, aided by the Party, in economic management. Rather than ad hoc interventions to keep the economy within the Party’s economic parameters, Beijing is now seeking to maintain much closer regular control over macroeconomic stability, public services, and market competition.

While these policy shifts will continue until 2020, we can already see a lot of their future impact on the Chinese economy. To be successful, they must tighten access to credit, reorganize SOEs, and address problems of industrial overcapacity. But if the Chinese reform agenda is derailed by a trade war with the United States, Beijing may be forced to backpedal on these economic changes, which is a worst case scenario that will cause greater economic instability than the reforms themselves.

Recap  

The Trump Admin may seek to cast economic retaliation in the form of a trade war as necessary to defend the livelihood of the American worker, or as a strategic tool in a broader geopolitical competition. But even despite China’s own economic woes, a protectionist push from the United States will cause economic pain on both sides of the Pacific – and it is uncertain whether it will aid Trump in remaining loyal to his blue-collar supporters. What a trade war will do, however, is enable Beijing to better co-opt other countries into its system of rules. In this instance, the more the Trump team seeks to make America economically great again, the more its efforts are likely to hurt both our own country and China..