Published daily by the Lowy Institute

What a US–China trade war would look like

The problem for the global economy is not what the Trump administration has done so far. It is what it may contemplate doing next.

Photo: Garik Asplund/Flickr
Photo: Garik Asplund/Flickr

Sometime soon, US President Donald Trump will announce his plan to respond to what the administration calls China’s “economic aggression”. When he does, it is not only China that needs to be prepared to respond. Together accounting for well over a third of global output, the collateral damage of a serious trade fight between the two countries would be enormous, let alone the damage casued to the two nations directly.

The risk of a serious clash is quite high. At Davos on Friday, Trump will quite likely reiterate his determination to right the wrongs of world trade, even as he affirms an American commitment to global economic leadership.

Trade decisions this week set the tone. On Monday, Trump imposed higher tariffs on solar panel imports and washing machines. Encouraged by the rhetoric of the new administration, last year already saw a 50% increase in anti-dumping cases brought by business before the US International Trade Commission, many aimed at China. The Department of Commerce has also finished its investigation of steel and aluminium imports into the US, and is said to have recommended tariff increases and quotas.

These actions are the usual business of the US trade machinery, little changed from administration to administration. They are not much concern to China which accounts for only a little more than a tenth of solar panel imports to the US, and the washing machine tariffs are aimed at South Korea. As a result of earlier temporary action, higher duties on solar panels and washing machines were already in place. US restraints on steel imports will not bother China much either because it does not rank in the top ten steel exporters to the US – a list led by Canada, Mexico, Brazil, and South Korea.

The problem for the global economy is not what the Trump administration has done so far. It is what it may contemplate doing next. Trump’s campaign rhetoric promised a serious attempt to balance trade with China and, perhaps, a wider aim to check China’s rise to global economic pre-eminence. Neither goal is achievable, and the attempt would come at fearful cost the US, China, and the rest of us.

The most detailed and premonitory exposition of the Trump administration’s complaint about China is this month's 2017 Report to Congress on China’s WTO Compliance, by US Trade Representative (USTR) Robert Lighthizer.

Lighthizer complains, as his predecessor did, about the pressures China exerts to extract commercial technologies as the price for foreign businesses operating in China’s market. He also criticises several other measures, including protections for intellectual property, various constraints on foreign direct investment, certain remaining tariff and quota restrictions (especially in agriculture), and more.

But there is also a wider and stronger emphasis in Lighthizer’s report on the economic role of China’s government. The report asserts that at the time China entered to the World Trade Organisation in 2001, it agreed to cut back the influence of government on the structure and direction of industry. The report argues that, on the contrary, Chinese authorities have in many ways increased their influence, citing the Made in China 2025 plan in particular.

The US now explicitly objects not only to particular trade measures but also the entire approach of the Chinese Communist Party and the continuing importance of state-owned enterprises. This supports the Trump administration's objection to declaring China a "market economy" under WTO rules, a status that assumes China's export prices are market-determined. But the terminology also implies that the US thinks something akin to a regime change in China is the only way it can meet its WTO commitments.

At the same time, the administration has changed its emphasis on penalties and compliance. Where preceding reports of the Obama administration undertook to pursue national sanctions, such as countervailing duties as well as WTO cases, the Trump report switches the emphasis to national penalties.

The report suggests that the trading relationship between China and the US is woefully bad, and much worse than it was. The reality is distinctly different. In the decade from 2006 to 2016, the last year for which we have full-year data, US goods exports to China increased at nearly twice the rate of China exports to the US: 116% compared to 61%, using US Census Bureau numbers.

While the trade deficit with China rose dramatically in the early years of the last decade, it now pretty much keeps pace with the US economy. It was 1.7% of US GDP in 2006, and 1.8% a decade later, again using Census Bureau numbers.

Presumably the main point of trade negotiations with China is to increase US exports to that country. While cutting Chinese exports to the US contributes to closing the trade deficit, it can only do so by raising costs for US business and reducing real incomes for American households.

But the USTR report has bafflingly little to say about increasing US exports to China. There are objections to remaining restrictions on farm imports and complaints about provincial government procurement preference for local products, but there is no plausible story suggesting that changes in China might dramatically increase the rate of growth of imports from the US. (Nor is there a plausible story suggesting that any large part of China’s exports to the US are sold at less than the cost of production.)

Part of the problem is that the USTR report and Trump’s rhetoric are rooted in times long past. China’s current account surplus was just short of 10% of GDP in 2007. By 2016 it was down to 1.7%. The current US account deficit peaked at 5% of GDP in 2004. In 2016 it was half that share, and there have been comparable shrinkages of the trade balances of both economies.

Taken literally, Lighthizer’s report threatens what amounts to a sustained campaign of trade sanctions against China, one designed to force a change in China’s economic model. If attempted, it would certainly fail because China will not be dictated to on such fundamental principles of political and economic organisation. It would fail, and at great cost.

How likely is the Trump administration to make the attempt at all? The question comes at a time when US and global economic growth are both picking up after two years of a modest expansion in global trade. Like its predecessors, the Trump administration will go as far as it can in extracting trade concessions from China, but not so far as to risk the economic expansion upon which its political fortunes depend.

None of this is to deny the difficulties that could potentially arise if the Trump Administration goes hard on China with a blizzard of dumping actions, countervailing duties, and WTO complaints. But it does remind us that both China and the US have very different economies now compared to 2001 when the US, after prolonged negotiation, supported the entry of China into the WTO.

The Trump administration now says that US support was a “mistake”. In 2001 China’s output was little more than a tenth of US output, both measured in US dollars. It is now nearly two-thirds of US output in US dollars. On IMF purchasing power measures, China’s GDP is already bigger than America’s. The US is still a bigger importer than China, but they are now about equivalent as exporters. Together they account for nearly a quarter of global exports, and roughly the equivalent share of world imports. Mistake or not, there is no going back.

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