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Trade War: Can Dragon beat the Eagle?

May 2, 2018

 

 

Donald Trump, like with many of his other policies, has polarized American opinion on his trade practices since the days of his campaign. More recently, the US-China trade war has taken center stage. Mr. Trump’s main bone is America’s massive trade deficit with the steel mammoth. US exports to China in 2017 stood at $130 billion compared to imports worth $506 billion. The result was a trade deficit of a whopping $375 billion. America’s primary imports from China consist of steel and machinery, mechanical appliances, electrical equipment, furniture, beddings, footwear, and apparel. On the other hand, US exports to China includes soybeans, civilian aircraft, cotton, copper materials, small passenger vehicles, electronic circuits etc.

 

During the 2016 election campaign, Mr. Trump accused China of being a currency manipulator to make its exports more competitive. This was in complete disregard to the prevailing opinion that China had taken substantial steps to ensure the yuan moved closer to its true market value. Unfazed, Mr. Trump threatened to slap import tariffs up to 45% on Chinese goods. As President, Mr. Trump recently imposed a 25% import tariff on steel and 10% tariff on aluminum. White House officials presented it as a matter of domestic and economic security, what was not pointed out was that in the steel industry in America, an overwhelming workforce is engaged in steel consuming industries rather than steel producing units.  He also declared on twitter that trade wars were “easy”.

 

 

In response, China slapped tariffs on an equivalent amount of American exports of pork, apples, steel pipes and other goods. The Trump Administration doubled down, imposing tariffs on goods worth $60 billion using a Special 301 investigation by the United States Trade Representative- the country’s international Intellectual Property Theft Watchdog. The investigation report highlights China’s use of foreign restrictions, including joint-venture requirements, equity limitations and other investment restrictions to pressure the US firms to transfer their technology to Chinese entities.

 

Simply put, the report highlights that China legislatively forces foreign firms to form joint ventures and transfer technology to their Chinese partners if they wish to manufacture and sell certain kinds of goods in China. A US car manufacturer wanting to access the Chinese market for manufacture and sales would, under Chinese rules have to partner with a Chinese firm to operate. In formulating such deals, most of these companies (a large number of them being state owned) are able to coerce the sharing of manufacturing processes- which would otherwise have been protected- leading to a captive technology transfer regime.

 

 

Within 24 hours of the Trump administration announcing its $50 billion hit-list, and as proof that the world is in the middle of a seething trade war, China retaliated. It placed tariffs on goods worth another $50 billion. These included goods such as soybeans, autos, chemicals, and some type of aircrafts, each of which are manufactured in American states which are crucial to Mr. Trump politically and were instrumental in his 2016 win. Chinese Vice Finance Minister, Zhu Guangyao took to the airwaves and said,

 

“No people can expect China to swallow everything which damages our legitimate interest. That's a principle we must follow…. It is time for the U.S. administration to change sides back to the right track, keep real dialogue with the Chinese side… We hope that we can work together.”

 

In a third wave of the trade war, Mr. Trump asked the USTR to consider an additional tariff on goods worth $100 billion under Section 301. These thankfully have not been instituted as yet. Mr. Trump also proceeded to declare that America was open for business and that,

 

 

Many believe that the tariffs were long overdue and well-deserved as China has been taking advantage of the protections instituted for poorer countries in the WTO regime. The jury is still out on the extent of responsibility China must bear over the global rise in protectionism. While American actions make airwaves because of the economic weight of the two countries, smaller countries in Europe and Asia have voiced frustrations with China's trade practices for decades. Not to mention the undercurrent of frustration that exists in countries which are absolutely unable to confront the Chinese such as Myanmar, Sri Lanka and a number of countries in Africa.

 

 

A second way to look at these tariffs is that the US could be targeting hi-tech manufacturers to disrupt President Xi’s flagship industrial strategy, the Made in China 2025 plan, which seeks to make Chinese manufacturing globally competitive by introducing more artificial intelligence and automation. Perhaps, a combination of both factors was playing on the President’s mind.

 

Potential Spillovers

 

 

The ongoing trade war between the two economic giants could escalate prices for consumer goods across the globe. This is considering that the thickest supply chains work between these two countries. American technology, coupled with Chinese manufacturing prowess has supplied a bulk of what the rest of the world consumes. Tariffs could dramatically escalate costs in these supply chains forcing cost increases in the short term.

 

In addition, from Japan’s electronics to Australia’s iron ore, the Asia-Pacific region’s survives by selling parts and materials to feed the Chinese export behemoth. Australia, which sends 30% of its exports to China, is one of the key raw material supplier to China steel making industries and could see orders declining if the Chinese aren’t able to find alternative buyer’s for the steel that America no longer wants to import. South Korea, is another potential victim, Mr. Trump has threatened tariffs on solar panels, primarily to hurt the Chinese. But this could impact South Korea’s solar cell manufacturing units, which find their primary buyers in China.

 

Disruptions in the global supply chains, in the long run, go beyond collateral damages of the trade war crossfire. Companies such as Apple might consider shifting production, atleast in part to soft locations such as Vietnam, a major production base for Samsung. This could hurt both manufacturers, primarily because Vietnam does not have the same level of cost advantages that China does, simply because of its population size. Furthermore, a prolonged conflict could lead to rising costs on America’s supermarket shelves as Walmart imports an overwhelming number of its products from China.

 

So what now?

 

 

 

There is a lot at stake for both countries. A trade war wouldn’t necessarily result in better protection of US technology or give American firms better access to Chinese markets, as Mr. Trump would have hoped. After an initial round of tariffs on steel and aluminum was unveiled, US and Chinese officials met to discuss ways for a more cooperative market. Opening up China would improve the US trade deficit situation. But doing so would not be easy. There are vested interests within the Communist Party as well as within the Chinese state structure that oppose opening up of certain sectors. In addition, there are cultural incongruences in the manner in which the Chinese bureaucracy operates and may thus not be amenable to change so quickly.  China is therefore, reluctant to open up its relatively closed markets to foreign competition, in the name of protection of domestic firms. That argument is slowly becoming untenable as some of the biggest companies in the world, such as Alibaba, Huawei, and Tencent are being run in the country with exceptional success.

 

But far from the US and China coming to the table and forging an agreement to open up trade, more rounds of trade barriers can be expected as no solution seems to be on hand. President Trump could also show his dissatisfaction with the body that oversees international trade, the World Trade Organization, something he has described as a “disaster”, and pull the US out of the regime. That would be disastrous for the global economic order that has stood since 1994, if not since the end of the Second World War. For now, we can only hope that we do not come to that, although that is what we hoped with the Paris agreement as well.

About the Author

Sarthak Agarwal is a student of Management Studies at the Shaheed Sukhdev College of Business Studies, Delhi University. He has won several national and international level business and strategy competitions, and also runs a blog where he decodes and explains articles published in The Economist Magazine. 

 

 

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