China's Weapons in a Trade War Are Formidable

June 21, 2018 5:00 PM
Photo Credit: 
REUTERS/Jim Young

The Trump administration tirelessly asserts that the United States can “win” any trade war with China. The assumption is that because Chinese exports to the United States are nearly four times the amount of US exports to China, a tit-for-tat escalation of tariffs will cause the Chinese to “run out” of products to target with tariffs long before the United States does. 

But this calculation, like so many others in the trade debate, is built on a fallacy. Here are four reasons why.

A major share of US imports from China is produced by multinational companies, including those based in the United States. According to the list released last week by the US Trade Representative, the largest single category of targeted Chinese goods is computers and electronic products. But 87 percent of these targeted products are produced by multinationals. Tariffs, which will reduce US imports of these goods, won’t hurt China as much as they will hurt multinationals. Also hurt are the non-Chinese East Asian firms that are part of the supply chains that provide the parts and components that account for a large share of the value-added in these products. In computers and electronic products, for example, the Chinese value-added is less than half, according to my PIIE colleague Mary Lovely. China will feel some pain but not as much as these firms in the supply chain that contribute such a large share of the value added in Chinese exports. The US administration has failed to recognize that tariffs on Chinese goods will primarily hurt multinational companies and our friends in Asia. China’s retaliatory tariffs, on the other hand, will hurt US suppliers directly. The tariffs on soybeans will fall on US farmers.

Suppose China does “run out” of goods to target with tariffs. It has other options to impose pain on the United States. For example, US goods and services produced and sold in China in 2015 (the most recent year these data are available) totaled $223 billion, far exceeding US exports to China of $150 billion in the same year. The Chinese government can easily launch a propaganda campaign that would quickly lead Chinese consumers to shun these US goods. Apple’s $40 billion market in China for iPhones, the largest in the world, could quickly collapse. Similarly, General Motors sells more cars in China than in the United States, sales that could easily be disrupted by the Chinese government. 

By contrast, Chinese investment in manufacturing in the United States is modest. The magnitude of Chinese goods made and sold in the United States is minuscule, only $10 billion in 2015. In short, China has many more opportunities to interfere with US firms operating in China than exists vice versa. China can also further delay regulatory approvals that are central to the economic future of US companies. In short, it can make life miserable for companies now doing business in China under hard-won concessions by US negotiators over the years. Qualcomm, a major US semiconductor manufacturer, has a bid pending to merge with the Dutch semiconductor firm NPX. This transaction has been approved by regulatory authorities in eight required countries. The ninth and last would be China, which does not seem to be in a rush to grant approval. China is not likely to speed up in the current climate. 

China can impose leverage in areas outside the economic sphere. In the most extreme case China could undermine the ability of the Trump administration to conclude a nuclear deal with North Korea. Already, China is gradually easing its trade sanctions against North Korea, much to the consternation of some policymakers, in the absence of concrete steps by the north to live up to its commitment to “denuclearize” the Korean peninsula. Further easing of sanctions by China could provide Kim Jong-un with breathing room to try to strike a better deal with the United States, probably leading to an impasse or even a collapse of the talks, ending President Trump’s goal of achieving a historic agreement on the Korean Peninsula.

Comments

Brian McCarthy

I think you miss the point on the U.S. supply-chain vulnerabilties, which is to motivate multinationals to move those capabilities out of China.  While this entails a one-off cost to the multinational, once production is moved the U.S. consumer no longer pays a tariff on the goods and China loses both the economic activity and the potential to poach IP and "know how."

Alex Bizanek

Though I share your concerns about Chinese trade practices, I think your analysis of the situation makes a few flaws. 

First, it will not just be a "one-time" cost to the multinationals involved. Though there's been a lot of talk about Vietnam supplanting China, we're still far away from that, with Vietnam still classified as a frontier-market (https://www.bloomberg.com/view/articles/2018-05-23/vietnam-is-a-frontier-market-for-good-reason). Generally speaking, the supply chains in China right now are there because the costs associated with production are cheaper than other locations (exempting a few cases, like when China required Boeing to make a factory in China in order to sell planes or the terms of JVs that might require production/tech transfers). The movement of these supply chains to other countries will incur a cost on multinationals, but it will also make products more expensive for American consumers. The trade deficit we have is a product of our high consumption and low savings rate, which means that even if we cut off all trade from China tomorrow, we'd still have the same trade deficit, just distributed across a different set of countries (absent a change in consumption).

Second, while I'm just as concerned about Made in China 2025 and other industrial policy measures being undertaken by the Chinese government as you are, your analysis that Western companies "moving out" would deprive China of the ability to "poach IP" and lose access to "know how" is also flawed. China's at a stage now where their tech giants are among the best firms in the world- companies like Alibaba, Tencent, Baidu, and Huawei. 

In 5G, it's generally agreed that it's head-on-head race between the US and China, with China eeking out a slight lead: (http://money.cnn.com/2018/04/16/technology/china-united-states-5g-technology-study/index.html , https://www.axios.com/china-leading-the-5g-race-102aaafa-138b-416a-a446-63f8ff0944cf.html , https://www.cnbc.com/2018/03/07/china-has-the-edge-in-the-war-for-5g-us-and-eu-could-fall-behind.html , https://www.cnet.com/news/china-not-the-us-is-most-ready-for-5g/). 

In the mobile payments segment of fintech, it's almost an established principle that the Chinese are way ahead of where the US and Europeans are and will continue to extend their lead. (https://www.bloomberg.com/graphics/2018-payment-systems-china-usa/ , https://www.ft.com/content/0f0b9b82-5ce0-11e8-9334-2218e7146b04). 

That being said, the Chinese aren't beating us everywhere. AI is a mixed bag, with varying analysts pointed to different factors (US favorability: http://www.scmp.com/tech/china-tech/article/2137887/china-trails-us-every-area-ai-development-except-big-data-oxford, Chinese favorability: https://qz.com/1150909/the-reasons-why-china-will-equal-or-surpass-the-us-in-artificial-intelligence-ai/, mixed bag: https://www.axios.com/chinese-ai-isnt-beating-the-us-yet-0cf27b7d-fe89-48e6-a5da-a7a5a3a1b84d.html).

I'm not trying to sound like a defeatist or deny the very real problem of Chinese IP theft (http://www.aei.org/publication/renewed-chinese-cyberespionage-time-for-the-us-to-act/)., which still exists and should be addressed, but you're doing a bit of disservice to imply that the Chinese aren't at least rivaling the US in some segments of the tech market. 

 

Mike Miller

South America and Europe are increasing their soybean imports from North America at a level and pace that negates Chinese loss. 

The U.S. could also launch a propaganda campaign which would hurt China more than it would hurt the United States. All Lardy's argument said was it would be painful to the U.S. but ignores how much MORE painful it would be to the Chinese if the U.S. retaliating in a similar fashion. 

Labor and other fixed costs are becoming more expensive in China and the infrastructure in most other nations in improving. Multinationals could do some quick math and see it would be better to incur a massive short-term cost and move out of China, especially when the trend is near-shoring. Most infrastructure and human capital is more developed in these frontier markets than China was twenty years ago after MNCs had already located to China.  

China is already doing whatever it can to collapse any deal between the U.S. and North Korea and nothing will change that. Just as they will always try to steal U.S. IP (which is key to their economic growth and them, realizing this, will act to keep U.S. MNCs in their own countries). Also, their best tech brands are built almost solely on stolen IP. Take away U.S. MNCs IP and these tech giants lose their long-term competitive advantage. 

This is Game Theory 101. At the end of the day it is really about how much stuff they sell to us and how much stuff we sell to them. It really is that simple, folks. 

 

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