[SCMP Column] Trade and Smiley Faces

April 09, 2018

From “Trade wars are good, and easy to win”, we now have a second, slightly more reflective iteration of Trump’s China trade battle plan – not this time in a Tweet, but in an interview with a New York radio station: “I’m not saying there won’t be a little pain… We might lose a little bit… but we’re going to have a much stronger country when we’re finished.”

It is good to see a little of the hubris gone, but there is every sign that the White House war room – from today joined by John Bolton, a man reputed to be as comfortable advocating real wars as trade ones – is as delusional as ever about the possibility of any happy outcome from a trade war.

As the former Washington Post correspondent Keith Richburg appositely noted in yesterday’s Sunday Post, what we see is “inadequate preparation, unclear goals and no clear exit strategy… Can someone please tell me how this ends?” There seems an almost willful disdain for the idea of defining an end, or what might constitute a “win”.

Trump himself might be forgiven for not having the depth of trade or foreign policy knowledge to recognize this, but he is surrounded by (mostly) men who ought to have deep knowledge, and who ought to be fully aware of how the logic underpinning this brewing trade war is dangerously flawed.

One of the good things to emerge from this White House initiative is a clearer distillation of international complaints about China and its trade and economic development policies. First is the general frustration that promises over trade opening, made when China in 2001 joined the World Trade Organisation, have been frustratingly slow to materialize. There are legitimate complaints over the pace of reform. As China’s domestic market becomes one of the most important in the world, so there is business impatience to win access, and frustration at the barriers still in the way.

Most important, concerns about IP protection, and forced technology transfer are well-founded and need to be addressed. So too do concerns about the scale of subsidies and support for state-owned enterprises (though most economies (including the US) provide generous subsidies to their own “champions”, so people in glass houses should be careful where they throw stones).

But these problems have little to do with tariff barriers, and much more to do with behind-the-border regulatory barriers and an array of policies intended to help domestic champions to develop the maturity and sophistication to compete with massive and well-established multinationals.

No wonder, therefore, that so many in the US business community are applauding the Trump administration for “getting tough” on trade, while attacking Trump for following a tariff-based battle plan focused on bilateral trade deficits that wholly misses the point. They don’t want additional costs imposed on trade. Rather, they want China’s market peeled open.

But to point a finger uniquely at China is disingenuous. The US and the EU have been as reluctant as China to tackle the hundreds of behind-the-border regulations that frustrate international companies’ access to their respective home markets.
Nor, as they play catch-up, has China felt in any way embarrassed by the strategy it has openly pursued. Ever since entering the WTO, they have been made glaringly aware that as “the manufacturer to the world”, their place has been at the lowest-value-adding point in companies’ global production chains.

When Acer’s Stan Shih first drew his production chain “smiley face” (see graphic), it was immediately clear that China’s companies were the assemblers that sat at the lowest point of the chain. It irked them that China’s workers at Foxconn in Dongguan accounted for just US$7 of the US$500+ of an iPhone being sold on US retail shelves.

If Beijing was to lift Chinese workers out of poverty and create a prosperous middle class, they needed to capture higher-value-adding parts of the production chain (see the green zones on the chart). There has since then been a relentless quest to capture better value-adding skills –capturing IP sometimes by illicit means, and ruthlessly squeezing foreign investors to transfer technology.

Theft of IP can never be acceptable, but it is my guess that China will continue to use the seductive potential of its massive market to continue to squeeze technology transfer wherever possible. Irritating but understandable in the ruthless horse-trading of international business.

Of course, slapping tariffs on steel, aluminium or US$50bn-worth of other goods being imported from China will contribute nothing to dismantling such barriers – even if anyone had the foggiest idea what the tariff numbers mean. We understand the US is proposing a 25 per cent tariff targeting Chinese exports worth US$46.2bn – mainly machinery, mechanical appliances and electrical equipment ($34.2bn), transport equipment ($2.7bn) and a grab bag of products like chemicals, base metals and plastics ($8.2bn).

But there are four possible responses to imposition of tariffs: 1. US importers could continue to import, which would leave China’s exporters unaffected, and US companies and consumers having to pay a lot more for inputs and consumer goods. Presumably Trump’s team don’t want that to happen. 2. US importers will import from other sources. This would certainly hurt some Chinese exporters, but exporters in other economies would gain, and the tightening of supply would presumably mean US importers would still pay higher prices. 3. US companies will “on-shore” the work linked with making the imports. With a US economy in full employment quite how such low-value-adding work could be beneficially “on-shored” is a puzzle. 4. US importers, and US consumers will “tighten their belts” and go without. Dream on.

One might guess that Trump’s preferred outcome would be 2. – importing from other sources. But this will simply shift US trade deficits to other economies, and will do nothing to improve US companies’ access to China’s market.
If the true aim of the threatened Trump trade war is to reduce the country’s trade deficit, and get better access to China, then the current strategy achieves precisely nothing.

But I don’t think this is his true strategy. Much more likely, he aims to deliver on long-standing campaign promises that can keep his core loyal through November’s mid-term elections. For this, the bluster alone can count as a 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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