Saturday, May 5, 2018

China, Trade and Trump

By Roy C. Smith

Perhaps it is now not unusual in the age of Trump to send an inexperienced team of officials with differing views on trade to Beijing for a two-day photo-op to deliver their “demands” for adjusting the “unfair” US-China trade balance. Among the seven US delegates, only Robert Lighthizer, the official US Trade Representative, has expertise in negotiating the endless minutia of trade issues. Though nominally led by Treasury Secretary Mnuchin, no one on the delegation seemed to be in charge or to speak for the president, something Commerce Secretary Wilbur Ross knows very well - last summer he negotiated a deal with China to reduce steel production that Mr. Trump later rejected as insufficient.

The Chinese side, quickly banged together by Liu He, president Xi Jinping’s new economic chief, replaces officials from the Commerce Ministry that were the previous trade experts. Liu’s team, trained in economics and finance, but inexperienced in trade details, seems to be fielded particularly to respond to the Trumpian form of blustery, highly politicized negotiations.

Neither side knows each other very well. Mr. Lighthizer said “we are going to spend the next year developing how we deal with each other.” If so, Mr. Lighthizer must assume his Chinese counterparts will not respond to the demands soon, or even take them seriously until they know each other better.

The US demands were an opening salvo of an economic artillery barrage that will go back and forth for a while. They include a unilateral reduction in China’s trade surplus with the US of $200 billion by 2021 (increased from $100 billion indicated before the meeting, which the Chinese said would be impossible), the ending of subsidies to Chinese tech companies competing in world markets, an immediate end to cyberespionage of commercial trade secrets and a strengthening of intellectual property protections, a lowering of Chinese tariffs on products in “non-critical” areas, opening of Chinese markets to foreign investments and services, and a promise to take no action, especially in the agricultural sector, in response to unilateral US tariff increases and other moves. These include the recent US announcement of higher tariffs on $150 billion of Chinese exports, restrictions on acquisitions in the US by certain Chinese companies and of exports to China of certain high-tech products, and penalties imposed last month on ZTE, a Chinese telecom company, for violating US sanctions on Iran.

China has already said it might open its markets to easier terms for foreign investment and is considering lowering some tariffs, but was unwilling to commit unilaterally to slashing the trade deficit. China recently announced a Made in China 2025 program as an essential upgrading of the economy with an emphasis on high technology industries. On May 5, a day after the Beijing talks ended, China announced the formation of a $47 billion China Integrated Circuit Industry Investment Fund to advance the 2025 plan. The US objects to this plan because of the large amount of government subsidies it will contain.

So, a year-long set of trade negotiations has begun with both sides firmly dug in. Nothing much is likely to happen for a while. China is not in a hurry and doesn’t face mid-term elections in the fall.  

But, China too has large political interests at stake in these negotiations. Newly anointed president-for-life Xi Jinping is in the process of consolidating all powers in China in the Chinese Communist Party (and himself).  His propaganda machine is constantly busy promoting Xi’s dynamic leadership, his “thought” and his “Chinese dream” even though growth is slowing, financial risks are increasing, and the problems of China’s huge aging population are becoming apparent. Like Mr. Trump, Mr. Xi has a populist side that appeals to nationalistic sentiments that the propaganda folks keep warm. He wants China to be recognized by the US and other countries as a great power, and not appear as Japan in the 1980s, so driven by economic ambitions that it could be forced into concessions by the US. Indeed, after the recent negotiations with the US team, Xinhua, China’s official news agency, pointed out that in a trade war, China was better off because of its strong centralized leadership, strong domestic consumer base, and “greater desire” (than the presumably soft Americans) to protect the current global trade system.

Mr. Trump’s style of deal-making is not unique in trade negotiations. Indeed, Richard Nixon, frustrated that Japan was not conceding to his trade policy demands, suddenly imposed a 10% surtax on all Japanese imports to the US. Japan responded by offering some concessions on quotas that solved the political problem Nixon had with US job losses for a while. But the trade imbalances continued and Ronald Regan followed a similar strategy a decade later.

China has emphasized that it is in a stronger bargaining position than Japan in the 1980s. Maybe it is, but the US is China’s largest trade partner, and its open markets continue to be important to China’s future. Meanwhile, China’s economic growth rate has declined from the 10% range to something around 6% despite enormous stimulus efforts and lose credit standards that threaten its financial stability. A trade war with the US certainly would not be convenient.

Economic forces already at work, however, will reduce the trade deficit on their own over time – rising costs for labor, land and raw materials have already caused some companies to move their manufacturing to a lower cost locale, and China will have a growing requirement to import goods as it becomes more of a market-driven consumer society. Meanwhile, while the deficits remain, US consumers enjoy lower prices and corporations pay lower interest rates as China recycles the surplus to invest in US securities, factories and acquisitions to protect its global market access. A great many Americans benefit a little from our present trade with China, but a few have lost their livelihoods. Cold-blooded economists don’t lose any sleep over the disparity, but hot-blooded politicians do.

China was admitted to the World Trade Organization in 2001 at president Bill Clinton’s strong urging. The US trade deficit with China was then less than $100 billion (it is now $375 billion, 2% of US GDP). China was granted some relief from WTO rules because it was a developing country. Some say because of China’s enormous growth since then, and the impact of its concentrated export activity on local businesses in the US and the EU, China should be regarded as a fully developed country and play by all the rules. China says with 60% of its population still poor and an urgent need to upgrade local manufactures to supply local markets, it should not be required yet to do so. And, China is still a one-party state with 150,000 state-owned enterprises that retains many aspects of the command economy it once was.

What's needed now is a set of practical compromises that both sides can live with and feel good about because they add real value.

These might start with a revised accounting system for calculating export values – The iPhone X costs about $370, according to one expert, for its various software and hardware components. Chinese content for assembling the units, however, is only 3% to 6%, or only $10 to $20 per unit. (The rest goes to companies in South Korea, Japan, Taiwan, the EU and the US, illustrating how Apple’s global supply chain works). On the other hand, Chinese content of commodity items like steel exports is nearly 100%.  If we ran the accounting to count only Chinese content, the pressure points would be different. China has excess and unprofitable capacity in steel and other commodity items that China needs to shut down in its own interest. If they are not shut down, the US can file dumping charges with the WTO and impose a special tariff on steel. Such tariffs have been imposed by almost all of Mr. Trump’s predecessors on a case-by-case basis. Mr. Trump could score some points by claiming his metal tariffs would be used for job retraining for displaced workers. But shutting down excess capacity, as Mr. Ross tried to do would be better. China knows it must do this sooner or later and would be better off doing so now.

Mr. Trump might propose that China agree to use its best efforts to offset the adjusted, net trade deficit with the US by increasing imports from the US, which could be of agricultural commodities, liquid natural gas (soon to be abundant in the US) and various forms of financial and other services. An accounting could be kept, and the process monitored to be sure that China conforms to the agreement, but how it does so would be left to it.

A special US-Chinese unit could also be established to continually monitor and address mutual security issues. The US wants to be sure that Chinese hacking of commercial trade secrets is ended and intellectual property protected. The Chinese want to be able to develop their technology industries, which the US should not object to if the effort conforms with restrictions on government subsidies recognized by the WTO and the EU. The US should leave private sector trade and investment in the high-tech sector to market forces, except for highly specific cases involving national security.

Having had the necessary dramatic opening session to satisfy local populations that each country is hanging tough on this important round of trade talks, it is time to get them off the stage and settled into quiet discussions of the complicated but hugely important trade relations between the two countries. A pragmatic solution awaits.

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