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America’s coming Trade War is based on a Misunderstanding of both China and Economics

Keyu Jin - 6th April 2017
America’s coming Trade War is based on a Misunderstanding of both China and Econ

The Chinese government is bracing for uncertainty under US President Donald Trump’s administration, and are even preparing for the possibility of a diplomatic collision ahead. Like the rest of the world, China is yet to find out which aspect of Trump’s policies – the good, the bad or the ugly – will materialize.

A much-dreaded trade war with China will inevitably be devastating for both sides. If China stops buying Boeings, 180,000 American jobs could be lost. An embargo of soybeans could lead to the loss of 10% of local jobs in Mississippi and Missouri. And reducing demand for business services could cost hundreds of thousands more jobs across the country. A full-on trade war might even push the US into a recession after a few years.

As dangerous as trade wars and protectionism promise to be, the political debates leading up to them are, ironically, misguided.

Misconceptions about China

Take, for example, the accusations that China has been undervaluing its currency. They in fact come at a time when the government is desperately attempting to avoid a currency freefall.

They also come at the same time that many other governments are actively pursuing policies to manage their exchange rates. And very soon, when the dollar appreciates, US President Donald Trump will find himself having to talk down the dollar.

The misconceptions don’t stop there.

One of the main points of contention for Trump and his administration is the so-called US-China bilateral trade deficit, which stood at $347 billion in 2016. But much of this exasperation is based on an outdated accounting procedure – measurements of trade flows that no longer accurately capture the income and jobs that are actually tied to trade.

The reason is that, today, 80% of trade is supply-chain trade. Technology and a reduction in trade costs have allowed countries to geographically splinter their production line, allowing intermediate goods to be produced in different parts of the world. Globalization’s unbundling and the intricate networks of production have made calculations of trade flows more complicated.

Take the iPhone as an example. Out of the $100 value of an iPhone exported from China to the US, only $4 is value added in China (the amount that is linked to income and jobs that are accrued to China). The rest of it is value added from intermediate products coming from other countries like Japan, Korea – and the US.

When measured based on the more accurate value-added method, the US-China trade deficit Trump is so angry about shrinks by at least 35%. The growing trade deficit is therefore partly a reflection of the fragmentation of production and trade.

Another misconception is that Chinese imports to the US are undermining American producers and taking their jobs. Actually, China is in large part simply replacing the role previously filled by Japan.

In fact, if you take the share of US imports coming from Asia and the Pacific Rim in 2015 and compare it to the share in 1990, you’d see that the numbers have barely changed. What did change was that China displaced other Asian countries – notably Japan – and took on their role of leading manufacturing exporter. Soon enough, the baton will be passed onto Vietnam and Bangladesh, and the debate will cool off, just as it has done about Japan.

Let’s talk about the positives

What is under-appreciated – or perhaps conveniently ignored – is the enormous good Chinese exports have brought to advanced economies.

For example, Chinese exports have helped reduce global manufacturing prices, and in doing so have helped the less wealthy disproportionately more. They gave low-income households access to toys, apparel, and furniture at affordable prices. Thus, the ‘China shock’ has helped to reduce real income inequality in advanced economies.

By that same logic, a trade war with China would hurt the poor the most. The very blue-collar workers that supported Trump’s ascendance are precisely those who would feel the pinch from a Chinese trade war.

Another area where Chinese imports have provided a boost to the West is, perhaps surprisingly, in innovation. Faced with stiff competition from Chinese imports, many companies were forced to adopt new technologies, find new niches, and to innovate. Those that did not went out of business.

There are many anecdotal examples of firms’ creative responses to the Chinese threat. Take Massai Barefoot Technology, a shoe company that instead of competing head-on with Chinese shoe manufacturing, decided to make “posture-correcting” shoes that emulated the effect of “walking on grass”. The company went on to file a patent and became a success story of innovation in highly customized designs.

Before the “China spectre” emerged, companies were comfortable producing the same old goods without much incentive (or need) to innovate. The period in which Chinese manufacturing goods flooded the shores of European markets coincided with a period of unusually rapid growth in patents. Both the direct stimulation on European innovation and the forced exodus of low-tech and low-innovating companies both contributed to the rise in productivity in advanced economies. Chinese imports are to thank for more than 15% of the increase in production experienced by advanced economies – which amounts to a transfer of €10 billion a year.

Trading with China is therefore not all bad news. But this does not mean there are no thorny issues still to be tackled.

From trade war to world war

Undoubtedly, the Chinese spectre remains a controversial one. Cases of intellectual property infringement and cyber hacking, along with examples of government subsidies to support state-owned enterprises do not jibe well with the current ethos of the world economic order.

But keeping China down by freezing it out of the global trading system would be the wrong response. The current US administration believes in imposing export subsidies, slapping on high tariffs, and labelling China a currency manipulator. But this kind of policy only delays restructuring and adaptation. It favours lobbying rather than investing for innovation.

The US-China bilateral relationship is the most important one in the global arena. And yet it currently has a whiff of what Graham Allison calls the “Thucydides trap” – a metaphor he uses to describe the dangers of contests between a ruling power and a rising power. We all know what happened when Sparta collided with Athens, or, more recently, when Germany challenged Britain’s dominance. Neither of those situations ended well.

Throughout history, we’ve seen 18 similar scenarios unfold. 12 of them resulted in war. To avoid history repeating itself, there needs to be a large adjustment in the mentality and attitude of both the challenger and the challenged.

We need a collaborative mentality

The current rhetoric and protectionist tendencies are dangerous and even borderline absurd because they are founded on false assumptions and bigoted conclusions. We may have misgivings about China, but the rising spectre on the global stage is not China itself – it’s the trumped-up stories surrounding it.

So rather than trying to keep China down – a catastrophic strategy – the goal should be to align its interests with the rest of the world’s. This calls for a collaborative mentality – precisely what globalization at its best is about.

 

 

Keyu Jin is a professor of economics at the London School of Economics. She is a World Economic Forum Young Global Leader and a member of the Richemont Group Advisory Board. This post first appeared on the Agenda blog.

Photo credit: Foter.com