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Guest Contribution: “Why China won’t yield in Trump’s trade war”

Summary:
Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. This is an extended version of a column that appeared at Project Syndicate on April 17th. April 20, 2018 — President Trump enacted steel and aluminum tariffs in March, citing national security. China is the intended target, as most other major suppliers were eventually exempted. On April 2, China retaliated by imposing tariffs on 128 American products (representing about billion of trade), ranging from 15% on fruits to 25% on pork. Trump April 3 announced 25% tariffs on another 1300 Chinese products [representing some billion of trade], citing forced transfer of US technology and IPR. China on

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Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. This is an extended version of a column Project Syndicate on April 17th.


April 20, 2018 — President Trump enacted steel and aluminum tariffs in March, citing national security. China is the intended target, as most other major suppliers were eventually exempted. On April 2, China retaliated by imposing tariffs on 128 American products (representing about $3 billion of trade), ranging from 15% on fruits to 25% on pork. Trump April 3 announced 25% tariffs on another 1300 Chinese products [representing some $50 billion of trade], citing forced transfer of US technology and IPR. China on April 4 responded with plans for retaliatory 25% tariffs on 106 US exports — including soybeans, autos, and airplanes — to go into effect when the US tariffs do. On April 5, the White House announced it was considering $100 billion of additional tariffs on China.
If these tariffs go ahead, yes, it is a trade war. How will it end?
The US won’t win. Of course economists have a general proposition that everybody loses in a trade war. But some defend Trump’s actions as bargaining tactics. There are reasons in this particular case to believe that China is unlikely to back down. I can think of seven.

Why China won’t give in


  1. The Trump tariffs hurt American consumers and users (for example, the steel and aluminum tariffs hurt the auto industry and, in turn, car-buyers), while China’s retaliation hurts other important American interest groups, starting with agriculture and on to manufactures. These negative effects are receiving a lot more public attention, as they become real, than they do when economists try to warn of them ahead of time, in the abstract.

  2. Industries and consumers in China would also be hurt by a trade war, of course. It is dependent on US soybean exports, for example. But China is not a democracy. President Xi Jinping is in full control. So Chinese leaders can overrule interest groups, to a large extent.

  3. To the extent that China’s leaders have to take domestic public opinion into account, public opinion will remain behind them in a trade war. You know how Americans remember the 1773 Boston Tea Party, a (successful) effort to reverse the British imposition on the colonies of taxes on imported tea? Residing as strongly in China’s national consciousness is the memory of the Opium Wars of 1839–1842 and 1856–1860, when it (unsuccessfully) resisted the British campaign to force the Middle Kingdom to open its economy to opium and other imports. [This was the low-point in British 19th century free trade ideology, as the 1846 repeal of the Corn Laws was the high point
    The conflict ended with the Unequal Treaties. Reversing the “century of humiliation” is as important to modern popular Chinese consciousness as the word “liberty” is to American consciousness. China’s memory of this humiliation means that it will not back down down to bullying trade threats. Meanwhile, on this side of the Pacific, most American voters tell pollsters that they support free trade and don’t support Trump.

  4. It’s not true that the deficit country is necessarily in the stronger bargaining situation. Distressingly, Trump tweeted, “When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win.” If anything, the surplus country is often in a stronger position, because it has accumulated financial claims against the other country, in this case well over a trillion dollars of Chinese official holdings of US treasury securities. It is true that if the Chinese government dumped US treasury securities, the fall in their price would hurt itself as well as the US. But that doesn’t nullify the point. For one thing, China doesn’t necessarily have to decide to sell them. As the US debt burgeons and US interest rates rise — both trends are virtually certain to continue this year – trade conflict could produce rumors that the Chinese might stop buying US treasury securities, which in turn could be enough to send US bond prices lower and US interest rates further up.

  5. The financial markets already don’t like Trump’s trade war. The stock market – which he has put so much stock in – goes down whenever perceptions that the trade war is real go up.

  6. China’s leaders, like those around the world, are concluding that there is not much point making deals with Trump because he is erratic and cannot be relied on to stick to a deal. Not even overnight, let alone for the long haul.

  7. What would it mean for China to “give in”, anyway? Trump has not been clear on his demands.

    • On steel tariffs? China could adopt so-called Voluntary Export Restraints on steel exports to the US, as South Korea has recently announced. But the Chinese already export relatively little steel to the US.

    • On intellectual property? OK, here the US and other countries have some valid complaints to bargain about. But the grievance is weaker when the US corporation willingly agrees to technology transfer as the price of admission to China, not to mention that facilitating the movement of production facilities to China was not what Trump promised his supporters.

    • On eliminating the bilateral deficit? If China wanted to try to satisfy the most specific and insistent of Trump’s demands, which pertains to the bilateral merchandise trade deficit, it could work to export less merchandise to the US directly and more routed through Taiwan and other third countries, perhaps with some final assembly taking place in the third country. Then the measured bilateral deficit would go down. But in that case Trump and his supporters would say that China was using smoke and mirrors to hide the bilateral deficit, unaware that bilateral deficit measures are as meaningless as smoke and mirrors to begin with: Chinese exports contain a lot of intermediate inputs produced in Korea, the US and elsewhere. What matters are the overall Chinese trade surplus and the overall US trade deficit. China’s surplus peaked in 2008 at 9 per cent of GDP] and by now is rather small, almost down to 1% of GDP. The overall. The overall US current account deficit is admittedly on the rise – but that is attributable not to trade policy but to recent Republican fiscal policy actions which are blowing up the budget deficit and thereby reducing national saving.



What would a serious US strategy look like?

A serious strategy to address meaningful complaints against China such as IPR appropriation or excess steel capacity would ally with other partners who have similar grievances. Pressure would be applied to China via rule-based institutions such as the WTO and TPP if possible or through bilateral negotiations if necessary. The Trump strategy is the opposite of this – acting to de-rail the WTO, withdrawing from TPP, and alienating most relevant trade partners with insults and tariff threats. Trump has accomplished something unthinkable: making the Chinese President look like an enlightened leader of the international trading order by comparison.

The common rejoinder is that the multilateral procedures and bilateral negotiations don’t work with China, so we have to get tough. But they work better than Trump’s aggressive trade war route will. It is easy to forget that the conventional approach with China, operating via established fora, has achieved such successes as a 37% appreciation of the renminbi over 2004-14 and meaningful crackdowns on the counterfeiting of US brand merchandise and stealing of US software.

Problems remain. But that doesn’t justify a turn to the aggressive unilateral approach. Consider three precedents for failed attempts to go that route:


  • Ronald Reagan’s so-called Voluntary Export Restraints imposed on Japan in the 1980s. They benefited Japan, not the US, and their eventual removal was beneficial for American consumers and even for a slimmed-down and newly competitive US auto industry. VERs have since then been agreed illegal.

  • George W. Bush’s steel tariffs in 2002, which cost many more jobs than it protected.

  • Trump’s allegations during the presidential campaign that China was “manipulating its currency” to keep it undervalued. During this period, 2015-16, it was doing precisely the opposite. (The reason is that by 2014 the yuan had already appreciated so much that its earlier undervaluation had been eliminated.) Trump just looked foolish when, after taking office, he admitted that the allegation was out of date.

Another rejoinder is that the US doesn’t win all of its cases in the WTO. But it does win 90 per cent of the cases it brings. Further, Americans should remember that occasionally it is their own country that has violated the international rules. The Bush steel tariffs were a clear example. (The relevant Bush officials did not even bother to argue that the tariffs were legal under the WTO. Sure enough, they were ruled illegal and the administration reversed them.) Recent US moves are more clearly in violation of the international rules than the Chinese policies to which they are supposed to be a response. Remember that under WTO rules it is usually legal for a trade partner to retaliate with tariffs on an equal value of trade if the originator’s tariffs are ruled illegal under the rules. This puts China in a stronger bargaining position.

To say that China will not surrender on the substance of the trade war is not to say that it might not give the American president a face-saving way to declare victory and get out. It could be some fig leafs (like agreeing to buy some US liquefied natural gas at the world price), just enough to give Trump a photo-op story to show his supporters via the Fox news network. But it won’t do anything to improve the US trade balance, output, employment, or real wages.


This post written by Jeffrey Frankel.
Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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