12/01/2018 No. 136
 
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Trade War
By Yung-Sheng Cha
October 1, 2018


It looks like Trump is determined to start a trade war with China. Similarly, China does not appear to back down from the threat of an all-out trade war with the U. S. It is difficult to predict what is going to happen because Trump is unpredictable and he is changing the goalposts all along the way. Early in May, Treasury Secretary Steven Mnuchin announced that the two nations have agreed to back away from imposing tough new tariffs on each other's exports, after reaching a deal for Beijing to buy more American goods to "substantially reduce" the huge trade deficit with the United States. But later Trump changed his mind and decided to impose tariffs on $50 billion of imported Chinese goods. Thus a trade war started between China and the U. S.

On trade, Trump believes that the entire world (China, Japan, Germany, Canada, Mexico, etc.) is taking advantage of the U. S. and the result is that the U. S. suffered huge trade deficits for many years. Most economic experts, however, understand that "the United States’ overall trade deficit is the result of a shortage in national savings relative to spending due to excessive government budget deficits and households consuming beyond their means. It is a purely domestic issue and has very little to do with the policy of foreign countries.

Trump claims that he wants to reduce trade deficits with China. A trade war is going to do exactly the opposite. The U. S. trade deficits mainly come from American families spending too much on inexpensive foreign products. If Americans do not save more or spend less, imports will not decrease. On the other hand, exports will definitely decrease if a trade war begins, because foreign countries will buy fewer American products. The result is that the trade deficit will increase. As a matter of fact, this actually happened. Latest data indicated that the trade deficit in June of 2018 was $46.3 billion, up from $43.1 billion in May of 2018. The U. S. trade deficit increased to a five-month high in July. The July trade deficit jumped 9.5% to $50.1 billion.

Trump's complaints about China span almost 20 years. Trump believes that China took advantage of the U. S. through unfair trading practices, although he never mentioned that the U. S. also benefited from trade with China. The inexpensive imports from China kept inflation rate low, particularly during and after the financial crisis of 2008 when the Federal Reserve printed a huge amount of money to save the U. S. economy from deeper recession or depression. American corporations also benefited from imports from China because it made American products more competitive. Whether it is justified or not, this idea that China is taking advantage of U. S. on trade is deeply ingrained in his mind and nothing is likely to change that.

One of the main complaints about China is the forced requirement of technology transfer if American companies wish to do business in China. From a business point of view, I find this complaint rather weird. There must be mutual benefits if an agreement is reached. In this case, American companies make money because they have access to China's large market. On the other side, China benefit by obtaining the new technology they need. It is a trade of market sharing with technology. Both sides benefit from the agreement. If American companies feel the trade is unfair, they need not sign the agreement. China has no leverage in forcing American companies to accept such an agreement.

The second reason to start a trade war is that the mid-term election is only about one-month away and the Republicans may lose the majority in either the House or the Senate. Special elections held across the country were either very close or won by the Democrats in traditional red districts or states. Trump is very concerned about this and would definitely like to reverse the trend. The threat of a trade war against China is a useful and powerful tool to arouse the support of his base and the public because getting tough on China appears to be quite popular in America.

The third reason for starting a trade war with China is the fear that China may catch up and exceed the U. S. in future and high technologies. China has announced the policy of "Made in China 2025" on ten future technologies (artificial intelligence, electric cars, etc.). This strikes fear in the minds of many in the U. S. This is why in the trade war against China, Trump and his trade advisors specifically targeted the high-tech industries of China by not allowing technology transfer and by preventing Chinese investment in these technologies in the U. S. According to Geoffrey Garrett, Dean of the Wharton Business School, this is the real reason behind the trade war. "What is really going on is not about trade; it is about who will lead global innovation in the 21st century."

Trump is not alone in his view of China. Going back to the year 2000 when George W. Bush was elected President, surrounded by neo-cons, he was ready to get tough on China. When asked how he was going to punish China, his answer was "whatever it takes". Then, 9-11 happened and the U. S. invaded both Afghanistan and Iraq. When Obama was elected in 2008, he was probably ready to do something to contain China, but the financial crisis prevented him from taking action against China. Finally, in 2011-2012, he announced the so-called "pivot to Asia", followed by the initiation of TPP. Both were aimed to contain China.

 

Trump claims that trade wars are easy to win. He is right in dealing with countries like South Korea, Mexico, etc. The economy of these countries is much smaller than that of the U. S. Even when dealing with China, Trump and some people in the U. S. believe that the U. S. will win in a trade war with China. The obvious reason is that the U. S. imports much more than it exports to China. In 2017, imports from China was $505 billion while exports to China was $130 billion, which resulted in a trade deficit of $376 billion with China. This means that the U. S. has more ammunition than China in a trade war. It should be noted that these numbers are for manufactured products only. They do not include services such as tourism, finance, healthcare, etc. Last year the U. S. had a trade surplus of services with China of about $60 billion.

 

However, there are several non-tariff measures which China can use in retaliating against the U. S. These non-tariff measures include targeting American corporations in China, such as General Motors, Apple and Starbucks. These corporations made a lot of money in China over the years. One possible target is Apple because it gets so much of its growth from China. One estimate of the money that American corporations made in China was as large as $550 billion. When the trade war escalates and when China runs out of tariffs to impose, they can simply make American business difficult to operate or stop buying U. S. products in China. Then the trade war becomes an economic war. The U. S. does not have many non-tariff barriers to employ in an economic war because there are not that many Chinese corporations operating in the U. S.

 

China holds $1.1 trillion of U. S. treasury bonds. If it stops buying new bonds, or sells off its holdings, it would increase the interest rate of the treasury bonds and the already huge U. S. federal debt will rise further. China can also devalue its currency (Yuan) to reduce the impact of U. S. tariffs on Chinese goods.

 

All these non-tariff measures of course will also hurt the Chinese economy and its people, just like the U. S. tariffs on Chinese goods will hurt U. S. consumers and corporations. But when push comes to shove, these are the weapons that China can employ in an economic war with the U. S.

 

It should be noted that the $505 billion worth of imports from China is not entirely from China. It is estimated that probably one-third actually involves inputs from elsewhere, including the U. S. An example frequently cited is Apple's iPhone. Of the factory-cost estimate of $237 for iPhone 7, all that is earned in China is about $9, or 3.6 percent of the total, mainly for labor used for assembly. The other $228 are parts supplied from different countries, which includes the U. S., Japan, Taiwan, and South Korea. But the U. S. counts the entire $237 as coming from China and adds it to the massive trade deficit between the U. S. and China. An iPhone 7 sells for $649. The difference ($412) is Apple's expenses plus a huge profit. One estimate suggests that import of the iPhone 7 contributed $15.7 billion to a year's trade deficit with China.

 

Unlike the trade war, the outcome of an economic war between China and the U. S. is not clear at all. It certainly will result in significant damage to both economies and substantial damage to the world economy, because China contributed to more than 30% of the growth of the world economy since the financial crisis of 2008. If China stops growing or if its growth slows down because of the economic war, the world will suffer and the U. S will not be spared.

Most businessmen know that there are no winners if a trade war begins. Tariffs are taxes on business and consumers. But Trump has the support of both the Republicans and the Democrats in getting tough with China because it is popular in the U. S. However, in a protracted economic war, when American consumers and businesses are hurting, the mood in the U. S. is likely to switch and the pressure on Trump to change his policy will be tremendous. On the other hand, President Xi will not have these kinds of pressure from the Chinese people because he is not democratically elected and he does not have to be concerned about the next election.

Y. S. Cha

August, 2018

Darien, Illinois

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Yung-Sheng Cha graduated from the Mechanical Engineering Department of National Taiwan University in 1967. He received his M.Sc. and Ph.D. degrees in Mechanical Engineering from Lehigh University in 1970 and 1973, respectively. He was employed by the Argonne National Laboratory in 1974 until his retirement in 2006. While at Argonne, his research focus was mainly on different energy systems. Dr. Cha is a U. S. citizen.
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