Trading Up With China

U.S. President Donald Trump is right to shine a spotlight on trade issues with China. No other country in the world plays such an important role in international trade while also pursuing a mercantilist economic policy. In fact, China hands and trade professionals broadly agree that the country has blocked or impeded U.S. firms—from financial groups to automotive businesses—from competing fairly in the Chinese market. China’s poor protections for intellectual property rights and other problems also place U.S. firms at a competitive disadvantage.

Trump is still assembling his Asia team and developing his approach to trade, but reminding Beijing that there are significant aspects of China’s economic and trade policy that are unfair to foreign businesses is not a bad way for him to start the discussion. After that, he’ll have to pursue the policy approach most likely to produce the results he seeks. But what would that look like?

THE TARIFF SEDUCTION 

“Zhongguo ye you zhengzhi,” said a member of the State Council to me. China also has politics. Between the Communist Party, government ministries, and state-owned industries, many constituencies push for policies—such as subsidies for inefficient factories—that protect their own interests. What is more, China’s leadership class views itself as the protector of the country’s international position. These groups will expect Beijing to respond forcefully to whatever actions the Trump administration takes. Not to do so would be an admission of guilt. Worse, it would be seen as a capitulation to a foreign power. 

China’s response to any U.S. move on tariffs would come on two levels: rhetorical and policy. Beijing’s rhetoric will attempt to reassure its domestic audience that China has successfully withstood U.S. pressure. There have already been signals of this approach in editorials in the government-controlled media. The more nationalist Global Times stated on January 19 that “Trump’s trade war with China will backfire.” A few days later, the more staid China Daily noted rather dryly that “Trump’s inaugural speech spurs worry.”

In terms of policy, China does not usually escalate trade disputes, but it does reciprocate. It will tend to match whatever tariffs the United States imposes with economically comparable levies of its own. For example, when former U.S. President Barack Obama placed taxes on Chinese tire exports in 2009, China responded by sanctioning U.S. poultry exports. Indeed, China tends to target either agricultural commodities that are easily substituted with imports from elsewhere or products that have a demonstration effect.

Consider apples. As with poultry, China can readily substitute American apples with those from Australia and elsewhere. Tariffs on apples would, in fact, give China a “three-fer”: they would punish the United States, reward Australia economically, and signal to the Australian political leadership, some of which has been flirting with developing closer ties with China, that Washington might not be their best ally. With the tariff only against U.S. products, similar goods from other countries would have a competitive advantage.

There are a range of other products, agricultural and otherwise, on which U.S. producers face stiff competition. A study from Deutsche Bank shows that China currently absorbs some 47 percent of U.S. fruit and seed exports, 11.8 percent of U.S. aircraft exports, and 23.3 percent of U.S. wood products exports. So China’s ability to respond to tariffs in kind is not immaterial. 

A U.S. tariff hike risks making it more difficult to get concessions from China.

More important than China’s ability to engage in tit-for-tat responses are the domestic politics of the matter. No Chinese leader can afford to seem to capitulate to U.S. pressure, regardless of the merits of the U.S. position. If anything, a U.S. tariff hike risks making it more difficult to get concessions from China. If Washington is looking for trade friction, a tariff war will get it there quickly. If it is looking for a reduction in trade barriers, there are better approaches available. 

PLAN B 

There are a few ways the United States could help China move toward global norms on trade.

First, the United States should be careful of conflating issues. There are multiple challenges in the U.S.-Chinese relationship, including geopolitical friction in the South China Sea, relations with Taiwan, human rights, North Korea, and trade. The United States should be mindful about linking these issues lest trade get handcuffed to the more intractable problems. As the United States’ difficult relations with Cuba, Russia, and some Middle Eastern states have shown, governments can move faster on trade issues than on political ones. It is worth noting that one of the parties that might be drawn into a dispute between China and the United States—Taiwan—also sees value in keeping issues separate. A friend in the Taiwanese government specifically cautioned against encouraging trade friction. “We will be hurt,” he said, referring to the intertwined U.S.-Chinese-Taiwanese supply chains. He was diplomatic enough to leave unstated China’s capacity to harm Taiwan.

Second, bad cops work better when good cops are in on the discussion. It might be possible to find some common ground on steel overcapacity, for example. The Chinese freely acknowledge that subsidized state-owned industries are a drain on their economy and cause distortion in steel markets. There could be non-adversarial ways to tackle the problem, at least partially. For example, a segment of steel industry employees and resources could be moved from production to environmental efforts at aging steel mills, including soil remediation and air purification. China does not need more steel, but it does need clean air and water. As that discussion unfolds, the United States should continue to pursue anti-dumping and countervailing duty cases against Chinese steel, as the law provides, keeping the bad cop in the picture.

Third, it is worth playing offense as well as defense. Trump should not solely focus on U.S. industries under pressure, such as steel. He should also push for market access for those that are booming, such as the United States’ technology, biotechnology, and civil aviation sectors. Even a successful defensive strategy to support jobs in the U.S. steel industry would by itself fall short because it would ignore opportunities in other industries. 

Fourth, the United States should make trade gains where it can. Trump has pulled the United States out of the Trans-Pacific Partnership, but there are alternative approaches he could support. To the extent that the United States can improve trade relations with other Asian nations, it will help the country bolster its export agenda and it would incentivize China to move toward global norms. Washington could likely find a member state of the Association of Southeast Asian Nations with which to pursue a reduction in trade barriers. It might even be able to agree with Japan on auto standards for safety telematics or for driverless cars. An open skies agreement with the Philippines likewise seems within grasp. The world is not standing still. China is not standing still. And the United States should not stand still, either.

Finally, there is a potential benefit to a rise in tension between the United States and China: China will more clearly see the advantages of reaching a deal. The country faces its own set of issues, such as slowing economic growth, a debt bubble, turmoil in Hong Kong, the upcoming 19th Party Congress, and the start of President Xi Jinping’s second term. Despite its outwardly defiant tone, China is likely to have a limited appetite for additional trouble.

It might be an opportune moment, in other words, for a breakthrough. Trump should direct the new secretary of commerce, Wilbur Ross, to convene an emergency team for 90 days to work with Chinese counterparts to identify the top ten trade barriers for immediate resolution. If these can be addressed in good order, the basis for further trade squabbles would evaporate on its own. In short, it is time for a bold move, the outlines of which are clear.

Start with tariffs. According to the WTO, some 16.4 percent of China’s import items (“line items” in WTO nomenclature) are subject to a tariff of more than 15 percent. Only 6.4 percent are duty-free. For the United States, the figures are 2.7 percent of items and 45.2 percent. So it is easy to see why the United States would feel unfairly treated. China could take a series of steps to diffuse these issues, all of which would also benefit its own economy: it could eliminate all tariffs on items it does not produce; it could limit remaining tariffs to 10 percent. Such a system would still favor China’s domestic industries but would allow greater scope for competition. 

China could also address non-tariff barriers. For example, the Chinese equivalent of the FDA requires that each size of a food product be tested and approved, with the U.S. company bearing the costs of testing it. So if a firm wants to sell eight-ounce jars and small cafeteria packs of strawberry jelly, both items have to be separately tested and approved. This would be an easy barrier to eliminate. Finally, China could budge in at least one of the service sectors. Finance, telecommunications, and healthcare are tightly regulated in China. The United States has global leadership in all of these sectors.

There are two caveats to this plan. First, Chinese market openings would benefit the United States and China primarily, but other exporting nations would also see gains. So the United States should complement its market-opening strategy with a market-entry strategy, to help U.S. companies take advantage of China’s reforms. Second, these reforms might not have a material impact on the trade balance, driven as it is by financial flows and macro-economic factors. This suggests that the United States needs a broader discussion about the ultimate goals of trade policy: to achieve open markets or to avoid a trade deficit. That is, does the country want equality of opportunity or equality of result? Those who believe that the only proper trade policy is one that guarantees equal outcomes are essentially arguing that a product can be imported only if a product of equivalent value can be exported—in other words, a barter economy.

The coming months could see heated rhetoric on trade, but that might be put aside if Chinese and U.S. negotiators can scramble to remedy some of the above issues at the dawn of the Trump administration. All parties would do well to bear in mind two truisms: trade wars can easily hurt the initiating country as much as the target country, and they are much easier to start than to stop.