[SCMP Column] Winning trade wars or winning elections

March 26, 2018

What a fascinating “Trump Trade War” discussion hosted by Bloomberg last Friday. So much alarm. So much consensus. So many unanswered questions. All dominated by the haunting and reckless naivity of Trump’s mantra: “Trade wars are good, and they are easy to win.”

Most of the discussion focused on the universal recognition that trade wars are NOT good, and that there is no precedent for them being easy to win, in the absence of overwhelming military force.

There are so many reasons why this particular trade war is not good – and that the US warriors’ guns are pointing at quite the wrong targets – that it is easy to imagine many bad outcomes. Trump’s first foray, involving steel and aluminium, provided a marvellous illustration when it became clear from the outrage from Europe, Canada, Japan and South Korea that China was an inconsequential exporter of steel products to the US. Even Taiwan and Vietnam sell more steel to the US than China does – thanks to barriers long in place in the US against Chinese steel.

Many troubling insights arose from the Bloomberg discussion. There was agreement that there is legitimate concern about China’s efforts to cull intellectual property, and about a minefield of local regulations that raise practical barriers for foreign companies wanting to do profitable business inside the increasingly important Chinese domestic consumer market (China’s GDP grew by more than US$770bn last year – more than the dollar value of economic growth in Europe and the US combined).

But there was also agreement that a tariff war targeting “old economy” exports like steel, shoes, toys or garments would do nothing to tackle these barriers. Wrong guns, pointed in the wrong direction. Back in 2005, when exports accounted for 35 per cent of China’s GDP, a tariff war might have concentrated Beijing’s mind. But today, with most growth being driven by the domestic consumer market, and exports down to 18 per cent of GDP, leverage has been lost.

But here arises an important – and so far unexplored – point: more than a decade ago, Beijing realised that much of its export processing economy, employing millions of mainly migrant workers, was actually immiserating China, not enriching it. An ADB Institute study of the iPhone provided shocking insight: for an iPhone costing (then) US$500 on a retail shelf in the US, the export value to China as iPhones left the Foxconn factory in Dongguan and passed Chinese customs bound for the US was just US$179. Worse, most of this $179 was made up of components imported just weeks earlier from Japan, South Korea, Malaysia, and the US. The value being captured inside China – mostly an assembly fee – was US$7.

So you have the US saying China is exporting goods worth US$179 (at one point iPhones accounted for an estimated 8 per cent of China’s exports to the US), but China feeling benefit of just $7 – shared between a Taiwanese company and migrant workers being paid poverty wages.

And iPhones were just one example. When Beijing officials realised that much of China’s export processing economy worked this way they determined two things: build skills so we can move up the production value chain; and start to capture some of the IP-protected “brand value” that captured so much of the gap between the US$179 the iPhone’s export price and its $500 retail price.

Come back to the current simmering trade war, and some things become obvious: what the US sees as IP to be protected, China sees as a more profitable part of the production value chain where they want to build a bigger presence; if Trump targets such exports, he is targeting export processing chains that work mainly to the advantage of US companies (like Apple) that still successfully keep most of the value in an iPhone inside the US.

Having learned these value chain lessons, Beijing has worked hard to bring more of the high-value-adding parts of value chains into China, and to build high-tech industries in which it can establish a globally competitive position. China has successfully done this in areas like high-speed trains (CRRC), digital telecoms networks (Huawei), drones (DJI) and high-tech batteries (BYD). Trump’s team is not wrong to be worried about China’s competitive emergence here, and to target these new-tech sectors in the latest trade war sortie.

But here’s the problem: China exports almost none of these new-tech products to the US, making US tariff threats meaningless. Rather, they go to developing economy markets – many embraced by the Belt and Road initiative – where China has succeeded in building a high-tech, high-value brand reputation.

As Trump’s team will quickly learn, the challenge of finding China’s pain points is bigger than expected: for a decade China’s priority has been to base growth on the domestic consumer economy and reduce reliance on the low-value-adding export processing industries (many of which are US- or Hong Kong-owned and concentrated in the Pearl River Delta); and most of China’s exports comprise inputs from dozens of economies dispersed across the region. Hurt a China export, and you hurt exporters from economies across the region – including back in the US.

By contrast, Beijing may find US exporters easier to target without the danger of “collateral damage” on the region’s other exporters. Whether it is soya, beef, almonds or Boeing aircraft, a large majority of the value in such exports is captured by, and stays in, the US. Tariff pain would be acute, and felt fast.

With so much obvious likely pain at home, and such clear difficulties in achieving targeted objectives versus China, you have to come back to Trump’s preposterous claim that trade wars are good and easy to win, and ask a different question: How will Trump measure a win?

My answer is simple. He is focused not on trade or even China, but on mid-term elections, and keeping a Republican majority in Senate and Congress. As with his tax bill, Trump is delivering on a fundamental promise to his “core”. Little of the pain arising from a China trade war will be felt until 2019. Meanwhile, he has an election to win.
David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view. Opinions expressed are entirely his own.

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