The US’ Trade War Fallacy: Washington Must Now Live With New Reality – Analysis

The current trade war between the US and China is a fallacy. There is no trade war going on here. A real trade war exists when a country tries to protect its industries by placing tariff barriers on the import of cheaper goods from foreign countries, or provides subsidies to local manufacturers to artificially lower production costs in order to compete with imported products. Trade wars are about protectionism. These rounds of tariffs on goods from China are not protecting any US industries.

In the current case many of the goods imported into the US are made by US corporations in China. Of the US$539 billion exports from China to the United States, a substantial portion is from US companies shipping inputs for assembly in China. Another 20 percent are OEM products produced for US corporations. The tariffs are not paid by China. They are either absorbed by US corporations, which reduces profits, or passed onto consumers who pay higher prices for goods, which adds to inflation.

According to estimates made by JP Morgan Chase, the tariffs will cost the average American family around US$1,000 per year. This is expected to deeply dampen Christmas spending. The major US retailer Macy’s share value dropped by 13 percent late last week. Share prices of other US retailers also fell.

The only thing that will hurt China is a reduction in demand for goods bound to the US, thus reducing some employment. However, China is reducing the value of its currency, the yuan, to compensate for the new tariffs.

Trump’s tariffs may put pressure on companies exporting to the US from China to relocate to third countries. This is something that has been already happening due to rising Chinese labor rates. This could be seen as Trump’s “scorched Earth” move. If the US can’t produce the goods destined to the United States, China shouldn’t produce those goods. The motives of Trump’s advisers should be questioned on this.

The consequence of continuing this action is more retaliation from China, a drop in worldwide aggregate demand and a recession which will hurt the United States, corporations and everyone else. Some already see the signs of the US slipping into recession with bond markets giving warnings.

It was the US Corporations that moved to China

Between 1990 and 2017 US corporations invested more than US$250 billion into China. Initial investments didn’t go that smoothly. Chinese authorities later eased the processes required for foreign investors, opened special economic zones and partly opened the domestic market, bringing US corporations in droves. US corporations moved to China for lower labor and operational costs and manufacture under less stringent regulatory regimes, increasing corporate profits immensely.

There was also the expectation that US companies would be able to enter the quickly-growing Chinese domestic market, as demand in the US has already matured.

As a result, manufacturing jobs dried up in the US. The promise of better jobs didn’t materialize. Only low-paid menial service, warehouse and retail jobs became available, which had absolutely no career paths. Those jobs were for the lucky ones, as many became unemployed. The middle class began to shrink, as did purchasing power and the tax base. Eventually a trade imbalance between China and the US occurred, partly brought about by US products, which now became imports.

Corporations made higher profits for their shareholders at the cost of a loyal workforce that became redundant. A generation of manufacturing skills was just discarded, along with cities and towns that once housed the manufacturing facilities of these corporations. Many of these factories became warehouses and condominiums, ironically bought up by Chinese, which inflated the housing market.

After more than 30 years of capital and production capacity flight, China is now a manufacturing economy and the US is not. US manufacturing has declined to around 11.5 percent of GDP against  40 percent post WWII.

A general economic lull in the United States existed before the last election, which helped give Trump the support base he needed to win the presidency. However, the tariffs may affect parts of this support base as the extra costs to consumers are felt.

China owes its faster-than-expected rise as an industrial power to the transfer of jobs, capital, technology, and business know-how from the United States.

The brands grab

Like Japan and Germany after WWII, China learned how to develop its economy through gathering technology and buying up well known established companies and brands around the world including Iconic brands like General Electric (appliances), Hoover, Motorola, MG, Pirelli, Sunseeker, Rotary, Superdrug, Ingram Micro, Wiko, Dirt Devil, Miss Sixty, Sandro, Tommee Tippee and Vax. China then went on to create its own companies, technologies and brands including Huawei, Oppo, Alibaba, Haier, Xiaomi, Geely, and Chery. The number of Chinese companies today on the 2019 Fortune Global 500 list equals those in the US. Chinese companies now have their own global brands which are challenging traditional company and brand leaders.

Branding is not just restricted to corporations. China launched the Asian Infrastructure Investment Bank (AIIB), that operates within the same domain of the World Bank and Asian Development Bank. More than 100 countries have applied for membership in AIIB, although boycotted by the United States.

Perhaps China’s most ambitious brand encapsulating what General Secretary Xi Jinping calls the Chinese dream to recreate the ancient Silk Road trade routes into a logistical trade and supply chain is the Belt and Road Initiative. The prime intent behind the project is to create a global trade and supply network that will enhance relationships with other countries and regions. Theoretically this would reduce the dominance of the United States in trade relationships, tipping influence more towards China.

After Obama’s Asian Pivot, Trump’s meandering Asian foreign policy is a bonus for China, especially with Trump early in his Presidency abandoning the Trans-Pacific Partnership. However, China has faced setbacks with logistical problems in rolling out the BRI over so many countries at once. Many media outlets have put out disinformation and highlighted Chinese mishaps in BRI development and rollouts.

The real problem

The problem isn’t China. Trump didn’t cause it either. He inherited the problem from successive presidential administrations. The problem was caused by the corporations which abandoned US production, and workers who were also their customers, lured by the promise of lower costs, higher profits and entry into the Chinese market.

Trump was elected to save and create jobs. To his constituency, ‘make America great again’ is about reacquiring traditional manufacturing jobs. However, corporations are blocked from returning from manufacturing offshore because of the high profits they are making and higher production costs they would incur if the company returned to US production. The levels of profits the corporations now enjoy can’t be made manufacturing in the United States.

Bringing back the corporations

Trump recently called on US corporations to leave China. He does have executive powers to force them, but this would be politically untenable. Working through a multi-layered constitutional democracy such as the United States would almost be impossible to garner strong and committed bi-partisan support to bring the corporations back.

Even if US corporations returned, the financial costs would be high. Companies would have to rebuild manufacturing facilities, recreate supply networks where local suppliers may no longer exist, and regenerate the community environments to house their workforce.

This would be one of the most ambitious projects the United States has engaged in, something along the mammoth scale of China’s Belt and Road Initiative. Extensive city re-planning would be necessary. Infrastructure built. Communities re-nurtured. The US Government would most certainly have to adopt a regime of incentives something akin to what South East Asian Governments are giving investors, something unprecedented in the US. This would most likely need to be accompanied with a tax scheme where companies manufacturing in the US would pay a lower tax than companies importing their products to factor in differential labor costs.

Has the horse already bolted?

This is the reality the United States must now live with. Now the US must learn how to accommodate China diplomatically and economically, completely outside the military paradigm. Unlike the Cold War, which was about military supremacy, this one is about trade. Although there are some real issues like IP that need to be sorted out between China and the US, economic relations with China must be based on the reality of mutual co-existence and avenues of cooperation. This would be a complete reversal in US policy thinking.

However, despite all the US rhetoric, American corporations are still investing in China. In fact, US corporations have gone far beyond just setting up factories to export back to the United States. They are heavily involved in distributing products within China’s domestic market, and investing in other sectors like fast food, leisure, and equities. A so-called trade war with a nation that the US have heavy investments in is nonsensical. There is the potential that US firms could be hurt in China. The interdependency between the Chinese and US economies needs to be recognized and reflected in policy.

Originally published in the Asia Sentinel