The Rise of China and America's Response

HARRISON NUGENT: On August 4th, 1941, only eight weeks after the German invasion of the Soviet Union, British Prime Minister Winston Churchill and his Chiefs of the Defence Staff embarked on a perilous rendezvous across the Atlantic to discuss with President Roosevelt and an American delegation the “common principles” that should guide a post-war international order. It was in this time, at a top-secret conference in a desolate bay off of Newfoundland, that the foundation was established for a renaissance of the liberal world order, an “Atlantic Charter” not guided on Thucydidean notions of realism but instead a compact whereby international institutions, forging links between nations large and small, could promote and enforce a rule of law that encouraged fair and predictable forms of collaboration.

Over time this paradigm was adapted to respond to the challenges of a rapidly evolving world, no change more paramount than the creation of the World Trade Organization in 1995, but progress has stalled over the last twenty years and new problems have emerged on the horizon. In particular, the ascension of China and its unique economic structure, unforeseen by the negotiators privy to the WTO’s creation, threatens to erode the spirit, if not the letter, of WTO rules concerning trade.

President Xi Jinping has utilized the outsize influence of the party-state to dominate Chinese industry and limit foreign competition, reversing an earlier trend of market liberalization. Far from a responsible stakeholder, China has been an agent of predatory and trade-distortive economic behavior, the likes of which threaten to cripple the international system and its regime of mutual economic growth and unparalleled poverty reduction. By imposing technology transfers on foreign firms, leveraging the party-state to provide domestic subsidies for national champions, and discriminately enforcing anti-trust laws to target foreign-owned businesses, China threatens to confound a multilateral trade regime predicated on the rule of law and the free market. As the world’s dominant power broker across international institutions, the United States, in responding to these practices, plays a pivotal role in determining not only the future of US-China trade relations but also the global economic order. But right now our response does not address the threat.

The current approach taken by the Trump administration has been to impose tariffs as a punitive measure on Chinese actions, betting that taxes on Chinese exports will weaken China’s economy through stymied growth and a decrease in the trade surplus, ultimately forcing them to the negotiating table to rewrite trade rules in America’s fashion. This strategy, however, miscalculates Chinese dependence on US trade and underestimates the growing burden of these tariffs on the US economy.

Compared to a decade ago, China is much less dependent on exports in general and is in particular less dependent on exports to the United States, with only 3 percent of the Chinese economy being comprised of value added in exports to the US. And because China sits at the end of many global supply chains, the effects of these tariffs are dispersed towards inputs from countries like Japan, South Korea, and Taiwan. Furthermore, because US tariffs on Chinese goods have led to financial uncertainty, the US has seen a surge in capital inflow from foreign economies, leading to a 5 percent appreciation of the dollar against a basket of currencies and a 4.3 percent depreciation of the Yuan relative to the dollar. This shift in the exchange rate largely undoes trade protection and actually exacerbates a trade imbalance. It is for these reasons that one can expect China to remain in a strong economic position, allowing President Xi to continue a game of “tit-for-tat” in retaliation.

This is a game that the US cannot afford to sustain, as the costs of tariffs placed on US exports have tremendous impact on American farmers, the target of many retaliatory Chinese tariffs. This impact has the potential to leave long-term consequences on American agriculture, as suppliers in Brazil and Argentina have replaced over 5 million acres of sugar cane crops with soy, hoping to replace America as China’s largest supplier. In other sectors like wheat, the impact of Chinese tariffs have been felt immediately as US wheat exports have declined by 21 percent in the first two quarters of 2018.

The potential for long-term harm in these key industries could lead to a significant shift in pressure from key interest groups domestically, weakening the US’s negotiating position and forcing negotiators to adopt a hardline strategy, one that will likely require a bitter, drawn-out trade war. But beyond domestic factors, the indiscriminate nature of Trump administration tariffs paints the US as the aggressor and undermines the international and corporate support Trump needs to solve the real problem. This erodes the US’s international standing and credibility, and the resulting solution will either result in China giving in to US demands after a prolonged and costly trade war or in the US conceding to China the right to distort the principles of market economics in their favor. Clearly there is a more optimal solution.

Max Magid