The US has been criticizing China for its unfair trade practices and currency manipulation, which are strikingly similar to the US-Japan disputes in the 80s and 90s. The US criticized Japan for its large current account surplus, which resulted in long intense trade negotiations between the two governments, and a broad range of economic policies to reduce Japan’s excess savings. With a bit of hindsight, the US arguably successfully contained Japan’s rising momentum, and adapted itself to the new economic environment. With this background, the important question is whether China will have a similar fate as Japan, once the US-China trade disputes are done. Our take is definitively no.
In the big picture, Japan and China challenged the US hegemony at very different stages of their economic development. Arguably, Japan faced pressure from the US when it was close to its economic peak with an increasingly aging population, and stagnant labor productivity. On the other hand, China’s GDP per capita was still small compared to the US, with a much younger population. Furthermore, China’s labor productivity has been improving rapidly, on the back of larger investments in manufacturing and infrastructure. In addition, while still at an early stage of economic development, China’s economic size is considerably larger than Japan at its peak, and takes up a significantly larger export share worldwide. Therefore, as China continues to climb up the technology ladder, its presence in the global economy is anticipated to increase, further challenging the US. In light of this, the outcome of the US-China trade war is anticipated to be quite different from the experience Japan had, not to mention China is less dependent on the US than Japan was, both politically and economically.
Arguably, Japan was an easy target for US bashing. After the Second World War, Japan has been both politically and economically dependent on the US, resulting in limited bargaining power to counteract the US. Being less dependent on the US, China is in a better position to resist US pressure to adjust its economic policies in order to create demand for US products. This was especially the case for the exchange rate (with a massive appreciation of the yen), and a lax monetary policy to create more import demand from Japan. We should not expect China to follow Japan’s “forced” exchange rate and monetary policy, as a strong RMB could be the nail in the coffin for China’s structurally weaker exports and rising wages. What’s more, while strong domestic demand could generate imports from the US, excessive policy measures to stimulate growth could lead to an overly lax monetary policy, potentially feeding an asset price bubble, easily aggravated by China’s aging trends in major cities.
Another important lesson relates to Japan’s downplaying of its strong industrial policy, by accepting an increase of US semiconductor imports, effectively reducing the competitiveness of Japan’s own semiconductor industry. Similar lessons can be learned from Japan’s auto industry. As the Chinese government has more control over its economy than the Japanese, the US could become more demanding of China under the Trump Administration.
Government intervention in the economy is a double-edged sword, as the US-Japan trade dispute revealed. On the one hand, it can support the development of strategic sectors, such as semiconductors. On the other hand, numerical import targets could reduce the county’s competitiveness, as revealed by the dismal fate of the Japanese sector after the US-Japan Semiconductor Agreement in 1986. While the private sector could respond to the crisis more effectively, as the Japanese auto companies did by increasing foreign investments in the US, state ownership of Chinese companies could pose challenges for adapting to a changing economic environment.
All in all, with less dependence on the US, China is in a better position than Japan to resist adjusting its economic policies to meet US demand, thereby avoiding Japan’s dismal economic performance. While the government can support strategically important sectors to win global market shares, it should avoid numerical import targets, as they effectively reduced the competitiveness of the Japanese semiconductor companies. Furthermore, China should not follow Japan’s “forced” exchange rate and monetary policy. A stronger RMB could reduce foreign direct investment into China, and policy measures to stimulate growth could lead to an overly lax monetary policy, potentially feeding an asset price bubble, as experienced in Japan.
Because China is at an earlier stage of economic development, it is expected to challenge the US hegemony for an extended period of time. Therefore, the US-China trade war could last longer than the one with Japan. With China’s growth prospects still relatively solid - it will soon overtake the US economy in size and it does not depend on the US militarily - China will likely challenge US pressure in the ongoing negotiations for a settlement to the trade war. This also means that any deal will only be temporary, as the US will not be able to contain China as easily as it contained Japan.