Since July 2018, the United States has waged a unilateral trade war against China. The current truce and verbal phase-one agreement between the American and Chinese governments, which was announced on 13 December 2019, is not a point of progress, but one that prevents further harm. Both sides have agreed to suspend another tariff hike and intended to partially lift tariffs that have already been imposed on $375 billion worth of Chinese goods and $120 billion worth of U.S. goods respectively. Both sides are aimed at signing the phase-one agreement in January 2020, and China has also verbally agreed to buy more goods from the United States. This time of truce provides a moment of reflection on the reasons for the trade war and whether the trade war has met the United States as well as the Trump administration's objectives.
The trade war is part of President Trump's protectionist "America First" economic campaign. Already before President Trump's inauguration in 2016, successive U.S. administrations had waged a war against the WTO, which has intensified under the Trump administration. As a consequence, WTO's dispute settlement mechanism ceased to operate on 11 December 2019. The "America First" campaign has been a central part of President Trump's 2016 election promise. The goal has been to reduce the country's overall foreign trade deficits and bring manufacturing and jobs back to the United States. On a deeper level, the Trump administration has also attempted to impose fundamental structural changes on China's political and economic system, with some U.S.-China critics ultimately seeking to contain China's development altogether. However, on both levels, the Trump administration has failed. The Trump administration could not reduce the overall trade deficits, revitalize its manufacturing industry, redirect investments away from China and back to the United States, and impose deep structural changes upon China. The American total trade deficits reached $612 billion in 2018 and this situation will not transform much in 2019. Unilateralism, protectionism, and containment strategies cannot cope with the rebalance of the global order, are unable to prevent the rise of China as well as emerging countries, and have had a negative impact on global economic growth and development. There is an urgent need to strengthen cooperation globally, so as to achieve the goal of sustainable development.
Since 1975, the United States has maintained a trade deficits with almost all of its trade partners. Over the past four decades, the United States has imported more products than it has exported. During the same period, on average, the United States also maintained a current account deficits, which means that the country must borrow foreign capital to finance its imports. Such overconsumption and overspending have made the United States the primary engine of global growth as well as the most attractive country for foreign investors. From the 1990s to the beginning of this century, the rise of globalization brought enormous wealth and tremendously increased living standards not only in the United States, but also in many other parts of the world, including Europe and China. In Asia, for example, America's trade deficits with Japan and the Four Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan) had already been large before the U.S.-China trade deficits became prominent. From the 1960s to the 1990s, the Asian Tigers, like Japan, underwent rapid industrialization and maintained high growth rates, eventually becoming high-income developed economies. However, since China's reform and opening-up in 1978, the United States has steadily increased imports from China. As a share of GDP, U.S. imports of Chinese goods rose from 0.2% in 1980 to 2.6% in 2018. During the 1990s and the beginning of the 2000s, China's economic growth increased rapidly, as did its trade surplus with the United States. At present, the United States is China's largest export market, and China is the third largest export market for the United States after Mexico and Canada. China is also the third-largest market for U.S. services, after the United Kingdom and Canada.
In the past, trade deficits were no issue for the United States as long as it maintained its comparative advantage and competitiveness. The division of labor based on comparative advantages has been a cornerstone of modern industrialization and the underlying structure of international trade. In the capitalist pursuit of maximizing profits while minimizing costs, the United States has outsourced manufacturing and assembly to countries with cheap labor forces and less restrictive labor and environmental regulations. Obviously, China and the other late emerging economies became preferred outsourcing destinations for the United States and Western Europe, which instead focused on research, innovation, and high-margin service sectors growth. A key indicator that the United States has followed this strategy relentlessly is its import of intermediate or half-finished goods, which are assembled into finished goods in the United States. Such goods make up 60% of U.S. imports, mainly including electronics, transportation, and machinery parts. However, the import of such parts contracted by 52% during the 2008 financial crisis, after which imports doubled again, highlighting that outsourcing remained unabated, as much did the country's overspending and overconsumption.
At the beginning of its 1978 reform, China increasingly became the assembly center providing the United States and Europe with low-value goods. The West greatly benefited from its outsourcing spree as well as from selling its high-value goods to China's rapidly growing industries and increasingly affluent middle class. In contrast, millions of cheap rural and urban workers became absorbed by China's newly emerging manufacturing economy. As a result, China contributed to human rights like no other countries before by lifting more than 850 million people out of poverty, contributing over 76% to the global poverty reduction (World Bank). Absolute poverty still exists mainly in some of China's western provinces, but China is on its way to fully eradicate poverty by 2020 and thus attaining the first target of the U.N. Sustainable Development Goal ten years ahead of schedule. China has moved up the value chain with fulminant speed. China has become the second largest economy and has provided jobs for 770 million people. China is no longer only the assembly center of the Western world, but directly competes against the United States and Europe in high-technology areas such as 5G, IoT, AI, Robotics, Quantum Computing, and Biosynthetics. China produces the half-finished goods that often go into final productions in the United States and Europe. Structurally, China has already possessed complete supply chains, highly skilled labor forces, modern infrastructures and cities, and a fairly efficient bureaucracy. Since 2013, when President Xi Jinping came to power, China's economy has undergone vigorous reforms against the backdrop of the aftereffects of the 2008 financial crisis caused by the United States, the sluggish growth in Europe due to its fiscal and debt crisis, and a slowing global economy. The Chinese economy has shifted from quantitative to qualitative sustainable growth, and supply-side reforms has been initiated to overhaul the state-owned sector and modernize the financial sector. China began more vigorously to transform from a factor-driven economy to an efficiency and innovation-driven economy, and it is still in the midst of this transformation process. Its total R&D spending is on the path to surpass that of the United States in 2019. China refers to this process and ambition of becoming world science and innovation leader as "Made in China 2025", which the West has denounced as a protectionist domestic industrial policy. In capitalism, however, the transition from a factor-driven to an innovation-driven economy is strategically an inevitable process, because only technology innovation ensures long-term competitiveness and helps to overcome the diminishing returns of a factor-driven or efficiency-driven economy. The West went through similar economic development stages while building its nascent technologies and industries. During the 20th century, technology innovation contributed not only to wealth and dignity, but also to system survival or, in the absence thereof, collapse. The West had largely accepted China's catch-up strategy over the past decades as long as the West could sustain its comparative advantage over China. As China has moved up the value chain and relentlessly focused on innovation and technological independence, however, still without liberalizing its political system, the United States, the European Union, and-for the first time-NATO have labeled China as a "strategic competitor", "systemic rival" and a "challenge" to the Western alliance.
Now, the United States' trade war against China is one of the key symptoms of a historic reconfiguration of global power and rebalancing of global trade relations. The main reason the Trump administration is willing to strike a first-stage trade deal is that many of the objectives of the trade war have not been met, including a return to manufacturing and jobs, a reduction in the trade deficits, and significant changes in China's system. On the contrary, the trade war has not made Beijing surrender to U.S. aggression, but has mainly endangered bilateral trade and put the U.S. economy under pressure, which could jeopardize President Trump's reelection in November 2020. Accordingly, in the first eleven months of 2019, the total trade volume between the U.S. and China fell 15.2% (Reuters) and in the first ten months, the U.S. trade deficits with China dropped 14.6% altogether from $344.8 billion to $294.5 billion year-on-year (US Consensus Bureau). However, the total U.S. trade deficits has roughly remained the same over the same period. Thus, the U.S. deficits with other countries have increased, which compensates for the decline of the deficits with China. Likewise, the manufacturing jobs, which amounts to 8.1% of civilian employment in the U.S., have remained the same since 2016, yet manufacturing activities have contracted and the volume of new orders has reached the lowest level since 2012 (U.S. Institute for Supply Management). Foreign direct investments (FDI) to the United States also help to boost innovation and create jobs. However, the flow of FDIs to the United States has dropped sharply over the past two years, especially the investments from China (OECD).
In addition, U.S. importers and consumers have absorbed the higher prices, since China's exporters tend to maintain prices, either because they cannot offset the tariffs costs or are confident that downstream purchasers cannot or will not accept another product from a different source. As the Trump administration passes the higher costs of Chinese goods to U.S. importers and consumers, U.S. consumers spend additional $600-900 on average per year on goods due to the tariffs. This also includes the effects of tariffs imposed on other regions and countries, such as the European Union and Japan, which have resulted in price increase of around 10-30% for intermediate and finished products. According to the National Foundation for American Policy, all U.S. tariff costs might well exceed the total benefits of all deregulatory efforts carried out by the Trump administration since 2017. If the trend continues, all tariffs costs are estimated to be triple the value of the benefits of all deregulatory efforts. Hence, whatever trade deal the United States negotiates, it will take years for the American economy to compensate for the tariff costs (American Economic Association and National Bureau of Economic Research).
In contrast, China appears to be more resilient against U.S. punitive tariffs, that on average increased from 3.1% to 21%. While the trade surplus with the United States has strongly declined, it remained at a relatively high level. In the first 11 months of 2019, China-U.S. trade totaled RMB 3.4 trillion, down 11.1% year on year, accounting for 11.9% of China's total foreign trade value, and China's trade surplus with the U.S. was RMB 1.88 trillion, down 3%. Although China's imports and exports to the United States have declined significantly, its trade volume to ASEAN countries have increased significantly. There are several explanations for China's resilience and ability to rebalance trade so rapidly. According to the Peterson Institute for International Economics (PIIE), China has increased counter tariffs from 8.0% to 20.7% on $120 billion worth of U.S. goods. To mitigate the negative impacts of higher prices on China's importers and consumers, the Chinese government has cut tariffs on imports from other countries and regions from 8.0% to 6.7% on average. In comparison, the United States has found it much more difficult to find alternative countries from which it can source goods due to China's increased competitiveness and its reliance on China.
In addition, although Washington might have primarily sought to punish China's state-owned sector, 90% of the companies in China impacted by the tariffs are from the private sector, and over 60% are foreign-owned companies—that is, most of them are American and European multinational companies and smaller businesses. Foreign businesses are severely impacted by both Beijing's counter tariffs on U.S. goods and U.S. tariffs on Chinese goods. Two thirds of U.S. imports from China come from foreign-owned companies (PIIE). According to a survey carried out by the European Union Chamber of Commerce in China, large firms have largely been able to side-step the intended impact, while smaller firms must endure the impact by absorbing the costs or passing them on downstream consumers. Only 6% of the surveyed companies responded that they have moved or are in the process of moving productions out of China—mainly to Southeast Asia and India. In contrast, 68% of European businesses have decided to stay in China. Although a rather small number of businesses have shifted investments out of China, roughly the same number are increasing their investments in China, adopting an on-shoring strategy to avoid American tariffs altogether. A survey conducted by the U.S. Chamber of Commerce in Shanghai confirms such conducts, but U.S. firms tend to be more pessimistic and more likely to seek to change their investments in China. Over a quarter of 333 firms, who participated in the survey, have redirected investments originally planned for China to other locations in the past year. Such development suggests that the trade war has not only failed but also overshot its goal. It threatens the business models of large Western multinational companies and severely disrupts global supply chains.
Nevertheless, the trade war has caused psychological damage to Chinese consumers and enterprises' confidence. China was in shock when the Trump administration imposed the first round of tariffs in 2018. Initially, stocks markets in Shanghai and Shenzhen plummeted, but they rebounded fairly quickly. However, business confidence remains pessimistic, and Chinese exporters hit by U.S. tariffs experienced increasing pressure on their profit margins and liquidity despite Beijing's carefully orchestrated countermeasures. However, the effect of the trade war could have been worse without Beijing's long-term structural changes. According to a McKinsey & Company report, China is working to reduce its over-reliance on world exports. In 2018, China's total exports as share of GDP fell to 18.6%, which is significantly below the OECD average of 29%. Structural changes in China's economy, particularly its comparative advantage and increasingly innovative-driven economy, have mitigated the negative impact of the trade war and provided space for negotiation. China's exports could also benefit from the 6.0% depreciation of the RMB. However, it is unlikely that the phase-one agreement will improve confidence and release the pressure on China's economy. According to PIIE, average U.S. tariffs on imports from China will only drop slightly from 21.0% to 19.3%. Even after the agreement is implemented, which is expected to happen in February 2020, U.S. tariffs would still be six times higher than that before the trade war. China is the largest trading country in the world with its trade volume accounting for 11.4% of the global trade volume, and it will continue to be deeply influenced by American unilateralism.
In addition to the trade war and despite of the truce, U.S. continues to rage a war against the international rules-based trade system, especially the WTO. The anti-WTO campaign, which is also directed against China, has already begun before President Trump's election in 2016. WTO members, including the European Union, India, and China, have made proposals to reform the WTO's dispute settlement procedures in the past. However, successive U.S. administrations have refused to engage in any reform. As the United States has continued to block the appointment of the Appellate Body and its judges, the WTO's dispute settlement ceased to be operational on 11 December 2019. The Appellate Body, which is WTO's core function, can still hear new appeals, but it can no longer settle disputes between countries. The Trump administration assumes that the United States will be better off not in a rules-based system, where an international court makes nationally binding decisions, but in a power-based system through which it can impose tariffs and other punitive measures directly if Washington feels unfairly treated. The United States strongly supported the establishment of the WTO in 1995 and, later, China's accession to the WTO in 2001. The United States benefited tremendously from low trade barriers and, thus, easier and cheaper access to other markets as long as the United States could sustain its comparative advantage as an innovation-driven economy. Since China has moved up the value chain, successive U.S. administrations have prioritized filing complaints and, eventually, blocking the WTO's reform and appointment procedures. The United States and the European Union argue that China does not follow the WTO's rules and China's status as a "developing country" is outdated and should be prevented from continuing to protect its domestic economy.
Although the European Union does not agree with the Trump Administration's unilateral and protectionist approach, it still agrees with the criticism raised by the Trump administration. In 2016, China's FDI in Europe reached a record high and had increased over 17 times from 2010 to 2016. This was a symbolic moment and a sign of China's competitiveness and unstoppable rise and the West's relative decline. Since that time, the European Union has increasingly joined the U.S. criticism of China's insufficient reforms concerning issues, such as foreign investment restrictions, state subsidies, the role of state-owned enterprises, intellectual property rights protection and enforcement, public procurement, non-tariff measures and other technical barriers, reciprocal market openness, and the transparency of currency management guidelines. The West has also accused Beijing of failing to implement and enforce previously agreed-upon reforms, especially in relation to China's WTO membership. China lacks an independent judiciary system, which has caused the West to doubt the sustainability, transparency, and robustness of China's reforms. With the support of the public and the media, some political forces in the United States and the European Union claimed that they would no longer believe in China's reform and intention and list China as a "national security threat". As of the end of October 2019, more than 200 Chinese companies and organizations, including Huawei, were on the U.S. Commerce Department's entity list. The European Union has also introduced an EU-wide screening coordination policy to restrict Chinese investments in Europe. These radical approaches clearly ignore China's unique development model, that allows China to make concessions on trade without changing its established path of technological innovation and existing political system.
Today, the WTO's breakup marks the beginning of the decline of the old American-led international order and the rise of Western nationalism, protectionism, and populism. The breakup of the WTO is also an opportunity to deeply reform the international trade order and define an efficient and effective multilateral, rule-based system that gives more weight to the rise of China and the Global South. The new order must balance the demand for growth, digitalization, social cohesion, and stability with the preservation of the environment. This new institution must level the playing field and erode profits derived from anticompetitive practices while encouraging markets and competition. It must find a mechanism to balance national interests and global trade and openness as well as the different stages and speeds of developments. Tariffs must be avoided, and disputes must be brought back to an international dispute settlement mechanism. However, the development of such a new multilateral order will take 10 to 20 years. At the same time, we may slip into a new dark period and need to make a right choice again. This period will likely remain to have persistent high tariffs, along with other forms of protectionism and slow growth of global economy as well as development. This era is less determined by a clash of civilizations than a clash of capitalisms. Still, the pursuit of profit and technological progress remains the most powerful way to increase efficiency and wealth, but the powerful blocs have diverging approaches to dealing with disruptions and defending their interests.
Not only the trade war, but also the fierce competition over technology leadership, the increasing technology nationalism and decoupling, the proliferation of cyber technologies used for espionage, and the low level cyber–physical disruptions, have already undermined the opportunity for international cooperation and governance. On this downward spiral, the United States not only has become the main source of global instability and uncertainty, but also risks becoming isolated and severely compromising its technology leadership. China is not responsible for the behavior of the United States but bears a great responsibility for changing the Western-led global order. China must also demonstrate its ability to cope with periods of low growth and recession, which the country has never experienced since reform and opening up. Europe with its new "geopolitical commission" remains sandwiched between a protectionist United States and an assertive China as it lacks integrity and unity, but Europe is most experienced with the benefits and drawbacks of a multilateral order. China is rising and will turn into the most important game changer for the future global order. But the United States and Europe cannot understand China's rise in the same way. It is hoped that China, the United States and Europe are able to reach the following consensus: to pursue common prosperity, dignity and sustainable development, and work together to build a new multipolar order.
Note: This article is an updated, extended, and revised version of a speech given by Dr. Thorsten Jelinek at the European Parliament during a public debate on 5G and trade.
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