China and tariffs

From the outside it looks like President Trump is just tariff happy and prone to apply tariffs on a whim. But I think there is a consistent strategy behind all of this, a strategy supported by far more than just Trump. Trump himself may just be working on gut instinct, but there are trade experts in the background whom I suspect have a well thought out and consistent strategy. Whether that strategy will work or not only time will tell, but if I have interpreted that strategy correctly it is not an unreasonable thing to try.

First some history. The second Bush administration and the Obama administration thought that by allowing China to join the World Trade Organization in 2001 they would encourage China to become a more democratic nation and to follow the common trade rules of the rest of the world. That was consistent with the prevalent belief at the time among the American foreign policy elite that with the end of the Cold War and the collapse of the Soviet system democracy had won and would soon spread to almost all the world (see, for example, Francis Fukuyama's 1992 book The End of History and the Last Man). In the event that has proved to be a naïve view. In fact both Russia and China have reverted to authoritarian regimes which, if not (yet) quite as repressive as the old Soviet and Maoist regimes were, are certainly headed that way.

In the case of China, it set about using its membership in the WTO to bootstrap itself as fast as possible into first world status. It did this in a number of subtle and largely illegal (according to WTO rules) ways. It engaged in massive technology theft.  It required companies that wanted to do business in China to share trade secrets as a price of admission. It restricted imports in key fields by a number of non-tariff means, like abstruse and arbitrary health and safety regulation. And it provided state subsidies, both openly and secretly, to key industries to allow them to capture market share in the world markets. It has been a highly successful strategy. Huawei, the telecom company now in the news, was only formed in 1987, and grew from a small one-room operation to the world’s largest telecom company in just 30 years, among other means by stealing from Cisco and Ericcson and Nokia (Some of Huawei’s manuals are word for word copies of competitor’s manuals, including typos, and some of their printed circuit boards are exact copies of competitor’s boards).

I think the administration, probably led by Trade Representative Robert Lighthizer and supported by advisors like Michael Pillsbury (who wrote the book The Hundred Year Marathon: China’s Secret Strategy to Replace America as the Global Superpower), has looked at China’s growing power and assertiveness and decided that right now, with the US economy strong and China’s economy in a difficult place, is as good a time as we will ever get to try to change their behavior. And the major weapon we have is tariffs.  As I have mentioned before, tariffs themselves are only part of the threat, since in fact they can get turned off in a day. The real threat is that tariffs, if they stay on long enough, will force companies all around the world to relocate their supply chains and manufacturing from China to places like Taiwan or South Korea or Vietnam – permanent losses to China’s long term economy.

The main reason tariffs might work is the massive imbalance between US and Chinese exports. China depends on world markets, especially the US market, to absorb its output and keep its employment high. The US, on the other hand, exports relatively little to China.  So our tariffs hurt them much more than theirs hurt us.

And by the way, the tariffs on things like steel that Trump put on Canada and Mexico are related to this – they are attempts to close “back doors” by which China could continue to sell subsidized steel to keep its steel plants going (and workers employed) despite massive overcapacity.

China has few retaliatory options. It can, for example, cut off exports of critical rare earths, for which it has been the world’s primary supplier. But it is the primary supplier only because, with cheap labor and few environmental or health regulations, it could produce them cheaper than anyone else. As soon as they cut off the supply new mines will open elsewhere (including here in the US) and they will lose their market.

This strategy, if I have interpreted it correctly, seems to me not unreasonable. The question I have is whether the Chinese government can afford to make the sort of changes we are demanding without losing its hold on the nation. President Xi is walking a tightrope. He knows China is badly over-leveraged, and he knows he has serious tensions between the wealthy coastal cities and the impoverished inland areas, and he is concerned that any serious unemployment will drive the sort of unrest that could get out of hand and destroy the Communist Party’s grip on the nation (the Tiananmen Square protests still scare the Chinese rulers, even 30 years later). China’s economy is slowing,  unemployment is rising, and they are facing some serious food issues, like the current devastation of their pork industry by African Swine Fever. Can he afford to have China play by the rules, or does he need to cheat to keep his populace employed and relatively content?

I suspect that China thinks they can simply wait out Trump and that eventually, perhaps as early as 2020, they will get a new administration that like Obama won’t have the belly to continue to play hardball (in fact, if one of the far left candidates wins, the new administration may not  understand or even be interested in trade issues).  And they may be right. The American public these days seems to have a very short memory and a low tolerance for near-term sacrifice, even to gain long-term improvements.