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Gaming the Sino-American Trade-War

Gaming the Sino-American Trade-War
China is a country with momentum. From abject poverty and isolation in the late 1970s, China’s economic growth has been unparalleled.
Technology Briefing


The United states and China are the world’s largest economies.

Since the early 20th century, the United States has been by far the world’s largest economy. Since the end of the Cold War, it has been the world’s sole military superpower. And it has recently recaptured the role of the world’s largest energy producer. Most global institutions including the IMF, World Bank, and United Nations rely disproportionately on support from the United States.

However, China is clearly the country with the momentum. From abject poverty and isolation in the late 1970s, China’s economic growth has been unparalleled. In fact, since 1987 its real GDP per capita has grown over 2600%. Today, China has the world’s largest population, the second largest economy, and a military typically rated as “the third most powerful.” It’s also the world’s biggest producer of many strategic minerals.

Its unprecedented economic growth has relied upon manufactured exports. And that success has depended heavily on what other countries call “unfair trade practices.” These practices include tariffs, as well as non-tariff barriers such as currency manipulation, subsidies, punitive health & safety regulations and the theft of intellectual property.

This unprecedented export-driven growth enabled China to rack up a cumulative trade surplus of around $5 trillion with the United States since 1987. In the process, it’s estimated that the United States lost 3.6 million jobs to China since China joined the World Trade Organization in 2001. About 36% of those jobs were in computers and electronics, while the rest were spread about evenly between apparel, services, appliances, metal products and furniture.

U.S. consumers have unquestionably reaped a windfall as China has steadily improved the relative price-performance of consumer products ranging from smart phones, to toys, to computers. For this reason, U.S. Presidents from Carter to Obama refused to retaliate aggressively for China’s violation of commercial norms.

More significantly, Americans have assumed that we could trust the fundamental principles of “free trade” based on comparative advantage. However, China’s increasingly belligerent geopolitical posture, coupled with its brazen disregard for commercial norms has led Americans in both parties to change that calculation. In fact, retaliation against Chinese trade practices has become a core policy objective for the Trump administration.

For that reason, a doctrine of de facto “economic containment” of China lies at the heart of Trump’s so-called “fair trade” strategy. By the 4th quarter of 2018, negotiations with China evolved to the point where “verbal warnings” and patient dialogue no longer sufficed. And by the second quarter of 2019, the United States sharply ratcheted up trade tensions with China. The result has been a great deal of anxiety as financial markets wrestle with the implications of an unprecedented U.S. trade strategy. And many have compared this to the trade practices of the 1930s. However, that concern seems highly misplaced.

Today, there are many possible trade war outcomes which lie on a continuum. At one end is the scenario under which both the United States and China eliminate all trade barriers, fully opening both U.S. and Chinese economies to “free trade.” That means no trade barriers of any kind coupled with verifiable adherence to international law regarding property rights and other standards by both parties. Classical economic theory tells us that this state-of-affairs would create enormous benefits for both countries and their citizens.

At the other extreme is a scenario where the United States and China impose 25% or greater tariffs on all imports from the other. That means that the United States would charge tariffs on all $539 billion of Chinese imports recorded for 2018, while China would impose tariffs on all $139 billion it imported from the United States. While some U.S. companies will be hurt by losing access to Chinese markets, most will see improved revenues and profits both medium and long-term. Meanwhile, U.S. based employment will grow, and U.S. consumers will pay little, if any, more over the next five years for manufactured goods. Most importantly, the long-term viability of non-Chinese businesses will be enhanced as Chinese predatory practices are preempted. Furthermore, the Chinese geopolitical threat will be reduced as China becomes increasingly marginalized.

To understand this scenario, we need to examine the asymmetrical nature of the Sino-American trade relationship and why highly targeted, country-specific trade-barriers will be so extremely effective in this case.

First, consider the nature of the specific items traded between the two countries. American products sold to China are primarily industrial commodities including oilseeds for producing cooking oil, navigational instruments for building dry bulk or container ships, intermediate producer goods for manufacturing, and energy in the form of coal, oil & gas. For the most part, these are, for this moment, irreplaceable items that China needs to import from the United States. In economic terms, the Chinese demand for these products is “inelastic.” This inelasticity restricts China’s capability of fighting a real trade war against the U.S. by imposing tariffs on the imports of these semi-finished products. And more importantly, since an American soybean is the same as a Brazilian soybean, If China buys fewer from the U.S. and more from Brazil, that simply means others will buy more from the U.S. to replace the Brazilian soybeans that are no longer on the market.

In the cases, where “market stickiness” penalizes U.S. farmers, the administration has already put in place compensatory programs funded by tariffs on Chinese goods. So, except in the cases of automobiles and aircraft Trump can do pretty much whatever he wants without undermining U.S. exports., in the short term.

Now, consider the implications for imports to the U.S. from China. According to a new study from the Coalition for a Prosperous America (or CPA), an across-the-board 25 percent tariff on all goods imported to the U.S. from China would “deliver a significant, sustained boost to the U.S. economy ” by creating 721,000 American jobs and adding $125 billion to the nation ’s GDP by 2024 .

The study produced by CPA researchers Jeff Ferry and Steven Byers reveals that “across-the-board U.S. tariffs on Chinese imports will stimulate the U.S. economy, will increase U.S. production and jobs, and lead to a reduction in U.S. import costs over time. This result is consistent with U.S. experience in 2018 and early 2019 when tariffs on steel, aluminum, and other industries led to job creation in those sectors. The modeling results provide additional evidence that decoupling the U.S. economy from China and its predatory trade and subsidy practices will make the U.S. economy stronger, with more production, investment, and jobs.”

If a 25 percent tariff was imposed on all Chinese imports, Ferry and Byers found that about $3.23 billion of production will leave China in 2020, and by 2024 nearly $300 billion in production will have left China. That’s not surprising since a survey of foreign manufacturers in China indicated that over 50% were already considering relocating elsewhere. Whether you’re talking about smart phones, clothing, or dog food, making it in Bangladesh, Vietnam, India or the Philippines is only slightly more challenging than making it in China. And while giving up the domestic Chinese market may seem risky, many believe that “free access to the Chinese market” was always a mirage, promised by Chinese officials seeking to lure unsuspecting multinationals.

Most prominently, the massive job-reshoring effort that would result from a 25 percent tariff on all Chinese imports would bring more American jobs back to the U.S. economy by 2024 than the state of California has lost to free trade with China over the past two decades.

Notably, nearly 193,000 of the 721,000 U.S. jobs created by a 25 percent tariff on Chinese imports would be in the manufacturing sector. This indicates that more than 1-in-4 American jobs brought back to the U.S. due to an across-the-board tariff on China would be U.S. manufacturing jobs.

While total U.S. production costs in many industries remain higher than in China, unit cost is not the whole story. Locating production in the US offers other advantages, including lower transportation costs, more logistical flexibility, and closer connectedness to consumer markets, distributors, and senior management. Relocating to the U.S. also insulates companies against the uncertainty of potential future trade tensions.

The 25 percent tariff on China, the CPA study finds, would “speed up the process” of reshoring jobs back to the U.S. specifically in industries like apparel.

Already, President Trump has imposed a 25 percent tariff on steel imports, a 10 percent tariff on aluminum imports, and he recently hiked tariffs on $200 billion worth of Chinese imports to 25 percent. Likewise, the Trump administration is reviewing hiking tariffs on an additional $300 billion worth of Chinese imports to 25 percent.

To date, Trump’s “economic nationalist agenda” designed to bring U.S. jobs and industries back to the American economy, while also protecting American workers and industries from unfair foreign competition, has been met with disdain from some free trade activists including GOP mega-donors Charles and David Koch. However, this view is not widely shared by the country’s working and middle class. A recent Harvard-Harris poll found that about 8-in-10 U.S. voters supported reciprocal tariffs, including more than 90 percent of conservatives and 88 percent of registered Republican voters.

The trade war’s competitive dynamics are clear, but the human element remains uncertain. Therefore, the situation will have to continue to play itself out.

Given this trend, we offer the following forecasts for your consideration.

First, China will be forced to come to the table on Trump’s terms.

Assuming Trump implements across-the-board 25% tariffs on all Chinese imports over the next few months, while advancing “fair trade” with other countries over the next five years, the consequences will be catastrophic for China and mildly positive for the United States. On the other hand, accepting Trump's “fair trade” policies will be good for China and a huge win for the United states.

Second, this trade war will be nothing like the 1930s.

Smoot-Hawley was a one-size-fits-all system directed toward all trading partners in an era when most trade was in commodity products. Trump’s 21st century strategy directs tariffs selectively against specific perpetrators of trade barriers, in this case China. By reducing barriers to trade from Mexico, South Asia, and Southeast Asia, while imposing “exorbitant tariffs” on China, Trump has put the Chinese in a vise. China will either have to quit exporting $500 billion in goods to the United States or give its companies $125 billion in subsidies. Meanwhile, other countries could see their trade with the U.S. boom.

Third, China will see a rapid exodus of export-based manufacturing.

Foreign companies manufacturing in China will relocate elsewhere. Even prior to the most recent Sino-American confrontation, polls indicate that over 50% of companies exporting from China were considering relocating capacity to the U.S., Bangladesh, India, Vietnam and Mexico. China can ether open-up its markets or face a mass exodus. China can only afford to subsidize this losing proposition for a, short time. And,

Fourth, one of the biggest winners in this trade war could be Mexico.

The new USMCA positions Mexico as one of the best places in the world to manufacture. With low wage costs, close proximity to the world’s largest consumer market, almost unlimited access to cheap U.S. natural gas, and minimal regulatory overhead, Mexico is (in many respects) the envy of the world. In the medium-term, widespread lawlessness is a major problem; but giving people access to well-paid jobs will undermine the appeal of the criminal drug cartels. For American workers this will have the added benefit of attracting many illegal residents of the United States back to their home country.


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