The causes behind China-US trade war

First, let's take a look at the "superficial" reasons behind China's trade war with the US. There was no mention of "superficial" when I talked about the trade war last year, but it now seems necessary to put it into context. There are three superficial reasons why the US is launching a trade war with China. First, China has a large trade surplus with the US. Second, China hasn't honored its WTO commitments. Third, China has gained US technologies through unfair means. These are major complaints filed by the US.

Let's make some simple comments on the whines. 

The first complaint doesn't deserve much discussion for economists. The US trade deficit is basically attributed to its domestic macroeconomic imbalance -- insufficient savings. Additionally, the US has repeatedly accused China of maintaining a trade surplus of more than $300 billion with the US. The accusation centering around a trade balance in bilateral terms is fairly absurd and no economist will accept it. The trade balance issue can't be discussed in bilateral terms. I maintain a surplus with you, but I have a deficit with others at the same time. 

You can criticize one country for maintaining a high current account surplus persistently. China had, indeed, maintained a very high current account surplus-to-GDP ratio until 2008, but it's completely different now. China's current account surplus merely accounted for about 1.4 percent of GDP in 2017. The ratio was believed to have fallen to 0.1-0.2 percent in 2018, meaning its current account is balanced at large. Although China has a large trade surplus with the US, it runs a large deficit with many other countries. The geographical distribution of China's current account balance is a result of the international division of labor and the pattern of global value chains (GVC). The transnational distribution of the value added of Apple's iPhones, which everyone is familiar with, serves as a good example.

Regarding the second complaint, to be honest, my view about whether China had fulfilled its WTO commitments was rather vague before trade tensions between China and the US surfaced. I was prone to believe that China had violated WTO rules on many occasions and China might not have done well enough. But after I carefully researched relevant papers, including those of the WTO, the US and Europe, I reckon it is not the case. Here, I would just cite a comment by Monsieur Pascal Lamy, the former director-general of the WTO: 

"China has done really well in terms of implementing its long list of commitments. But no country is above criticism… What I can say is that members have complained about certain services sectors not being open sufficiently and that intellectual property rights (IPR) protection needs to be improved." I think this is a fair comment. In another occasion, he rated China's WTO compliance as A+.

Since 2001, the office of the United States Trade Representative (USTR) has begun to submit annual reports to the Congress on China's WTO compliance. Although there were many complaints in the reports, they nonetheless had delivered a basically positive review of China's fulfillments before 2017.

China's growth has been too fast. When China first joined the WTO, some of the rules were thought of as being capable of putting some constraints on China, but it was found out later that these rules were not enough. It's like playing soccer with preset rules. If you fail to prevent the opposing team from scoring, you should not stop the game and accuse your competitors of foul play. Certainly, China should listen carefully to the complaints by the fellow members of the WTO. Issues such as whether WTO rules need to be revised and whether China should take on more responsibility are renegotiable. But the US accusation that China has failed to honor its WTO commitments is not fair and unacceptable.  

Does China have defects in fulfilling its WTO commitments? I think China does. Take subsidies as an example, does China grant too much subsidies to certain industries and companies? That is a question we can discuss. Another issue is that China tends to use tax rebates as a means to stimulate exports. When the economy faces downward pressure, rates of rebates probably would be increased. In addition, the pace of opening-up in the financial services sector is slow. We promised that China would comprehensively open up its financial services sector within five years after it joined the WTO, but we fail to keep this promise fully. 

In the early years since its entry into the WTO, China's protection of IPR was inadequate. This not only affected foreign firms but also Chinese ones. China is willing to improve its IPR protection and has made substantial progress in this regard in recent years.  

In the USTR's Section 301 report, the focus was on China's industrial policy. In fact, this is an issue that has long been debated feverously by Chinese academics and policymakers. Now, US sanctions on China's high-tech companies have put into a new context the question of whether China should implement an industrial policy, and what kind of industry policy China should have. Ironically, the sanctions imposed by the US on China's high-tech companies have justified programs such as Made in China 2025.

While criticizing China for failing to honor WTO commitments, the US itself is not a model in complying with WTO rules. The Trump administration's imposition of additional tariff on Chinese products without appealing to WTO dispute settlement body (DSB) in itself violates WTO rules. Many key US officials such as Robert Lighthizer hold WTO in contempt. According to him, "WTO commitments are not religious obligations," he told the US-China Commission, [and] "do not (and should not be construed to) impinge upon national sovereignty, and are not subject to coercion by some WTO police force." 【1】Very well, then how can you accuse China of failing to abide by WTO rules?

Understandably, US' imposition of additional tariffs on Chinese products is not based on WTO rules. The USTR and the US government knew that their accusation of China cannot be justified, if they base it on WTO rules, so they point a finger on China based on their "Section 301" and other domestic trade rules. In the 182 page-long Section 301 Investigation Report issued on March 22, 2018 by the USTR, the main text rarely mentioned the WTO, which usually appeared in the footnotes. For quite a long time, I couldn't get why the US nitpick China and adopt such an unfriendly attitude toward China. After I read the US National Security Strategy, it suddenly occurred to me that the US actions against China are not merely about trade issues. To US policymakers, the key issue is not about trade. They see China as their key strategic competitor. They not only refer China as a "strategic competitor," sometimes they also use the term such as "opponent" or "rival." Although they haven't used the term "enemy" to label China, they are gradually moving in that direction. The National Security Strategy Report reflects US strategic intent. If you want to understand why the US wages a trade war against China, you cannot ignore the report. You cannot separate the trade issue from US geopolitical strategies.     

We can look at the remarks made by some American politicians. For example, Republican heavyweight Newt Gingrich said in a recent speech that 5G will be central to the battlefield of the future. Although Gingrich didn't talk directly about the military battlefield, he mentioned the military applications of 5G. In this context, it's no longer a question of fair trade or WTO rules, but a political, or even military and security, issue. When Americans look at 5G from this perspective, many issues are really hard to negotiate.

The reasons why trade consultations failed to reach an agreement



People are curious why after 11 rounds of consultations, China and the US have failed to reach an agreement. US officials accused China of backtracking and reneging. I think they should calm down. "Nothing is agreed until everything is agreed." Because information on the consultations is scarce, my guess is that Trump used an extremely aggressive tactic and China was pushed into the corner and has to fight back. We don't know what demands the US side has raised during the consultations. But from the US' "draft framework" for the trade talks with Chinese officials issued by the US on May 4, 2018, we can see how aggressive the US trade delegation can be. The bossy demands included:

Reducing the US-China trade deficit by $100 billion in the 12 months beginning June 1, 2018, and an additional $100 billion in the 12 months beginning June 1, 2019.

Ceasing providing subsidies and other types of government support to industries targeted by the Made in China 2025 industrial plan.

Ceasing the targeting of American technology and intellectual property through cyber operations, economic espionage, counterfeiting and piracy. 

Not taking any retaliatory action in response to actions taken by the US, including any new US restrictions on imports or investments. 

Removing all identified investment restrictions on foreign enterprises.

Reducing China's tariffs on all products in non-critical sectors to levels that are no higher than the levels of the corresponding tariffs of the US by July 1, 2020.

Withdrawing the request for WTO consultations targeting the US side and take no further action related to this matter.

Withdrawing the WTO complaints regarding designations of China as a non-market economy and refrain from challenging the treatment of China as a non-market economy in the future.

Understanding if it fails to uphold any commitment under this framework, it is likely that the US will impose tariffs on imports from China, and commit to not taking any retaliatory action in response to the imposition of tariffs or confiscations by the US.

Such demands are not only rude, but fairly ridiculous. Didn't you say that China hasn't complied with market-economy principles? You've now set a target in quantitative terms for the trade deficit with China to be reduced. Is there anything in line with market economy principles? In fact, such demands from the US are considered unacceptable even in the eyes of many Western journalists and economists. I would like to quote Martin Wolf, a highly respected economics commentator at Financial Times (FT), who has an impeccable reputation for impartiality and certainly does not hold a pro-China stance. In an opinion piece published in FT on May 8, 2018, Wolf said the Trump administration has presented China with an ultimatum on trade and China could not accede to its demands. He argued that "the idea that the US will be judge, jury and executioner, while China will be deprived of the right to retaliate or seek recourse to the WTO is crazy. No great sovereign power could accept such a humiliation."

The atmosphere between China and the US had improved since the G20 Summit in Argentina in December 2018. The expectations for the two countries to reach some kind of trade deal were once running high. Perhaps, because of China's conciliatory attitude, Trump reasoned that by putting extreme pressure on China, he can eat everything on the table. This approach backfired. As a result, to borrow a Chinese proverb, he let "cooked duck fly away."

Scenarios of China-US trade conflict escalation



What will happen next with the trade consultations? We do not know. If in the coming G20 Osaka Summit, the two heads of state fail to reach a cease-fire agreement, China has to prepare to fight a war of attrition in various economic fields. Here are a few thoughts.

First, the tariff war may escalate. The Trump administration may impose additional tariffs on the rest of some $300 billion Chinese exports to the US. What should China's response be? No one wins in a trade war. When the US imposes tariffs on China, the US will hurt itself as well. The US will not win a trade war, and what it is engaged in is a game of "killing one thousand foes while losing eight hundred of its own." Although the US-China trade war will cause a bigger loss to China because it is the country with a trade surplus, it is highly capable of enduring difficulties, which the US should not underestimate.

Many institutions both within and outside China have estimated the impact of the increased tariffs on China's economic growth rate, and most results show that the tariffs will drag China's growth down by 0.5 to 1 percentage point.

While there is no need to panic about the negative impact of future tariff increases on the Chinese economy, we should also prepare for the worst. The trade war is not only about the direct impact of tariffs on trade which in turn undermines economic growth and employment, it also involves the entire industrial chain. The tariffs will impact the entire economy through a cascading effect. The situation could be stressful, but China has experienced tougher times before, and has pulled through every time. 

Trump boasted that "billions of dollars are pouring into the coffers of the US because of the tariffs being charged to China." However, many institutions in the US, such as Goldman Sachs, believe the US has suffered greater losses. In my view, it is more likely that the US may suffer more at the beginning, and China's losses could be bigger later when more tariffs with higher rates are imposed on Chinese products. 

China has no choice but to strike back. But China's retaliation is restrained. Its goal is not to fan the flames of war but to extinguish the flames. We're not supposed to initiate new battles or be on the offensive.

My belief has always been that China needs to take an active role in negotiations, but can't accept ultimatums, and can't sacrifice its sovereignty and dignity. 

It is possible that the Trump administration will further escalate the tariff war. In the face of the US provocation, China should stay calm and continue to respond in a measured way. Perhaps, the China-US tariff war has entered a new stage where the best tariff measure that China can use to retaliate is the tariffs imposed on China by the US administration. I believe that more and more US consumers and entrepreneurs will gradually feel the pain of tariffs, and voices within the US against the Trump administration's reckless tariff policy will grow. Hopefully, the tariff war can be prevented from further escalating. On the one hand, China should take the initiative to reduce its trade surplus with the US through various market-oriented policies. On the other hand, it should reject the US attempt to force China to accept artificial quantitative targets for such a reduction.

Second, the trade war has spread to cross-border investment. As labor costs in China increase, some foreign investors have already been making adjustments. The trade war is speeding up the process - some foreign companies will pull out of China and Chinese companies may relocate overseas. But take South China's Guangdong Province, for example: A total of 3,500 foreign companies moved in while about 2,200 foreign companies withdrew in 2017. China should further improve its investment environment by adhering more strenuously to WTO rules. Regarding US companies, China should listen carefully to their complaints and answer their reasonable concerns. The Trump administration wants American companies to leave China while creating various obstacles for Chinese companies to invest in the US. In response, China should make American companies feel comfortable in China, instead of scaring them away.

Third, the US is trying to cut China's high-tech industry off the global value chain. The move began with ZTE and now targets Huawei. The US government has made it quite clear that its goal is to strangle China's high-tech companies at all costs. China has three options under these circumstances. One is to be completely self-dependent by decoupling from the global value chain. Another is to further embrace the global value chain. The last is something in between and similar to Huawei's backup plan. Some of China's high-tech firms can still buy some time while others may have no time to work out a backup plan. The US is pushing China to the first option. And whether the second option will work for us, the ball is not in our court. But one positive factor is that China has integrated with the global value chain deeply already. Striking China will deal a blow to US companies like Qualcomm. If not China, it is hard to think who will buy their products in such a large quantity. It seems that Chinese companies should try their best to stay in the GVC, while preparing backup plans. However, the devil is in the details. Companies like Huawei will know best how to deal with the situation. China should let the high-tech companies make their own choices. However, the government should provide adequate help to the companies that are repositioning themselves in the GVC and coordinate individual companies' repositioning so as to reduce the social costs resulting from the move.

Fourth, the trade war may escalate into a currency war. It would be difficult to imagine what excuses the US could find to initiate a currency war against China, but this could happen in the case of Trump. If the People's Bank of China (PBC) doesn't intervene to stabilize the yuan when the yuan is under devaluation pressure against the US dollar, will the US designate China as a currency manipulator? I reckon it is possible.

One problem confronting us presently is China's economic slowdown. I personally believe China should adopt a more expansionary fiscal policy, supplemented by an accommodative monetary policy. Lower interest rates may put the yuan under depreciation pressure. The central bank has lately succeeded in stabilizing the yuan through the issuance of central bank bills in the offshore market, but what if the depreciation pressure increases?

Whatever measures are taken, stabilizing the exchange rate when it is under depreciation pressure will push up interest rates. We would then have no choice but to give the exchange rate greater flexibility in order to maintain monetary policy independence. By then, Trump might say China is manipulating its currency. We have to be mentally prepared for that.

Fifth, would the US government impose financial sanctions on Chinese companies? Theoretically speaking, the US government can use the dollar's hegemonic position in the international monetary system and the so-called long-arm jurisdiction to do whatever it wants to punish any companies it deems punishable. This is horrendous. For example, the US has sanctioned some Iranian and Russian companies, and if you have transactions with those companies, the US might impose sanctions on you. Once a company is on the US Specially Designated Nationals (SDN) list, it may be kicked out of the international and US settlement systems, meaning the company can't use the US dollar, or its dollar assets might be impounded.

In the worst-case scenario, because you're on the blacklist, no one, including Chinese domestic businesses, would dare to do business with you even though you don't use the dollar, don't have to deal with SWIFT and CHIPS, and have no assets in the US. A company as such would hardly survive.

That being the case, we have to consider countermeasures. The so-called "blocking statute" is being deployed in Europe to nullify financial sanctions by the US. It might not necessarily be very effective, but it puts laws in place to abide by. China should step up legislative efforts to protect the interests of Chinese enterprises. The yuan's internationalization is also a key link in resisting US financial sanctions.

Sixth, the US government may go as far as to sequester China's overseas assets, including its foreign exchange reserves. I would say the US is unlikely to go that far, because it is almost equivalent to declaring war on China. Some entrepreneurs have expressed concerns over the possibility of petroleum embargos. I hope this worry is entirely unwarranted.

A short summary of China's policy responses

No matter how provocative the Trump administration is, China should insist on the following moves:

First, China needs to speed up reforms, enhance and improve protections of intellectual property and private property. It should also accelerate marketization, eradicate market distortions and let the market play a decisive role in resource allocation. The competitive neutrality principle should be upheld throughout the process. 

Second, China needs to revise its long-term development strategy to focus more on the domestic market, as there's room for the country to reduce its dependence on overseas markets, especially the US market. China should focus more on its own matters, making domestic demand a major growth driving force. 

Third, China has to fine tune its position on global supply chains. How should that be done? I reckon Huawei has to a large extent answered the question. The government needs to provide necessary support to companies that are facing difficulties as a result of repositioning. The government should coordinate individual companies' repositioning so as to minimize the costs of repositioning for the economy as a whole.

Fourth, China should firmly adhere to multilateral principles and strive to preserve the current international order. 

Fifth, it is important to continue fulfilling its WTO commitment and maintaining all-round opening-up. 

Last but not least, China should enhance friendly diplomatic relations with neighboring countries, actively take part in the process of bilateral and multilateral free trade, as well as WTO reform. Some thought should be given to joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

The author is an academician and senior fellow of the Chinese Academy of Social Sciences. bizopinion@globaltimes.com.cn

【1】Robert Kuttner:

Trump's One Good Appointee, American Prospect, February 28, 2019