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3 Reasons Why Trump Can't Win a Trade War With China
A truck passes by cargo containers labeled "China Shipping" at the Port of Seattle (April 6, 2018).
Image Credit: AP Photo/Ted S. Warren

3 Reasons Why Trump Can't Win a Trade War With China

 
 

Both the rhetoric and actions of the Trump administration point to the rising probability of an economic war between the United States and China. To have a chance of winning such a war, the Trump administration needs to get the rest of the world on its side. This is not likely to happen for three reasons: the United States’ economic leverage is not strong enough; national interests in much of the rest of the world are not aligned with such an arrangement; and the U.S. is at a comparative disadvantage in terms of resources.

Tariff hikes don’t have much chance of breaking China. Nowadays exports are about 20 percent of China’s GDP; exports to the United States make up about 18 percent of China’s exports, and the domestic value added of Chinese exports is about 70 percent. Multiplying these, one gets the total share of U.S. exports in China’s GDP as about 2.5 percent. With this rather low level of dependency, the impact of tariff hikes on the Chinese economy will not be hard to manage with monetary and fiscal policies. The impact may be magnified through changes in expectations that lead to reduced consumption and investment expenditures, or these may trigger a crisis in the highly leveraged economy, but judging by its past performance, Chinese government is likely to be able to contain these risks.

With tariff hikes, the Trump administration might be aiming to change the topology of the international supply chains, to induce export-oriented producers in China to relocate, preferably to the United States. Such relocation is likely to be very limited and very unlikely to be to the United States. As attested by the former and current CEOs of Apple, China’s current position in the international supply chains is based on the qualification and size of its labor force, its developed physical infrastructure, and its sophisticated manufacturing ecosystem, rather than low labor costs. These are products of the country’s size, culture, and specific economic development path, and are not likely to be matched by other candidates in the near term. Hence, relocation is likely to be limited to low value added, labor intensive products and production processes, especially final assembly stages; and the relocation will be to neighboring low wage economies. Such production activities by both Chinese and foreign firms have been relocating to neighboring low wage countries for some years now. As this is a process encouraged and helped by China’s minimum wage policies, apparently aiming to spur the country’s economy to higher value added activities, is not likely to put much pressure on the Chinese government.

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Cutting off U.S. technology supply, as in the ZTE and Fujian Jinhua cases, is not going to break China either. In the long run it is likely to speed up China’s technological catch-up. In the short run China can rearrange its technology resources to reduce the impact: ZTE is very dependent on U.S. technology but Huawei, designing its own chips, is not; should ZTE again be the subject of a technology restriction, a merger between the two may save it. More importantly, China can source the withheld technologies from elsewhere: cutting of Fujian Jinhua from the world’s top semiconductor equipment and materials suppliers is a blow, but these can be sourced from Japanese, European, South Korean, and partly domestic suppliers.

Ineffective as they are, these policies are costly for the United States. Aside from China’s retaliation, as is well recognized, U.S. tariff hikes will raise the cost of living for middle and lower income households, and degrade the cost competitiveness of U.S. industries because of rises in the price of production inputs. Cutting China’s access to U.S. semiconductor technology is at the same time cutting the U.S. producer’s access to the world’s number one market, essentially giving it away to competitors from other countries. With such a dismal cost-benefit structure, these policies do not have much chance of success.

The chances of success would increase if the Trump administration could get other countries, especially those with advanced economies to go along. The impact of tariff hikes and other trade barriers on China would increase along with the total economic size of the “coalition,” and the technology restrictions can really bite if other technology supplier nations join in. However, the Trump administration is likely to have hard time recruiting members for such a coalition, for three reasons.

First, the main leverage the Trump administration has for forming such a coalition is the size of the U.S. market. But the Chinese market is larger today for many products, from cars to groceries, and is expected to be the largest soon for pretty much everything. Even though there are restrictions for some goods and services, most of the Chinese market is quite open, and advanced country producers are already taking full advantage through exports and production in the country. Foreign-funded enterprises, which are mostly firms from advanced economies producing for the local market, account for more than 15 percent of the industry profits in the country. Including those from Hong Kong and Taiwan, which produce more for the export market, about a quarter of all industrial profits in China are made by non-domestically funded firms. In fact the most profitable premium segments of the markets for most consumer and producer goods in China today are dominated by companies from advanced economies, with domestic producers holding the price-sensitive lower segments. Consequently other countries, especially the advanced economies and others that aspire to that status, will not easily trade access to the Chinese market for the U.S. one, if it comes to that.

Second, even though some countries may share the Trump administration’s concerns about China and others may have their own worries, unlike (apparently) the Trump administration, the issues most of these countries have are not big enough to take the economic and political risks of an economic war, which is not at all guaranteed to stay economic. A China completely broken in this conflict would not serve the national interests of many either; for most countries, a world ruled by China holds risks, but so does one ruled by the “America First” principle. Many of the emerging economy countries, themselves likely harboring own versions of the “Made in China 2025” plan or Chinese Dream, are not likely to become staunch opponents of government-led economic development either. Consequently most countries in the world, rather than taking an active part in this conflict, are likely to use it to shape the policies of the two sides to their best national interests and try to try to maintain a state of balance of power between them.

Third, with its Belt and Road and similar initiatives China has become a significant source of investment and finance for many countries in the world, with an impact on their international policies. The United States does not have the resources to compete with China in this arena. In 2017, the United States’ and China’s GDPs in purchasing power parity terms were $19.4 trillion and $23.3 trillion, respectively; their national savings rates were 18 percent and 48 percent. This puts their national savings, the amount of resources that can be spent on investments, at about $3.5 trillion and $11 trillion. Considering that its government has stronger control over the use of these resources, the amount China can spend on strategic domestic and international projects is much larger.

Given these factors, the Trump administration is not likely to be able win an economic war against China. But no one should take comfort in this; such a war will cause serious damage to the world economy, and precisely because it is not winnable, an economic war has the potential to turn into a more serious form of conflict. It seems the time has come to do some out-of-the-box thinking on the rules of conduct for and governance of a world characterized by rise of new economic powers — not only China, but India and others on the line.

Fatih Oktay is the author of a widely acclaimed book, China: Rise of a New World Power and Changing Global Balances, in Turkish. He teaches Chinese economy and politics at leading universities, and has served in the top management teams of banks and technology companies in Turkey. Follow him on Twitter: @Fatih_Oktay_ENG.

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