How China is Winning Economics of Sino-U.S. Great Power Competition Dr. Leif Rosenberger Chief Economist ACERTAS Introduction As the American people worry about the Coronavirus “invisible enemy” killing them in April 2020, Donald Trump has one more thing to bash China about. To be sure, the outbreak of coronavirus can be traced back to Wuhan province in December 2019. But Trump is wrong to blame Beijing for what he calls the “Chinese virus.” Trump should blame himself for gross mismanagement. Trump was warned about a pandemic likely to hit America ever since the Obama/Trump transition three and a half years ago. The U.S. intelligence community also warned Trump early on. Trump dismissed this strategic warning as well as the tactical warnings starting in early January 2020. Trump also did
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How China is Winning Economics of Sino-U.S. Great Power Competition
Dr. Leif Rosenberger
As the American people worry about the Coronavirus “invisible enemy” killing them in April 2020, Donald Trump has one more thing to bash China about. To be sure, the outbreak of coronavirus can be traced back to Wuhan province in December 2019. But Trump is wrong to blame Beijing for what he calls the “Chinese virus.” Trump should blame himself for gross mismanagement.
Trump was warned about a pandemic likely to hit America ever since the Obama/Trump transition three and a half years ago. The U.S. intelligence community also warned Trump early on. Trump dismissed this strategic warning as well as the tactical warnings starting in early January 2020. Trump also did nothing to mobilize America.
Instead of dithering for two and a half months, Trump should have manufactured and imported enough testing kits to get ahead of the virus and contain the spread of the pandemic across America. Trump also did nothing to manufacture or import enough ventilators to save patient lives. He also failed to manufacture or import enough personal protective equipment (PPE) to protect our brave doctors and nurses who put themselves in harm’s way.
As a result of reacting two and a half months late to the tactical warning rather than anticipating the threat and preparing for it, Trump is hopelessly behind the power curve and thousands of American lives have needlessly been lost (Lipton, E. et al 2020) and (Rosenberger, L. 2020). That said, Trump is not alone in bashing China. If there’s one thing that unites Republicans and Democrats these days, it’s the ill-advised narrative that China is a “clear and present enemy” in America’s Great Power Competition.
During Trump’s campaign for the US presidency, he liked to wear a baseball cap that read, “Make America Great Again.” He would tour the rust belt and promise who he called “the forgotten” blue-collar workers that he’d bring back their lost jobs (Bradlee, B. 2018). These workers not only believed him – they helped to vote Donald Trump into office. Today Trump wears a baseball cap that reads “Keep America Great.” Nothing could be further from the truth.
Trump’s Costly and Unnecessary Trade War
President Trump blames China for “stealing” American jobs. In an effort to bring these jobs back, in July 2018, he announced $50 billion of tariffs on products that America imports from China. His 25% tax on Chinese imports – including steel, aluminum, washing machines and solar panels – is the most extensive trade protectionism in nearly a century.
China predictably retaliated in force, with a 25% tax on imports of US automobiles, Boeing aircraft and soybeans, and many other agricultural products. This didn’t faze Trump; he just raised the stakes. On 7 September 2018, he threatened new tariffs of an additional $267 billion on US imports from China (Dollar, D 2018).
As expected, President Trump’s high tariffs and China’s retaliation have hurt US workers across America. For instance, US car exporters in Southern states like Tennessee were hit hard, as were Boeing workers in the Northwest (Dollar, D 2018).
In addition, Trump’s trade war with China has resulted in American farmers in the Midwest who produce soybeans’ losing their export markets in China. China, the world’s largest market for soybeans, is now looking to Brazil to replace America as a supplier (Dollar, D 2018).
To be fair, President Trump has offered to compensate these Midwest soybean farmers. In fact, he has proposed a $15 billion farm bailout. But this subsidy is a misguided attempt to cushion the damage and is unlikely to address long-term risks. US soybean farmers fear that they may permanently lose their export market to China. Trump’s subsidy could also trigger a challenge to the World Trade Organization.
US consumers are also being hurt. The high tariffs are a tax hike on embattled American consumers. In the past, American consumers were free to buy the lowest-priced, best-quality products, which often meant buying products with final assembly in China. The trade war means that Americans will be forced to buy inferior-quality, more expensive products from other countries. That is tantamount to a large tax increase and a lower standard of living for struggling US consumers.
Trump’s trade war with China plays well with his political base, who long for the days when those in the rust belt were doing better. To provide perspective, let’s turn the clock back to the so-called “glory days” of US manufacturing. For instance, George Will says that President Trump would like to “make America 1953 again.” Trump would say that America was “great” back then because it was “winning.” America had a 30% share of global manufacturing. If this 30% market share of global manufacturing was all important to post-World War II US presidents, they could have tried to keep this manufacturing “success story” going into the future (Will, G 2016).
But thankfully, back then, America had statesmen who had bigger things in mind – like internalizing the lessons learned from the punitive Treaty of Versailles, which ended World War I and led to the rise of a vindictive Adolf Hitler and World War II. Instead of repeating this strategic failure after World War II, US statesmen learned to be magnanimous.
George Marshall’s Shared Prosperity
One of the American heroes at this time was US Secretary of State George Marshall, who wisely created the Marshall Plan that helped Germany rebuild its manufacturing base. He had an implicit vision of “no (vindictive) victor” and no vanquished loser. Instead of pursing a fool’s errand of trying to keep Germany forever defeated and in ashes, he fostered a web of economic interdependence and shared prosperity (Keohane, R and Nye, J. 1989). He helped to turn a bitter enemy in World War II into a close friend and ally. The Marshall Plan enabled Germany to use its exports to earn hard currency to import American goods and services. The United States’ shared prosperity, together with the North Atlantic Treaty Organization (NATO), helped to foster a responsible stakeholder in the heart of Europe for 70 years.
Just as George Marshall was an international hero, the scholars at the World Bank were equally impressive, connecting economics to global security. In their definitive 2003 study “Breaking the Conflict Trap: Civil War and Development Policy,” the World Bank used statistical evidence to reveal a striking pattern: civil war does not occur randomly around the world. Instead, it is heavily concentrated in the poorest countries. The important reason for this concentration is that poverty increases the likelihood of civil war. Thus, the World Bank study concludes that the root cause of conflict is the failure of economic development (Collier et al, 2003). More recently, scholars in the United Nations (UN) have highlighted the importance of free trade to counter this rising demand for violence. The UN finds that free trade across the world has cut the extreme global poverty rate in half since 1990.
In contrast, if Trump’s protectionism and economic nationalism were to incite a global trend that rolled back this progress in free trade, he would also reverse this impressive decline in global poverty. This, in turn, would provide fertile ground for an even greater rise in demand for violent extremism, which would lead to the brave men and women of the US military being needlessly put in harm’s way repeatedly.
President Harry Truman once said, “the only thing new in the world is the history you don’t know.” (World Press, 2013). If we look at the past, we learn that protectionism was a bad idea then, and it was still a bad idea when President Trump opted for this kind of economic coercion against China in mid-2018.
Back in 1930, President Herbert Hoover’s Smoot-Hawley Act’s high tariffs achieved the glorious trade surplus that Donald Trump’s economic nationalism calls “winning.” But in economics, appearances can be deceiving, especially if you are obsessed with the wrong economic indicator. In 1930, shrinking the gains from trade by making the global economic pie smaller also produced a US unemployment rate of 25% – and the Great Depression (Zoellick, R 2012).
To be fair, Donald Trump and Herbert Hoover are not the only US president who have tried to “bring back American jobs.” But President Trump has no problem listening to economists who dismiss lessons learned about protectionism from history and going instead with his uninformed “gut instincts.”
Unfortunately, each time an American president makes this painful mistake, protectionism backfires and worsens the overall US economy. For instance, when President Carter tried to protect US manufacturers by restricting imports of Japanese televisions, imports from South Korea and Taiwan increased. When imports from South Korea and Taiwan were restricted, manufacturers in Mexico and Singapore benefited (Ip, G. (2016).
When this replacement happened, American consumers lost because they had to settle for higher prices and worse quality. Not exactly life, liberty and the pursuit of happiness!
The US middle class and other US businesses are also financially hurt by unhappy second- and third-order effects when the US government singles out one industry for special protection. In 2012, President Obama took credit for protecting over a thousand US jobs after there was a surge in Chinese tires. But this government interventionism cost $900,000 per job, paid for by American purchasers of now overpriced vehicles and tires. Meanwhile, imports of low-end tires from Thailand, Indonesia, Mexico and elsewhere largely replaced Chinese imports (Will, G 2016).
To make matters worse, the Peterson Institute notes that this money’s being needlessly taken out of the wallets of struggling US consumers had other negative consequences. It reduced their spending on other retail goods, which, in turn, brought the net job loss from the “job-saving” tire tariffs to about 2,500. To add insult to injury, China retaliated with duties on US chicken parts, costing this US industry (which had done nothing wrong) $1 billion in lost sales (Will, G 2016)
Moreover, the number of Americans hurt far outnumbers the number of people who benefit from protectionism. For instance, Douglas Irwin from Dartmouth College asks: Is it fair to sharply increase the price of clothing for 45 million poor Americans just to save jobs in the US textile industry? (Will, G 2016).
It also makes no sense for Trump to raise tariffs on imports and force American businesses and consumers to pay more and have less freedom to choose. Foreign competition keeps prices affordable for consumers and increases the quality of US-made goods.
Instead of learning about the negative aspects of protectionism and the upside of free trade, President Trump is stuck on blaming China for US unemployment in the rust belt and says that his trade war with China is designed to “bring back American jobs.” The problem is that there is nowhere to bring the manufacturing jobs back from because the lion’s share of US manufacturing jobs were lost to technology, not trade (Will, G. 2016) and (Miller, C. 2016) and (Lehmacher, W. 2017).
Trump Never Mentions Technology
A Ball State University study notes that out of the 5.6 million US manufacturing jobs lost between 2000 and 2010, productivity improvements accounted for over 85% (Will, G. 2016).
Take farming. Patricia Daly notes that half of all U.S. jobs were in the agricultural sector in 1870. By 1980, only 4% of American workers were in agriculture. Thanks to stunning advances in agricultural technology, US agriculture is now a success story and certainly not what Trump would call a disaster. In many ways, America is now the breadbasket of the world (Daly, P. 1981).
A similar pattern of rising productivity happened in US manufacturing. Thanks to technological advances, US manufacturing output was at an all-time high in 2015. Over the past three and a half decades, US manufacturers have been able to produce more goods than ever with seven million less people. American factories are now producing twice as much as they were in 1984 with one-third fewer workers (Desilva, D. 2017).
Global Operations and Supply Chain Management
Thanks to equally amazing advances in manufacturing technology, US manufacturing became just as much a success story as US agriculture. And for the past 40 years, the US market share of global manufacturing has held at around 20%. All the while, American manufacturing has moved up the value-added ladder, thus fostering strategic stability and peace in the world by allowing developing countries to move into lower-end global manufacturing.
Somewhere along the way, President Trump missed this transformation in global manufacturing. Back in the old days that President Trump says were “great,” manufacturing was one-dimensional. Victor Fung notes that it was done “in-house” … in one factory, under one roof, and in one country … before that product was exported and sold in another country (Fung, V et al, 1979).
But things changed, and products have become increasingly dispersed across different factories in different countries and thus globalized. Because of this dispersion of global production, countries previously omitted from manufacturing can now participate by performing just one or two pieces of the supply chain. Fung calls this the “democratization of the global production system.” Dispersion also benefits American consumers because it reduces costs and makes products more affordable.
We now live in a world where global supply chains involve goods repeatedly crossing open borders, thus making traditional trade metrics relatively obsolete. In fact, two-thirds of international trade now takes place through these global value chains (Dollar D. and Wang Z, 2018).
Therefore, when Trump criticizes China for its large trade surplus with the United States, there are simple reasons for this development. As it turns out, many Chinese exports are put together from parts produced elsewhere (Krugman, P. 2018).
With the dispersion of global production, China became a final assembly point for goods that the US previously imported from companies based in Japan, South Korea and Taiwan. As the final leg of the supply chain shifted to China, US imports from China rose as the United States imported less from the rest of Asia. In other words, there is nothing evil about China’s last leg in this dispersion of global production.
It’s important to understand that US and Chinese goods are often in different market segments – they therefore do not always compete head to head. So, when Trump’s trade war increases the cost of US imports from China, the United States imports less from China and more from other, higher-priced Asian producers – not from producers in the United States. Not only is the result no net increase in US jobs, but it also means higher prices at Walmart for struggling US consumers.
Unfortunately, this inconvenient truth is not what President Trump tells his base in the rust belt. Instead, he also accuses China of stealing American jobs by manipulating its foreign exchange rate so that its export prices are lower than US export prices. Is this argument persuasive? Let’s check China’s foreign exchange rate against the US dollar in recent years.
If China wanted such a low foreign exchange rate to underprice US products, why did its foreign exchange rate rise so much against the US dollar? This rate rose from 8 renminbi (RMB) to $1 in the mid-2000s to 6.3 RMB to $1 in 2015 (Rapoza, K. 2015).
China’s central bank depleted its foreign reserves numerous times in order to strengthen its foreign exchange rate. In fact, at the end of October 2016, its central bank’s foreign reserves hit their lowest level since March 2011.
Since President Trump has come into office, the RMB has weakened. But that’s because the Federal Reserve (or the Fed) had to raise interest rates to offset a super loose fiscal policy resulting from a huge tax cut. In other words, investors are chasing rising US interest rates, which strengthens the US dollar and weakens the RMB against the dollar.
Trump Should Blame Himself
Instead of blaming China, President Trump should blame himself for policies which end up strengthening the US dollar and therefore overpricing US exports. His huge $1.5 trillion tax cut increased public spending, a large percentage of which goes into imports. As imports grow faster than exports, the trade deficit rises. America must offset this deficit with a surplus in the capital account (financial flows) in the balance of payments. To attract capital inflow, the Fed must tighten monetary policy by increasing interest rates. Rising interest rates strengthen the demand for the US dollar, and a stronger US dollar overprices US exports, worsens US trade and current account deficits, and puts Americans out of work in export industries (Eichengreen, B. 2017).
In addition, President Trump likes to justify his trade war against China by pointing to what he calls “America’s $500 billion trade deficit with China.” For starters, the US trade deficit with China in 2017 was only $375 billion (Krugman, P. 2018).
Second, the high US trade deficit with China also reflects national security realities regarding Taiwan and North Korea. US strategists must forego trade advantages with China when they have bigger fish to fry. To help protect Taiwan’s security, America has placed an embargo on items which would give China’s military advantages, even though this decision increases the US trade deficit with China. In addition, North Korean long-range missiles carrying nuclear weapons could blow up Seattle in about two years unless something is done to curb North Korea’s military buildup. To avoid this existential threat to America, US strategists need China to use its economic relationship with North Korea to dissuade it from this unacceptable course of action. If the US launched a trade war against China with the hope of bringing back some US manufacturing jobs, China would see no incentive to put pressure on North Korea to curb its nuclear threat to Seattle (Rosenberger, L. 2007).
Third, President Trump fails to understand that this large trade deficit is what Nobel Laureate Paul Krugman calls a “statistical illusion.” That’s because over 50% of the value of these Chinese exports to America are parts and components produced in places like South Korea, Taiwan and Japan, even though China is the final assembler. As a result, over half the pain from Trump’s tariffs will be felt by a wider group of countries, many of whom are close US allies and friends, and because of dispersion, Trump has much less trade leverage over China than he imagines (Krugman, P. 2018).
In addition, over 20% of the goods produced in China and then exported from China to the US are created by foreign companies working in China (Krugman, P 2008). President Trump says that these American companies doing foreign investment in China should return to the United States. But US businesses have significantly benefitted from large US investments in China. Over the years, American and other foreign companies have dominated China’s high-tech and industrial exports. Profits for these products are thus not China’s alone. In the past, China has only retained $4 out of the $300 final price for the iPods that Apple produced in China. US corporations benefit by recycling their profits back into the United States and other foreign companies. US consumers benefit by getting lower prices, higher quality and greater variety (Rosenberger, L 2007).
Trump’s Fiscal Irresponsibility
Instead of blaming China for America’s high trade deficit with China, President Trump should blame himself. His huge $1.5 trillion tax cut has caused the budget deficit and national debt to soar. The federal budget deficit is headed back towards at least 7% of GDP over the next ten years (Roach, S. 2018a). That’s over twice the 3% of GDP level which an EU Maastricht criterion says is financially unstable.
Similarly, the non-partisan US Congressional Budget Office (CBO) estimated that President Trump’s public debt would hit 78% of GDP by the end of 2018, the highest level since 1950. The long-term projections are even worse. CBO says that the debt to GDP ratio is on track to hit 100% of GDP by 2030 and 152% by 2048 (EIU 2018). That’s a far cry from the 60% of GDP level which another EU Maastricht criterion says is financially unstable.
Dangerously Low National Savings
When President Trump says he wants to make America great again, he is half-right about one thing. In the 1950s, 1960s and 1970s, America’s national savings rate was about 8% of GDP. By international standards, that was still low, but it’s a lot higher than it is today. Unfortunately, the national savings rate fell sharply to just 2.4% of GDP in mid-2018. The problem is that President Trump is pursuing policies which are counterproductive. His 1.5% tax cut will send the already dangerously low national savings rate into negative territory.
The trade deficit that President Trump complains about exists because America is running a large deficit in national savings. The United States must import its savings from countries like China, Germany and Japan, which have large surpluses in savings, because America lives beyond its means by consuming way too much, thus leaving it with a large deficit in savings. As long as the United States maintains its large savings deficit, eliminating a trade deficit with China simply turns into a larger trade deficit with other US trading partners (Roach, S. 2018b).
In this regard, President Trump’s own domestic economic policies are widening the US trade imbalance. He is running a loose fiscal policy that promises to generate rising budget deficits. The Fed has already said it will offset this loose fiscal policy with higher interest rates, which, in turn, is likely to strengthen the US dollar and increase the cost of US exports. More expensive exports will thus worsen the overall US trade deficit and lead to rising unemployment in US export industries (Eichengreen, B. 2017).
Xi Jinping’s Shared Prosperity Marginalizes Trump’s Economic Nationalism.
Trump officials are critical of Chinese economic initiatives in developing countries. They accuse China of “predatory” lending policies. They say its five-year-old “Belt and Road Initiative” (BRI) is dangerous because it gets developing countries hooked on excessive debt. That criticism is ill-advised for several reasons. First, no country in the world is as highly indebted to China as the United States. The American government owes China over a trillion dollars in debt. And America’s debt is becoming far worse because the Trump administration’s tax cut for millionaires and billionaires is increasing the national debt by over a trillion dollars (William B 2018). Perhaps they should have hired former Admiral Michael Mullen, Chairman of the US Joint Chiefs of Staff, who said, “the most significant threat to our (America’s) national security is our debt.”
In the old days, America was a role model when it came to building modern infrastructure. Not anymore. The Trump administration has done virtually nothing to rebuild America’s collapsing infrastructure. One of the biggest critics of China’s BRI was Trump’s Secretary of Defense James Mattis. And yet it was James Mattis who waved the economic white flag and zeroed out the funding for America’s New Silk Road Initiative, which General Petraeus had wisely started before him at the US Central Command (CENTCOM). Second, America is still offering developing countries virtually nothing in contrast to China’s multi-trillion-dollar initiative.
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