The US-China trade war escalates, putting both economies at risk

In his book Fear, journalist Bob Woodward suggests that Donald Trump’s protectionist instincts may be stronger than previously thought, preventing him from making commercial peace with traditional allies or trade partners. Recent actions against China leave no doubt. Yet, this is not simply the Trump administration directing “protectionist firepower” against China, to quote James Politi of the Financial Times. A geopolitical fight is also emerging about global technological leadership and US ambitions to contain China on this crucial frontier.

During his election campaign, Trump singled out China, declaring that he would impose 45% tariffs on Chinese imports, comparing its development to “rape.” Tariffs are already in place on $50 billion worth of imports. Last week Trump announced that tariffs of 10% would apply to imports worth another $200 billion that would rise to 25% on January 1. China retaliated with $60 billion in tariffs on US goods despite Trump’s threat of “phase three” – more tariffs on another $267 billion worth of products, covering almost all Chinese exports to the US.

At first, the assumption in Beijing was that President Xi Jinping could persuade Trump that escalation would be prohibitively harmful for both countries. China’s leaders relied on advice from US business leaders with a history in China and liberal US Treasury Secretary Steven Mnuchin, while underestimating the role of US Trade Representative Robert Lighthizer, chief architect behind Trump’s “aggressive unilateralism,” and trade advisor Peter Navarro, who argues that China must be contained at any price.

When Chinese leaders met in Beidaihe for a retreat in August, threat of an emerging trade war cast a shadow over what should have been a euphoric celebration of a new era under Xi. A few days before the meeting, Trump had announced intentions to put tariffs on another $200 billion, more than a third of total US imports. Had Xi aggravated the conflict with overconfidence? According to Financial Times, a prior Politburo meeting had stressed “stable employment, stable finances, stable foreign trade, stable investment and stable expectations” while at Beidaihe a politburo member urged the country’s leading scientists to “have a patriotic heart” and help China “independently control key technologies.” Made in China 2025 was a patriotic matter of the heart. Realities stood against ambitions.

The undoing

In Trump’s world view, there is no international system, only bilateral transactions. He has displayed almost pathological desire to overturn every accomplishment of his predecessor, President Barack Obama. He rejected the Trans-Pacific Partnership agreement with 11 other Pacific nations even though it pointedly excluded China. In accordance with this logic, Trump has made trade deficits a key issue, describing these as a measure of how much countries in question have “taken” from the United States. Nobel laureate economist Joseph Stiglitz’s explanation is blunt: “The United States has a problem, but it’s not with China. It’s at home: America has saved too little” – borrowing and importing too much.

Trump also ignores that a large part of US imports consists of goods and components manufactured by US companies operating in China. An explanation of China’s success is the large inflows to the country of foreign investment and foreign technology. China, since its era of “reform and opening” was launched 40 years ago, has taken a giant technological leap that would have been impossible without integration into the global economy and complex production chains. Appealing to patriotism, Trump wants to destabilise the Chinese economy and in August declared that the tariffs worked “big time.” He triumphantly noted that Shanghai’s stock market fell by over 20 percent in six months while US exchanges hit new records.

Earlier in spring, Trump’s focus was on steel and aluminum. Few could have imagined that Trump would also announce tariffs, with reference to the country’s security interests, on steel imports from the European Union and NATO-allied Canada. Still, China clearly is the main target of Trump’s offensive.

The problem is that China has succeeded too well, with methods increasingly questioned. Within the EU, there is growing criticism of China’s actions and concerns about strategic Chinese acquisitions of European companies and technologies.

The Trump administration maintains that China’s success is based on stolen technology, unfair commercial practices and cybertheft. Patents, intellectual property rights and innovation capabilities are the heart of this drama. The Trump administration hopes to curb China’s increasingly threatening technology development, symbolized by Made in China 2025, the country’s commitment to lead the fourth industrial revolution. China’s advances in robotics, driverless cars and biotechnology are increasingly evident, and in artificial intelligence, China is on its way to becoming a world leader.

The United States considers the World Trade Organisation of no use for limiting China’s technological development. Trump has threatened to pull the United States out of WTO “If they don’t shape up.” According to The New York Times, Trump’s national security adviser John Bolton has defined US exit from the WTO as a strategic goal though Congress does not support such action. China, on its part, seeks WTO backing.

China’s strength and weakness

For China, the confrontation takes place at an unfortunate moment due to its response to the 2008 financial crisis. The financial crisis had, as Brookings economist David Dollar noted, lasting impact by accelerating China’s catchup with the United States, undermining US fiscal strength, and slowing China’s reform. The crisis shook China, threatening growth and jobs. The solution was a major credit expansion, escalating the country’s already exceptional levels of investments. High growth could be maintained. The problem was that credit expansion became chronic. Today, China has a total credit volume of 290 percent of GDP. Steel, aluminum, cement and other sectors suffer from unsustainable overcapacities.

Thus, the economy is both China’s strength and Achilles heel. Measures taken in 2017 to contain credit expansion are now scaled down due to concerns about the trade war. A more expansive policy is considered necessary. A goal not to allow the Chinese currency to fall below seven yuan per dollar could be expensive.

Chinese leadership has reason to ask if more could have been done to prevent ongoing escalation of trade conflicts. Mistrust has grown worldwide. China, 15 years after accession to the WTO, was to be given so-called market economy status, but neither the EU nor the US find that the requirements have been met. China has not reformed its economy as needed and wants the anti-dumping tool to remain in place.

China is the great winner from globalisation, but remains a party-state characterised by extensive government interventions in the economy, facing growing demands from advanced economies for reciprocity in terms of trade and foreign investment and respect for intellectual property rights. Ultimately, the western world must put its own house in order and show competitiveness.

Until now, China responded to US tariffs with equal measures. Such a response is no longer possible with the current US escalation. Total Chinese imports from the US amount to less than $140 billion. China, with its $60 billion retaliation, has already put tariffs on $110 billion and, hence, has no tariff ammunition left. If Trump escalates further, China, in no mood to yield but eager to break a vicious circle, would suffer disproportional pain. So far, there are no serious negotiations. In November, shortly after the US midterm elections, Trump and Xi will meet at the G20 meeting. That Xi wants to reduce tensions can be taken for granted. Trump’s stance may hinge on the outcome of those elections as Congress could constrain the president’s trade power, but the country is in a protectionist mood.

The drama is in its infancy. The global power shift will continue, and even in the best of times, the relationship will remain characterised by strategic distrust.

Börje Ljunggren is a former Swedish ambassador to China and author of The Chinese Dream - Xi, Power and Challenges”(2017), published in Swedish.

This article first appeared on YaleGlobal Online.