We Just Lost the Trade War with China

With all the carefully-hedged language around Trump’s Phase 1 deal with China, it’s not surprising people are unclear about what it means. Even in this blog we haven’t been explicit enough. It’s time to remedy that. There is no ambiguity about what happened. We just lost the trade war with China.

We start with the agreement itself. There are two parts:

1. The $200 B plan to buy US products is the more publicized but murkier part. The purchases are spread over two years and are allowed only in specific, politically-advantageous sectors. Since there is no notion of market reform, it is unclear who is doing the buying, or how the sector targets can work. What’s more, given the arbitrary level of the targets and the fact that either party to the agreement can just opt out, there is little actual skin in the game. It is significant that nothing will be known about real progress until after the election. Overall the $200B figure is highly inflated at best; at worst this is an electoral show for Trump voters in the designated sectors.
2. The rest is a collection of statements of principle with no language for enforcement. Whether the Chinese will or won’t comply will be on their terms not ours. This is entirely parallel to what we got on denuclearization from the North Koreans. There is no substantive progress on any of the issues targeted by the trade war.

These conclusions have appeared in the press, but they tend to get drowned out in the general relief that accompanies a truce. So it’s easy to think something important has happened. In fact Trump needed a deal for the election, so he declared victory-by dialing down his own hostilities. And the Chinese were happy to punt all substantive trade questions at least a year or two down the road (more on that in a minute). That’s all that has happened with Phase 1.

But the main scam is the term “Phase 1” itself.

“Phase 1” implies we’re in a continuing process to get to our objectives in the trade wars. That is out-and-out false. We took a shot at winning a trade war, and we didn’t win it. Our leverage is diminishing with each passing day.

The premise of the trade war, as Trump himself said, was that we had the power to destroy the Chinese economy, so we could dictate the terms of the peace. That’s why the trade war was going to be “easy”. In fact we represented 18% of Chinese exports, and exports represented 20% of Chinese GDP (see chart below). We don’t own them. This is just one more example of the danger in our blind belief in overwhelming US power. It didn’t work.

What’s more both of those percentage numbers are going the wrong way. Chinese exports are recovering overall since the hit at the start of our tariffs-but with the US now a smaller part.

Further the Chinese have been working systematically to increase domestic consumption and thereby reduce the dependence on exports. Here is the picture (2019 figures are down further but not finalized yet):

The Phase 1 deal demonstrates that we don’t have the leverage to win today. That situation is only getting worse. We’ve just seen the decrease in financial leverage. To that gets added the decreased dependence on US technology, fueled in part by the threats to deny it. (It’s hard to imagine anything less productive than making them mistrust our operating systems.) The trade war has ended constraints on what it takes to fight back. Chinese hardliners have taken control of the relationship, and the uptick in intellectual property theft is one result. Despite the rhetoric, prospects will not be better next year. There’s no Phase 2 triumph coming for this trade war.

When you start a war there are consequences, even if you quit. Your opponent is going to continue to treat you as an enemy unless something pretty dramatic changes. The Chinese have made it clear that they want to be as insulated from the US as possible. Since they are rapidly becoming both the world’s largest market and the world’s largest proving ground for new ideas, that’s not a great situation. There are other possible consequences as well: a new cold war, lower world economic growth, an uncontrolled and expensive arms race, no leverage on Chinese behavior, even increased chance of war.

The rejoinder to all this is of course “We have to do it. We have to get tough. We can’t just cave in as in the past.” On that subject the press has done us all a great disservice. There are several points:

1. We didn’t get tough, we got weak. We abandoned our allies to get ourselves an exclusive deal. We lost half our leverage, and suffered the consequences. That’s what happens when you just assume overwhelming power.
2. We didn’t cave in before, we got results instead of pain and bluster. Under Obama both the balance of payments deficit and intellectual property theft were reduced significantly-instead of the opposite. We also made important progress (some since reversed) with climate change. The job wasn’t finished, but for all the chest-beating, we’ve gone backward since. It should also be noted that essentially 100% of the job loss from Chinese competition occurred under George Bush or as a direct result of his 2008 crash. Nothing prevented action on currency manipulation other than the distraction of our then-current war.

3. The rise of China is not something in our power to stop. They’re not just cheating; they’re doing a number of things right, some of which we’ve forgotten how to do. It is counterproductive to think we can make it all go away. You can’t win just by being a bully; you have to play the game.

4. Finally, we had every opportunity to make real progress with the Chinese. They expected to renegotiate China’s status as a developing country for the WTO, and they certainly expected to face a unified front in the West. There is actually a common interest in intellectual property — especially when it’s not used as a weapon against them. It’s also worth noting that government subsidies to private companies aren’t so black and white here either. There was an agreement to be had for labor, environment, and world-wide prosperity. We lost it by going gung-ho for our very own holy war.

There may still be opportunities for full leverage and common interest, but considerable damage has already been done.

The result of the trade war can be summarized in very few words: we botched it, got nothing, and hurt ourselves badly in the process.

Originally published at http://ontheoutside.blog on January 28, 2020.