The U.S./China Trade War – Strategy and Consequences
January 16, 2019
Trade allows countries to specialize in industries that are their strengths. For example, country A can specialize in apples while country B specializes in washing machines. Once these countries specialize, they can produce higher quality products at lower prices and then sell those products to consumers of other countries. In our case, country A would sell its apples to country B. For the United States, which is the world’s largest trading nation with nearly 2.3 trillion in exports in 2013, the specialization dynamic has resulted in faster economic growth, job growth, and higher living standards.
Trade agreements are deals to reduce or remove barriers to trade: reduced tariffs (taxes only applied to imports) and improved opportunities for businesses to sell their goods and services overseas. Other aspects to trade deals include deciding which domestic regulations apply to foreign firms, removing barriers enacted against foreign firms, copyright protection, and the rights of labor. For example, the European Union enforces a domestic regulation against genetically modified foods from foreign farms and agricultural companies. As of now, the U.S. and China have no formal trade agreement.
Although on a whole trade may benefit an economy, individuals do lose in trade agreements and firms face competitive challenges. For example, some individuals could lose employment if their industry or firm’s business is outsourced. To illustrate with the previous example, apple farmers in country B will be hurt by the influx of apples from country A, even if the citizens of country B are better off because of cheaper apples. Another criticism is that trade agreements could lead to the lowest common denominator of consumer protection, public health, and environmental standards that ultimately harms consumers in the long run. Consequently, nations adopt different strategies to address some of trade’s shortcomings.
Such strategies may include utilizing protectionism and the World Trade Organization (WTO). Protectionism represents government policies that restrict international trade with the intent of protecting local businesses and jobs from foreign competition. Protectionism is one aspect of the United States’ current renegotiation of existing trade deals globally, but it too has negative consequences. For instance, if the government protects washing machine manufacturers in country B, consumers on a whole pay more for washing machines than they would from country B, resulting in a lower standard of living. Another method is to rely on international trade organizations like the WTO to solve international disputes. The WTO is an organization created to enforce internationally agreed upon trade standards. To enforce these agreements, the WTO retains the power to adjudicate trade disputes. For example, if country B felt that country A was utilizing unfair practices in apple production, they would bring that dispute to the WTO. Since 1995, the number of trade disputes has decreased dramatically. Recently, the United States has tried to use both protectionism and the WTO to address its issues with the current trading system.
A Brief Timeline of the U.S./China relationship and Trade War
The modern U.S.-China relationship began with President Nixon’s visit to China in 1972 where he met Chairman Mao and began establishing improved U.S.-Sino relations. The process that President Nixon started, culminated in the U.S.-China Relations Act of 2000, which normalized trade relations between the two countries and allowed China to join the WTO in 2001. China became the U.S.’s third largest trading partner soon after, and the U.S.’s trade deficit with China peaked at $295.5 billion in 2011. Recently, there are trade tensions between the rest of the world and China, as exemplified by a joint complaint filed by the European Union, the U.S., and Japan against Chinese trade practices in 2011, during the Obama administration.
In 2018, trade tensions escalated dramatically as the Trump administration imposed tariffs on Chinese imports, starting with a worldwide tariff on steel and aluminum, and later high tech Chinese products. The Chinese responded in kind with tariffs on U.S. agricultural products. The U.S. complained to the WTO about Chinese intellectual property theft and later promised to tax all remaining Chinese imports unless a deal that would make the U.S.-Chinese trade relationship more favorable was reached. This would extend tariffs on another $250 billion worth of Chinese imports. President Trump and President Xi met at the G20 summit in Argentina at the end of November 2018 to resume trade negotiations.
U.S. Strategy and the Chinese Response
The President claims that he is trying to bring manufacturing jobs to the U.S. by initiating and escalating a trade war. While manufacturing jobs have been decreasing, real output from manufacturing has been increasing, and U.S. factories have been gradually replacing human labor with robots.
Most of the job losses in manufacturing are due to the replacement of human labor with robots. Therefore, the trade war may not have its intended effect.
Alternatively, the U.S. may be seeking to make itself less reliant on the Chinese economy and to reset the trade relationship between China and the rest of the world. Vice President Pence himself said in a recent policy speech about China that “the U.S. is seeking a relationship grounded in fairness, reciprocity, and respect for sovereignty” and is taking swift action to achieve that goal. The Chinese trade practices that the U.S. characterizes as unfair are as follows: forcing American companies to disclose detailed information about their manufacturing processes and products to obtain licenses (leaving them susceptible to intellectual property theft), censoring companies in certain industries like movie production or internet media, forcing companies in some industries to form joint ventures with local partners where the local partner owns the majority stake in the business (i.e., automobile manufacturing, stockbroking), and manipulating currency by keeping the Chinese yuan at an artificially low valuation (lower currency value boosts exports because foreign citizens can convert more of their home currency into Chinese currency to buy more Chinese goods).
The trade war and trade renegotiation may be an attempt to gain leverage, ultimately forcing China to allow American companies more freedom to sell their goods without having their technology stolen. It is no coincidence that the latest trade deal signed by the United States, the United States-Mexico-Canada Agreement (USMCA) which is a renegotiation of NAFTA, includes a section nicknamed “The Trump Veto” (Clause 32 Section 10). This section allows signatories to pull out of the USMCA if one of the countries pursues a separate free trade agreement with a “nonmarket country.” Essentially, this is a thinly veiled warning against the signing of any side deal by Mexico and Canada with China. The U.S. is concerned that other nations trading with China could undermine the effectiveness of U.S. tariffs by offering the Chinese an alternative to U.S. goods and services. Senior White House economic advisor Larry Kudlow has said that the USMCA is a blueprint for future trade deals, including ones that the U.S. is currently negotiating with Japan and the European Union. The United States is building a global coalition and gaining leverage to force China to change its trade practices.
Despite U.S. efforts, the trade deficit with China has increased since the trade war began to $305 billion this year up from $276.6 billion last year. China has options at its disposal to minimize the effects of U.S. tariffs. One of these options is to become more self-reliant. Recently, President Xi Jinping called on the Chinese people to make a concerted effort to focus on creating cutting-edge technologies in industries subject to other countries’ control like artificial intelligence. His initiative, entitled “Made in China 2025”, is meant to try and position China for a rapidly changing technological landscape and protect China from the whims of outside economies like the United States. Another option is to source materials that the U.S. supplies from other countries that are not joining the U.S. coalition anytime soon. This has been China’s main strategy to replace U.S. agricultural imports like soybeans. Lastly, China is being strategic with its retaliatory tariffs, targeting industries in states which President Trump won in 2016, making it more politically difficult for the President to continue his trade war. According to Vice President Pence, “The tariffs imposed by China to date specifically targeted industries and states that would play an important role in the 2018 election.” The eventual effectiveness of these various strategies is unclear.
An Industry Case Study: Agriculture
No industry has been targeted more for retaliation than the agricultural industry. That is no coincidence. Much of the U.S. agricultural industry is in areas that happened to vote Republican and two thirds of U.S. agriculture exports are to nations that are engaging the U.S. is in trade talks or disputes.
China accounts for more than half of U.S. soybean exports in value. To retaliate against U.S. tariffs, China instituted a 25% tariff on U.S. soybeans earlier this year, making it almost impossible for U.S. farmers to compete in the Chinese market. As a result, U.S. exports of soybeans to China have almost stopped entirely, decreasing commodity prices to decade lows.
The same story is true for other agricultural commodities including pork (one in four hogs is sold to the export market), sorghum, and lobsters. U.S. net farm income will fall to $65.7 billion this year, down 47% from just five years ago.
In response, the U.S. government has enacted a $12 billion aid package, with $3.6 billion dedicated to soybean farmers. The financial aid is merely temporary though, and if the trade war lasts longer or the trading relationship with China is fundamentally altered, U.S. farmers will need a more permanent solution.
One idea from the industry itself is to build new agricultural export markets. As an example, some U.S. soybean farmers are trying to secure Sri Lankan buyers. Unfortunately, building these types of relationships takes time and much effort will be required to aggregate the markets it would take to replace China fully. For context, the U.S. would need 11,000 markets the size of Sri Lanka to replace Chinese soybean purchases. The enormity of the task of replacing the Chinese market has not stopped the U.S. from organizing more trade trips than ever.
Does the loss of U.S. agricultural exports hurt China? The answer is unclear. On one hand, there is a growing belief within China, the world’s largest pork consumer, that it can wean itself of U.S. soybean exports (which are primarily used in animal feed) and achieve more agricultural independence. This can be accomplished by reducing the soy ration for hogs from 20% of their feed to 12% of their feed, the international standard. Additionally, China is diversifying its sources of agricultural inputs, buying more from Brazil and Argentina, which at this point have not joined the U.S. coalition against China.
On the other hand, crop yields in China have historically been lower than the U.S. for a variety of structural reasons that will take time to alter. A combination of a lack of approval of GMO crops in China and Chinese farms being on average two acres instead of 200 like the U.S. has limited Chinese agricultural production. Additionally, Chinese farmers not being allowed to own the land where they farm, poorer climate conditions, and most importantly, the fact that China, despite being about as large as the U.S., has only half of the arable land that the U.S. does, will make it hard for China to achieve agricultural independence.
Trade in its ideal form is meant to bring greater economic prosperity and increased standards of living to all nations. However, that does not mean that trade and trade deals have no shortcomings. Although the U.S. and China have developed a strong economic relationship over the past 40 years, an attempt to change Chinese trade practices has resulted in a trade war that will continue to hurt each country in the short run, especially the U.S. agricultural industry. As of now, no resolution is in sight, and if one is not reached, the war will just continue to escalate.
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