Understanding the U.S.-China Trade War part 1

Understanding the U.S.-China Trade War
Tao Liua and Wing Thye Woob,c,d,e
a
Central University of Finance and Economics, China; b
University of California, Davis, USA; c
Sunway
University, Malaysia; d
Fudan University, China; e
Chinese Academy of Social Sciences, China

ABSTRACT
Three major concerns drove the U.S. into initiating the trade war, and
they are (a) the concern that China’s chronically large trade surplus was
depressing job creation in the U.S. (b) the concern that China was
using illegal and unfair methods to acquire U.S. technology at an
effectively discounted price; and (c) the concern that China seeks to
weaken U.S. national security and its international standing. On the
dispute over China’s exchange rate and trade imbalance, the first
conclusion is that it was marked by analytical confusion over the
meaning of the term ‘equilibrium exchange rate’. The second conclusion is that China’s trade imbalance reflects the economic conditions in
both China and U.S., and that the efficient and fair solution of the
problem requires policy changes in both countries. On the industrial
policy dispute, the first conclusion is that the issue of forced technology transfer is largely a dispute about China using its market power to
benefit itself at the expense of its trade partners. The second conclusion is that China’s use of market power can last only until the other
large countries could unite and retaliate as a group. The inevitability of
retaliation means that China should replace the joint-venture (JV)
mechanism for technological diffusion with other ways to strengthen
its technological capability. On the U.S. concern about whether China
trade weakens its national security, the first conclusion is that the
notion of national security that is commonly adopted in the U.S.
trade policy debate is ignorant about the primary determinants of U.
S. capability in innovation. By focusing instead mainly on how to hold
down China technologically, the long-run outcome will be a technologically weaker U.S. and hence, a more vulnerable U.S. The second
conclusion is that the U.S. must identify a clear, short list of critical
technologies and critical infrastructure for the recently reformed
Committee for Foreign Investment in the United States (CFIUS) to
cover, and update this list constantly. Otherwise, the broad and changing nature of notions about national security would allow the bureaucratically driven phenomenon of mission-creep to steadily expand the
coverage of the CFIUS process, thereby steadily rendering CFIUS to be
operationally capricious. Our principal policy suggestion to China is
that, because China’s economy in 2018 is very different from that in
1978 (e.g. many parts of China now look like Singapore and China is
Africa’s biggest donor), there should be more reciprocity in China’s
trade and investment relations with the advanced economies despite
China’s status as a developing economy under WTO rules. Our principal policy suggestion to President Trump is to stop equating strategic
competition with economic competition. Strategic competition is normally a zero-sum game. While fair economic competition is usually a

zero-sum game in the short run, it generally creates a win-win outcome in the long run.

 

Introduction
As this article goes to press in early August 2018, China and the U.S. are engaged in a
trade war that looks very likely to escalate. The U.S. implemented a 25 percent tariff on
6 July 2018 on Chinese imports that had amounted to $34 billion in 2017 and is
planning to impose the 25 percent tariff on additional Chinese imports worth $16
billion on 23 August 2018. And China has responded in a tic-for-tac manner to this
two-part U.S. tariff action.
In reaction to the Chinese retaliation, the U.S. has announced that it would impose
25 percent tariff on another $200 million worth of Chinese goods. In quick reply, China
promised to respond with 25 percent tariff on $60 billion more of U.S. imports. Why
did China not match the U.S. action in scale in this likely second round of the trade
war? The answer is that China’s export of goods to the U.S. was $505 billion in 2017,
while U.S. exports to China was only $130 billion.
Needless to say, both the U.S. and China have been hurt by the trade war. $27 billion of
U.S. agricultural exports have been adversely affected by Chinese tariffs implemented on 6
July 2018, and the U.S. now plans to dole out $12 billion in subsidies to U.S. farmers.
China has eased up on credit growth in the last month to offset the negative consequences
of U.S. tariffs, effectively suspending its efforts to reduce the debt-GDP ratio which stands
at the dangerously high level of 300 percent compared to 170 percent in 2009.1
Three major concerns drove the U.S. into initiating the trade war, and they are (a)
the concern that China’s chronically large trade surplus was depressing job creation in
the U.S.; (b) the concern that China was using illegal and unfair methods to acquire U.
S. technology at an effectively discounted price; and (c) the concern that China seeks to
weaken U.S. national security and its international standing.
China’s journey in external economic engagement has been marked by many
disputes, and it is safe to predict that its future course will generate new disputes.
This paper hopes to help reduce the intensity and frequency of these future international economic disputes by evaluating (a) two protracted and cantankerous external
economic disputes of the last 40 years – the disputes over China’s chronic large trade
surplus and over China’s industrial policy – and (b) the hypothesis that trade with
China undermines U.S. national security.
To anticipate the coming discussion in the paper, we will summarize some key
conclusions here.
On the dispute over China’s exchange rate and trade imbalance, the first conclusion
is that it was marked by analytical confusion over the meaning of the term ‘equilibrium
exchange rate’. The second conclusion is that China’s trade imbalance reflects the
economic conditions in both China and U.S., and that the efficient and fair solution
of the problem requires policy changes in both countries. The third conclusion is that
the dispute on exchange rate misalignment has diverted attention away from better
solutions that (a) address the underlying structural factors causing the trade imbalance,

and (b) improve the of U.S. job transition programs whose inadequacy has exacerbated
U.S. unhappiness with trade imbalance.
On the industrial policy dispute, the first conclusion is that the issue of forced
technology transfer is largely a dispute about China using its market power to benefit
itself at the expense of its trade partners. The second conclusion is that China’s use of
market power can last only until the other large countries could unite and retaliate as a
group. The inevitability of retaliation is why we do not see the imposition of optimum
tariffs by large importers and which is why China should replace the JV mechanism for
technological diffusion with other ways to strengthen its technological capability. The
third conclusion is that the state subsidies component of China’s industrial policy is too
large because it has been used too often as macro-stabilization and socio-stabilization
instruments, resulting in the phenomena of ghost cities and zombie firms.
On the U.S. concern about whether China trade weakens its national security, the
first conclusion is that the notion of national security that is commonly adopted in the
U.S. trade policy debate is ignorant about the primary determinants of U.S. capability in
innovation. By focusing instead mainly on how to hold down China technologically, the
long-run outcome will be a technologically weaker U.S. and hence a more vulnerable U.
S. The second conclusion is that the U.S. must identify a clear, short list of critical
technologies and critical infrastructure for the recently reformed Committee on Foreign
Investment in the United States (CFIUS) to cover, and update this list constantly.
Otherwise, the broad and changing nature of notions about national security would
allow the bureaucratically driven phenomenon of mission-creep to steadily expand the
coverage of the CFIUS process, thereby steadily rendering CFIUS to be operationally
capricious.

 

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