President Trump's initiation of a trade war with China will result in the U.S. and the American people as the ultimate losers. China is far better suited to withstand the pain of reduced exports to the U.S. than is the U.S. in its trade with China. To a significant extent, this is due to the authoritarian nature of the Chinese government and its ability to control its economy.
China is Likely to Weather a Trade War Better than the US
By Weijian Shan
Trade wars are bad for all the warring parties involved. Their use springs from the general assumption that if I erect trade barriers , and you don’t, it will be bad for you and good for me. But that assumption isn’t true and one needs to look no further than America’s doorstep for an example.
In the 1960s and 70s, a number of Latin American countries practiced protectionism and so-called import substitution policies, meant to encourage the domestic manufacture of certain products they would otherwise have had to import. But these countries had no comparative advantage in producing these goods; their policies were a failure. The import substitution producers never became global competitors because they never had the chance to learn to be competitive in a protected market. The protectionist policies imposed higher costs on the consumers than if the goods were imported without high tariffs. The economies in question remain economic backwaters.
There is an argument that firms in developing countries need to be protected as they climb up the long learning curve to global competitiveness, otherwise they risk being nipped in the bud by more established foreign rivals. For some industries, there might be some validity to that argument. For this reason, the rules of the World Trade Organization allow developing countries to phase out their trade barriers over time. But if an infant still hasn’t grown up after 20 years, it’s unlikely to ever become a giant. A sapling has no chance of growing into a tall tree in a greenhouse.
No one would argue with the fact that the U.S. has been a more open economy than China when it comes to trade. But when it comes to threats of a trade war, the question really should be whether or not China has lived up to its obligations under the WTO. If the answer to that question is yes, then the difference in openness is merely one of degree, and is no excuse for unilateralism. If the answer is no, well, the WTO has a mechanism to address these breaches, which has been used by trading nations quite effectively.
Like any bureaucracy, the WTO isn’t particularly efficient. But there is no reason to believe it is biased. More importantly, there is no fairer or more effective system to resolve trade disputes in a globally integrated world -- just as democracy is the worst form of government, as Winston Churchill supposedly observed, except for all the others.
The point is that the historical lessons show that unilateral protectionism isn’t necessarily good for the country imposing it. Say America imposes high tariffs on Chinese imports and China doesn’t retaliate. Will America be better off? It’s unlikely.
First, American consumers will ultimately pay a higher price for everything they buy, especially if the eventual tariffs are on the scale that the administration is talking about.
Second, there’s no reason to think that blocking Chinese imports will boost production at home. Apple, for example, may stop sourcing iPhones made in China from its Taiwan-based manufacturer, Foxconn. But it is far more likely that Foxconn would move its assembly plants to other low-cost countries like Vietnam, Thailand, Indonesia or India than to the U.S. Of course, if the U.S. bans imports of all foreign made iPhones, American consumers would suffer from skyrocketing prices; Apple’s market value would plummet due to lower profits and sales. The situation gets much worse if China decides to retaliate by imposing high tariffs on iPhones. Given the intense competition in the smartphone market, Apple is likely to lose the China market entirely.
It is true that American manufacturing has found it difficult to compete with foreign imports, leading to shuttered factories and lost jobs. But is China responsible for the hollowing out of these American industries? Hardly. In fact, the very term, “hollowing-out,” in connection with US industries was coined and frequently evoked in the 1970s and 1980s with the rise of Japanese (and later Korean and Taiwanese) manufacturing, long before China became a significant trade partner. When did America stop producing televisions and radios altogether? That was nearly 30 years ago, when Japanese brands like Sony and Panasonic came to dominate the U.S. TV market. Now Japan has lost that market to even more competitive producers, such as Samsung, LG and TCL.
This “hollowing out” isn’t necessarily bad for the U.S., or any country --in the long run. It is just part of the industrial evolution process. It inflicts some amount of economic pain, to be sure, particularly on workers who lost their traditional jobs. But this tends to be short term, particularly if a far-sighted government moves to provide training to increase labor mobility; the next generation of displaced workers is unlikely to hang around waiting for the old jobs of their parents to return. America is resilient precisely because of its high labor mobility. In the long run, that has been how America has upgraded to become the world’s dominant technology powerhouse.
Meanwhile, China is facing its own “hollowing out.” Labor costs have been rising at a double-digit rates for at least the past ten years. China’s currency, the renminbi, has appreciated 27% since 2001 when China was admitted into the WTO. Consequently, many of China’s export businesses have either shut down or moved operations to lower-cost countries in Southeast Asia or to India.
Hong Kong, where I live, is situated just south of Dongguan, a Chinese city long known as the “factory of the world” – a major manufacturing base for Taiwanese, Hong Kong and international firms. For decades, when the winds blew out of the north in the winter months, Hong Kong would be blanketed in thick smog, thanks to the scores of factories upwind. Now, the air in Hong Kong is much cleaner; Dongguan’s smokestacks have idled as most export-oriented manufacturing moved away to lower cost countries, especially after the provincial government adopted a policy of “emptying the cage to change the bird,” phasing out low-cost manufacturing to accommodate higher value-added businesses. Hollowing-out in this case, has been good for Dongguan (not to mention for Hong Kong).
China does run a large trade surplus against the U.S., although the two countries also dispute the exact numbers depending on how they are counted (Chinese products may contain American parts and vice versa). China is already running a deficit in its current account (which includes services in addition to trade) overall. Where did China’s surplus go? For many years, China has been the largest buyer in the world of U.S. Treasuries and its holdings of Treasuries amount to more than $1 trillion, which has allowed the U.S. -- both its government and its consumers -- to live beyond their means. China sells real goods to America and buys American paper in return. Isn’t that a good deal?
If a trade war is bad for both countries and if there are more Chinese exports to the U.S. than American exports to China, why might China be better positioned to weather it than America? It is really a matter of which country has a higher pain threshold. I would argue that China has a much higher threshold than America. It is not only a matter of economics but also politics.
In terms of economics, as many pundits have pointed out, China’s exports to the U.S. represent only less than 4% of its GDP although such estimates are somewhat misleading for their failure to take into account of ripple effects in the supply chains of exporters. . Whether for good or ill, a more centrally controlled system like China’s is better able to withstand and adapt to macro disruptions than a freer economy like the U.S.’s, over which the government has limited control. One doesn’t have to look further than what had happened in the Great Recession of 2008-2009 to see how this played out. In recent years, too, China has significantly cut production capacity in a number of industries such as steel, aluminum, coal, shipbuilding, etc. by fiat, regardless of the short-term economic costs and pains. It has also forcefully shut down polluting businesses on a scale that significantly dents its economic growth. The current round of deleveraging, at a societal level, also stymies economic growth. These “supply-side reform” measures are more costly than the entirety of China’s exports to the U.S. But the Chinese government has taken these steps to improve the quality of its economy even though they are very costly and disruptive.
Imagine the U.S. attempted to take the same steps, even in a single state. It would risk a revolt.
The political consequences of a trade war for the U.S. administration are much greater than for the Chinese government. The administration has to worry about mid-term elections this fall, and about re-election by 2020. And tariffs and trade wars can inflict precisely the kinds of short term political pain that can harm an incumbent politician’s chances of reelection.
Commerce Secretary Wilbur Ross, in his recent grilling at a Senate hearing, faced irate senators representing an assortment of interests, from nail manufacturers in Missouri to soybean farmers in Iowa. Senator Orrin Hatch estimated that Trump’s threatened 25% tariff on the auto industry would amount to a US$73 billion tax increase on American consumers and endanger 200,000 jobs and US$65 billion in annual auto exports. Senator Chuck Grassley, a Republican from Iowa where soybean growers are heavily dependent on exports to China, blasted the administration for pursuing “a government-run mercantilist economy as opposed to a free market economy.” It was, as the AFP put it, “a rare rebuke of a sitting president by the members of his own party.”
Do you think that the Chinese government would be hauled in front of the People’s Congress to be questioned and criticized for engaging in a trade war with the U.S.? Do you think that the People’s Daily or any of the Chinese newspapers would publish commentaries calling the government “stupid,” as one New York Times commentator said of the Trump administration? Do you think that Chinese leaders need to worry about losing their office or their power base due to a trade war? Painful as it is, they will be able to take it much better than you can, Mr. President.
Weijian Shan, a former professor of the Wharton School, is Chairman and CEO of PAG, a private equity firm based in Hong Kong whose investors include large North American, European, Middle-Eastern, Asian and Australian institutions. He can be reached at firstname.lastname@example.org