China’s Response to the Trade War

by minxin pei
 

minxin pei is director of the Keck Center for International and Strategic Studies at Claremont McKenna College and a senior fellow with the Asia program at the German Marshall Fund of the United States.

Illustration by Michael Austin/theispot

Published February 11, 2019

 

A core doctrine of American governments since World War II has been that trade liberalization would lead to a virtuous cycle of rising wealth and ever more resilient democratic institutions. Economic convergence, the thinking went, would pull the world out of poverty and into wealth and freedom — and we would all live happily ever after.

Alas, the fairy tale was not to be. Western leaders didn’t understand that autocratic regimes would adapt to economic liberalization in ways that protected their interests. And nowhere is that more evident than in the tortuous story of U.S.-China relations.

U.S. presidents Bush and Obama both backed their trade policies with bets on Chinese democratic reforms they presumed would come. China’s president, Xi Jinping, turned those bets into dead money. Now he’s countering President Trump’s “easy to win” trade war with a mix of retaliation and one-off concessions. Given the adverse geopolitical dynamics at work here, it’s hard to come up with a sequence of moves in which both countries don’t lose.

The First Round Goes to…

With the benefit of hindsight, it is clear that Xi Jinping initially made costly mistakes in responding to President Trump’s threats. The first was thinking Trump could be easily — if not cheaply — appeased with promises of purchasing more American goods along with some heavy-duty personal flattery at the extravagant reception accorded him during his state visit to Beijing in November 2017.

China’s second mistake was underestimating Trump’s willingness to apply America’s enormous leverage in an all-out trade war. When Washington fired the first salvo with 25 percent tariffs on some $50 billion worth of Chinese imports in June 2018, Xi apparently assumed that Trump would back down if China retaliated. What he overlooked was one obvious but crucial fact: Chinese merchandise exports to the U.S. in 2017 totaled $505 billion while the U.S. sold only $130 billion worth of goods to China. (Trade in services pared the imbalance, but not by much.) And the lopsided nature of the U.S.-China bilateral trade meant that Beijing would soon run out of ammunition if Washington chose to escalate. 

By the time Chinese leaders realized their errors, it was too late. Instead of bringing the trade war with the U.S. to a quick end, Xi’s initial defiance led to another round of tariffs that has threatened to unravel the entire Sino-American trade relationship.

China had already paid a steep price even before its $12 trillion economy felt the direct effects of U.S. protectionism. Confidence in the Chinese growth machine evaporated in 2018, as foreign companies accelerated their plans to hedge their bets by diversifying their supply chains. Although Chinese sales to the U.S. actually increased in the second half of 2018 as companies ramped up shipments ahead of the tariff increases scheduled for January 1, 2019, total exports will almost certainly contract in 2019 (they fell more than 4 percent in December 2018).

Digging In

The global stock market roller coaster triggered by the trade war created an opportunity for Xi to re-engage Trump, who apparently began to realize that a trade war against the world’s second-largest economy would not be duck soup to win. The two leaders agreed to a three-month truce when they met in Argentina on December 1, 2018.

Since then, the contours of a new Chinese strategy are becoming visible. The essence of this strategy is to offer modest concessions in exchange for delays on the day of reckoning. Chinese leaders understand that a 25 percent tariff slapped on all Chinese exports to the U.S. could shave off as much as 1.5 percentage point of growth in 2019 alone.

 
Under more normal circumstances, Beijing could count on the American business community to lobby Washington on its behalf. But China’s own protectionist trade practices and poor record in protecting American intellectual property have alienated American business leaders.
 

But Xi has limited means to achieve his objective. Under more normal circumstances, Beijing could count on the American business community to lobby Washington on its behalf. But China’s own protectionist trade practices and poor record in protecting American intellectual property have alienated American business leaders, who seem to be quietly enjoying Xi’s trials. Without American corporations to carry the day, China is reduced to offering real concessions, while hoping that Trump will soften his position should the trade war show signs of hurting his chances for re-election in 2020.

There are four fronts in the U.S.-China trade war: the bilateral trade imbalance, American access to the Chinese market, intellectual property rights protection, and Beijing’s industrial policy and subsidies for state-owned enterprises. Chinese leaders believe that they can dangle enough goodies in front of Trump — and American corporations — to strike a deal, which will last at least a few years.

So far, China has offered concessions on the first three fronts. Beijing has promised to purchase an extra $1.2 trillion in U.S. products in coming years and floated proposals that would allow American companies to gain access to previously restricted sectors, including finance, autos and energy. However, Chinese negotiators apparently refuse to budge on industrial policy and subsidies, the two pillars of China’s state-capitalist system.

Now that they scent blood in the water, it is doubtful that the Trump administration will meet Beijing halfway. Even if Chinese negotiators promise to strengthen IP protection, the hawks in the West Wing aren’t inclined to take them seriously. China will probably put more concessions on the table.  And if Beijing puts some big-ticket purchases and significant market access on the table, American business will be loath to walk away. As for Trump, he will be torn between accepting a tweetable trade “win” and missing an opportunity to go for the jugular.

A Lose-Lose Scenario

The fluidity of the negotiations makes it impossible to predict whether China’s short-term strategy will bear fruit. However, it is not too hard to discern its long-term consequences of the turn in Sino-American relations.

International relations in the coming decade will be defined by the geopolitical rivalry, even a cold war, between the U.S. and China. The trade war is merely the opening shot in this contest for global leadership in economic influence, technology and security. In this new environment, economic integration between the U.S. and China, regardless of its efficacy as a mechanism for wealth creation, will be seen by both countries as posing unacceptable national security risks.

China’s excessive dependence on American markets and technology makes it extremely vulnerable to American sanctions. For the U.S., allowing China access to critical technologies would simply strengthen a strategic adversary and raise the future costs of confrontation.

As a result, prospects for ongoing global economic integration are problematic at best. Even if Xi and Trump strike a deal to end the trade war, there’s every reason to believe that the two economic giants will gradually decouple. Sooner rather than later, trade between economies that account for 40 percent of the world GDP will likely be a fraction of what it is today. Global supply chains will fragment and become less efficient. Rival technology blocs, centered respectively in the U.S. and China, will divide the world. Multinational firms will have to find new business models to survive in this new environment. 

Could Humpty-Dumpty be put back together? Probably not: global integration was more dependent than we like to admit on America’s geopolitical dominance. And while the combination of Trump’s impulsiveness and Xi’s rush to assert China’s power apparently accelerated the process, a cold war was probably inevitable. The real question, then, is whether China and the United States can adapt in ways that minimize the consequences.

main topic: China
related topics: Trade