Reality check may make Trump rethink trade war

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In news reports around the world, from Hong Kong’s South China Morning Post to RT.com, US President Donald Trump is reported to have softened his “tough” trade stance against China. In the April 8 reports, he said that Chinese President Xi Jinping will always be his friend and China and the US will negotiate a trade deal that will benefit the “two great nations,” a far cry from his blistering response of upping the ante to triple the number of Chinese goods subject to tariffs.

But in true Trump tradition, he claimed victory, suggesting that “China will do the right thing and bring down trade barriers [against the US].” The Washington Times reported on April 10 that Trump’s economic adviser, Larry Kudlow, said China may have “blinked” because Xi’s Boao Forum touched on China opening up and lowering the tariff on cars.

However, if one were to examine Xi’s April 10 speech, he simply reiterated his promoting of and support for globalization. Xi’s promise to bring down trade barriers is not to appease Trump – it is consistent with his globalization narrative. Sorry, Mr Kudlow, President Xi did not “blink”. It might be your president that “blinked.”

Why is Trump softening his trade war rhetoric?

Three things might explain Trump’s sudden “U-turn” from his “fire and fury” posture (threatening to triple the amount of Chinese imports from $50 billion to $150 billion subject to tariffs of up to 25% when China announced retaliatory measures) to one of negotiation just a few days ago.

One, Trump’s tariff policies are violating the letter and spirit of World Trade Organization rules. Two, the charges – currency manipulation, stealing technology, market inaccessibility – are exaggerated or misleading if not “fake news.” Three, China is not Japan, South Korea or other “allies” that the US can pick on at will.

Trump’s proposed tariffs on Chinese goods

Chinese steel and aluminum

Trump invoking Section 232 of the Trade Act, allowing him to impose tariffs on steel and aluminum on national security grounds is legitimate under World Trade Organization (WTO) rules. But exempting some countries (ie Canada, Mexico, the EU and others) from the tariffs would weaken the argument, particularly if these were the countries’ major exports.

That precedent was set when the WTO ruled against the US in 2002 because George W Bush exempted Canada and Mexico from his tariff on steel (CNN Money, March 8, 2018). Perhaps it was over the ruling, and that the tariff cost far more than it benefited the economy that Bush rescinded it a year later (US International Trade Commission, December 4, 2003, Guardian report).

Further, China is taking the US to the WTO, perhaps for the same reason as the plaintiffs in 2002 (People’s Daily, April 4, 2018). The WTO precedent suggests China will likely win.

Section 3o1 of Trade Act tariffs

According to the American international relations expert, Sourabh Gupta, the US does not have a legal leg to stand on against China under Section 301 of the Trade Act (South China Morning Post, April 6). He argued that China has complied with WTO rules on technology transfers and mergers and acquisitions transactions, and did not abuse them.

Rather, China’s own aggressive push to make innovation the center of economic development might be the reason for leapfrogging information technology.

China’s innovation stances

China made the decision to climb the value chain at the aftermath of the 2008 financial crisis when then Premier Wen Jiabao realized that exports and investment-driven economic growth are “unstable, unbalanced, uncoordinated and ultimately unsustainable” or the “four uns” (Yale Professor Stephen Roach in his 2011 Project Syndicate article, China’s Turning Point) .

China decided to rebalance and restructure the Chinese economy from being export/investment-driven to making domestic consumption the engine of growth in the 12th Five Year Plan (2011 t0 2015), the country’s economic development platform. It was also during this period that the government decided to restructure the economy, increasing value-added output by 4% to 47% of the economy and raise funding for R&D from 1% to 2.2% of GDP (www.gov.cn>english>content_1816822).

What’s more, Chinese enterprises have made concerted efforts on mergers and acquisitions of foreign firms as a way of attaining advanced technology to increase productivity and move up the value chain (Xiaohui Liu and Huan Zou, Journal of World Business, Vol. 43, Issue 3, July 2007).

Is China guilty of technology theft?

The allegation that China is the major culprit in stealing US technology might be just that. The US has never produced any substantive or convincing evidence to substantiate its accusations against China. The only evidence, in fact, was: “The hacking is most likely from China”(Mandiant, US-based technology security firm).

 

But that did not stop some US news media and politicians from both major political parties from accusing China of stealing American technology. An April 5 Washington Times report indicated that “China has been stealing US technology and vexed American companies for decades.” But the author did not elaborate or bother to verify whether the claim was true.

The US Commission on the Theft of American Technology (USCTAT) reported in 2013 that technology theft cost the US economy over $300 billion a year. In a 2017 update, that number was estimated to be between $225 and $600 billion per year. However, neither report showed how the numbers were arrived at.

Still, USCTAT accused China of being the biggest technology thief in the world, committing between 50% and 85% of the crime in its 2017 update: “[China] is committed to policies that include maximizing the acquisition of foreign technology and information, policies that contributed to greater theft”.

Missing from the USCTAT reports

The reports left out the fact that China increased its innovation budget by over 10% annually to almost 2.2% of GDP (Reuters, February 26), an R&D/GDP ratio only second to the US at 2.4%. China has also lavishly funded universities, especially in the areas of science, technology, engineering and mathematics (STEM). That policy is responsible for producing over 6 million STEM graduates each year (China Ministry of Education).

The commission also ignored the fact that China has obtained technologies through mergers and acquisitions (M&A), and invests in foreign countries and technology transfers in order to leapfrog innovation. According to Bloomberg, Chinese firms acquired over $53 billion worth of internet/software technologies between 2007 and 2017, a third of its total M&A transactions. The US consultancy, Statista, estimated that US direct investment (FDI) in China rose from a little over $11 billion in 2000 to over $92 billion in 2016, bringing in huge amounts of technology.

Whether technology transfer is forced depends on one’s perspective. China did not point a gun at US firms; they accepted the condition as financially viable in view of the huge increases in US FDI to China.

Additionally, Chinese firms invest in Western technology startups, financing their activities. US-based CBINSIGHTS estimated that Chinese investors were involved in 679 US tech firms valued at over $18 billion between 2011 and 2016.

Is China manipulating its currency?

Whether China is a currency manipulator depends on whom one talks to. Prominent economists like the “father of the euro,” the late Robert Mundell, argued that China did not manipulate its currency to gain an export advantage. But Noble Economics Prize Laureate Paul Krugman argued that China did. The conflicting views are based on perception and how currency manipulation is defined.

Whether China is a currency manipulator depends on whom one talks to. The conflicting views are based on perception and how currency manipulation is defined

No one agrees with the US’s definition of currency manipulation: A country records two-way of $50 billion or more and a surplus of $20 billion or higher is a currency manipulator (Ken Moak, Developed Countries and the Economic Impact of Globalization, Springer Nature, July 2017). What’s more, the US Department of the Treasury rejects that argument by because it consistently refuses to label China as such.

China’s huge surplus in merchandise trade is probably because the majority of “imports” are produced by US firms in China and that the US Congress routinely blocks exports of “sensitive dual-use technology” to China. That is, the US deficit figures might be guilty of double accounting and paranoid US policy. Besides, the deficit figures run all over the map, from $227 billion (China’s calculation) to $500 billion (Trump’s number).

What’s more, the US seems to forget that it deliberately devalued the greenback by 33% over 30 years in 2012 (The Federal Reserve Open Market Committee). Trump’s proposed “weaker dollar” policy (CNBC, January 25, 2018). Both were meant to increase exports, spurring economic growth. It should also be pointed out that massive quantitative easing, an unconventional monetary policy designed to increase the money supply as a way to promote economic growth, could also be considered currency manipulation.

No one is suggesting that China did not manipulate its currency. Restricting the value of the yuan within a narrow band of its major trade partners’ currencies is a “dirty float,” fixing currency value. However, the US calling China a currency manipulator is like the toad calling Miss Universe ugly.

Is China denying US firms access to its market?

Trump accused China of unfairly imposing high tariffs on US cars to China (RT.com, April 9), complaining that Chinese Customs imposed a 25% duty. China only exported 21,000 cars to the US in 2016 (Global Times, April 9).

However, the 25% number was allowed by the WTO when the US first exported cars to China (Global Times, April 9). In the same article, China has also fulfilled its obligation of reducing the rate to 15% and 10%, having reduced the rate to 9.8% in 2010.

China is too big to coerce and too important to ignore

As indicated in past articles, China is too big to be coerced. Its economy, though less than that of the US in nominal exchange rate ($12.9 trillion) but greater than America’s in purchasing power parity terms ($23 trillion), according to 2017 World Bank estimates. China is also the world’s largest trading nation with a two-way trade totaling over $4.1 trillion (China General Customs Administration).

Further, the two economies are joined at the hip, needing each other to sustain economic growth and stability. A trade war would disrupt them, making both countries worse off.

Reality check

Trump and his advisers must have done a reality check, telling them that negotiations are better than confrontations. China opens the door for dialogue, reiterating the same message over and over again. But that does not mean “capitulation” as seems to be suggested by Kudlow.

China promises to “fight to the end,” so it is up to Trump whether he will follow through on his trade war threat with China.

 

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