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Economy

Trump’s Murky Trade War End Game

Sep 26 , 2018

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This week President Donald Trump intensified his trade war with China, adding to tariffs imposed earlier this year so that about half of all Chinese exports to the U.S. are subject to a 10% tax, with this amount increasing to 25% by the end of the year. If Chinese officials retaliate, which they are already promising to do, he threatened additional tariffs on nearly all the rest of Chinese exports. Trump’s pressure keeps ratcheting up with no end in sight. The end game is murky because Trump’s expectations of what China should do to end the crisis are both expansive and vague. Most media commentators speak of the need for China to end its “unfair trade practices” as if it is obvious to everyone what trade “crimes” China should cease committing. However, the specifics are not easy to find.

One enumeration is the report of the U.S. Trade Representative (USTR) that provides the ostensible excuse and legal cover for Trump’s trade war. It complains about a pattern of Chinese spying, hacking, technology theft, and so-called “forced transfer” of technology in joint venture partnerships. It also attacks the ambitious Chinese “2025 Plan” that targets China’s numerous cutting-edge new industries. The implication of the report is that China will achieve such goals only by intellectual property theft and supposedly illicit government subsidies to research and develop new technologies.

Many in the media have focused on charges like these, but if they were Trump’s real priority, then the solution would be to tighten U.S. laws related to foreign direct investment abroad and improve U.S. counterintelligence, perhaps including assistance to U.S. companies operating abroad. Ideally, the U.S. would propose a bilateral agreement with China, or a multilateral one, on better rules for safeguarding data and technology worldwide. That is something negotiable. But Trump does not want more rules and regulations for business. He certainly does not want more global regulatory agreements. That is the liberal way. He wants results, not more rules.

He says again and again the specific result he wants: rebalancing U.S. trade. He wants to export more and import less so that more goods are made in America. That was his very popular promise to voters that pushed him over the top in the election race, especially in the key swing states of the industrial Midwest. China’s “unfair” trade practices from this standpoint are not any specific bad behaviors, but simply its competitive success. He does not want a new set of rules, he simply wants China to buy more and restrain its exports. He does not want free trade – he wants managed trade.

One model for former Democrat Trump is the now defunct “industrial policy” wing of the Democratic Party, led by former Rep. Richard Gephardt (1977-2005). Another hero of “managed trade” is supposed free trader, former Republican President Ronald Reagan, who relieved Japanese competitive pressure on the U.S. automobile and steel industries by letting the value of the dollar fall (increasing the dollar prices of Japanese goods) and by demanding that Japan impose “voluntary export restraints” on key exports, especially automobiles. Decades ago, Japan was the U.S.’ most formidable competitor. Now it is China. Managed trade like this is based not on rules, but on results. If you compete too successfully, you must be restrained.

So-called “voluntary” export restraints are based on forming an effective cartel among exporting firms. The U.S. suggested a quantitative limit for Japan’s annual exports, and the Japanese car companies divided up this “voluntary” quota among themselves, as would any cartel, in order to limit the quantity and raise the price. Actually, Japanese auto executives did not mind so much because although they exported somewhat fewer cars to the U.S., they charged more for each one, so their profit margins increased. They switched to selling more luxury cars and fewer cheap compacts.

Unfortunately for China, this managed trade solution is not an option today. Although ignorant U.S. commentators like to portray the Chinese economy as dominated by state-owned enterprises, they are a minor factor in the export sector. More than half of Chinese exports are products manufactured or sourced by multinational corporations, many of them American. Managing their trading practices is more of an issue between the U.S. government and the “offending” companies. The Chinese government would in any case be criticized by other powerful U.S. interests if it tried to restrain the export behavior of foreign firms. The same Republican government that is tearing up myriad regulations on U.S. businesses is not likely to take the lead in regulating what it does in China. Instead, Republicans would put this onus on Chinese officials and then of course blame them for whatever action they take.

Those Chinese exports that are not manufactured by multinational corporations are mostly produced by myriad small- and medium-sized private firms scattered all over China. Unlike the highly concentrated and already well-organized Japanese car industry, it would be an administrative nightmare to organize thousands of firms in industrial cartels, allocate market shares to each, and thereby restrict output and raise export prices. Furthermore, if Chinese exports were significantly reduced, much of the business would flow to other low-wage countries around the world, not return to the U.S. China would bankrupt many of its own exporters without even solving the U.S. trade deficit “problem,” which has deep structural roots in the U.S. economy itself.

Managed trade may be a solution in a few instances where there are enormous firms whose activities can be easily regulated, but this would raise hackles. Otherwise, a broad solution to the problem of the U.S. trade deficit would require comprehensive reform of the U.S. economy. Even if it were desirable, Trump and the Republican Congress are busy throwing away the regulatory and tax tools to do that. In fact, the U.S. trade deficit has only increased during Trump’s presidency. I am skeptical whether any solution satisfying Trump can be found. The Chinese government lacks the regulatory power and incentive to give him what he wants. The U.S. government is likewise unwilling or unable. The trade war is likely to continue until Trump falls.

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