Is the US Ready for a Trade War?

WASHINGTON: A trade war between the United States and China may help resolve their deep differences, but the fight won’t be easy. Trade wars are hard to start, end or win. Winning requires smarts, not bravado. If the Trump administration proceeds without adequate preparation, the United States and the global economy may be far worse off than if nothing had been done.

There is no doubt that China plays unfair, damaging itself and its trading partners with discriminatory policies and growing ambitions to dominate advanced technologies. Given the nation’s size, a distorted Chinese economy means a distorted global economy. The tumult China has caused by overproduction in steel, aluminum and solar industries could well be repeated in electric cars, semiconductors and a host of other sectors.

The Trans-Pacific Partnership’s rules on intellectual property, investment, the digital economy and state-owned enterprises, abandoned by Trump, could have been an excellent tool to constrain Chinese industrial policy, but that may not have been enough to discipline a Xi-led China, the world’s most enticing domestic market with growing capabilities, deep financial pockets and reduced concern about Western approbation. Perhaps the only way to move China may be to forcefully push – and punish – with unilateral measures.

This appears to be President Donald Trump’s conclusion. He wants a fight. Hence, his announcement that the United States will adopt tariffs of 25 percent and 10 percent on steel and aluminum, respectively. While China isn’t the only target, it is the central concern. The US “Section 301” investigation into Chinese intellectual property rights abuses could result in a wider range of actions, potentially including tariffs, limits on direct investment, expanded export controls and visa restrictions.

Trump has drawn fierce domestic criticism, with some opposing unilateral measures out of free-market principles. Others, mainly in industry, disagree not because their businesses are harmed by Chinese policies, but because they benefit from Chinese subsidies. Another camp raises concerns about how a trade war might be fought.

The United States is woefully unprepared in five ways.

First, the administration has not decided what it wants. Perhaps because it doesn’t want to set out a finite list that the Chinese will negotiate down and meet one-tenth of the way. The reticence highlights that US concerns are systemic and structural, not about any single sector or policy. Yet remaining silent creates two problems.

One is that there is zero precedent for China making concessions without being given a clear idea of what is demanded. China will not “connect the dots” on its own. It needs precise instructions. To avoid minimal concessions by China, these “asks” should be halfway between meta issues like “become a free-market economy” and highly specific targets like “open electronic payment services.” In between are asks such as “eliminate ownership caps for foreign investors” and “reduce all industrial-good tariffs to the OECD average.” Put another way, the United States should make carefully considered proposals so that negotiations do not start with China’s most limited offer meant to reinforce business as usual.

The other problem is that the administration lacks its own internal consensus on what it wants. A fundamental choice the administration must make is whether it is more interested in reducing the bilateral trade deficit or liberalizing China’s economic system. This is a choice because it is entirely possible that a more open China will attract more foreign investment, resulting in more exports to the United States and a larger bilateral deficit.

Second, the administration may have a misguided view of its opponent. The administration appears to have sized up China this way: The economy looks stable now, but it has deep-seated problems that would become more apparent if a trade war erupts; Chinese leaders are highly risk averse, willing to pay a high price to avoid potential economic and political instability, and China’s President Xi Jinping is strong enough to force any market-opening concessions through his system. The bottom line: Some in the administration expect little Chinese retaliation in any significant way and China could raise the white flag soon after the shooting starts, if not before.

That’s a highly debatable proposition. Yes, China’s economy has substantial weaknesses and a meltdown isn’t an impossibility, but Beijing is in the midst of a major financial crackdown addressing the biggest risks. China has many shock absorbers, such as its high savings rate, and its economy has a bevy of bright prospects in many sectors. Xi probably could impose substantial costs on state-owned enterprises, banks and local governments and is more willing to take chances than any Chinese leader since Mao, but he does not want to do so under threat from the United States. It’s entirely possible that Xi is willing to push the envelope and engage in a back-and-forth tête-à-tête with Washington.

Third, the administration has not sufficiently taken care of details or prepared for various scenarios. A trade war creates new losers not only abroad, but at home. The United States must prepare to respond to these reactions. Two examples make the point. Raised tariffs on steel and aluminum will likely lead to higher prices not only for soup cans, as noted by Commerce Secretary Wilbur Ross, but for cars and manufacturing equipment. The administration needs to prepare compensatory benefits for downstream sectors and consumers. And if as a result of the Section 301 case the United States limits Chinese investment and the constraints apply retroactively to businesses already in operation, foreign companies, their American customers and both sides’ lawyers could go into federal court, seeking a stay of the president’s order that blocks them from fulfilling existing contractual obligations.

Fourth, the administration has not prepared Americans for potential sacrifices of a prolonged fight. Business and labor could suffer, and the administration needs to persuade them that the pain, kept to a minimum, will be worthwhile in the end. The stock market could wobble a lot more, generating a larger backlash. Lining up domestic troops is smart politically and diplomatically, signaling that the United States has sufficient staying power.

Fifth, the administration goes into this battle with few allies. Despite the huge US market, the country cannot pursue this cause alone. With no help, China can find other sources for raw materials and technology, and redirect exports to other markets and expand domestic consumption. Western Europe, Japan, South Korea, ASEAN, India and others have felt the sting of Chinese discrimination and could offer support, pledging to adopt parallel measures and work with the United States at the World Trade Organization. But aside from a reassuring statement at the WTO ministerial in Buenos Aires, others have limited their criticisms of China. There’s a simple reason: The administration appears to be doing everything it can to alienate allies: withdrawing from TPP, foot-dragging at the WTO and questioning its utility, reopening KORUS, threatening to withdraw from NAFTA, pushing Japan to negotiate a bilateral agreement, and now announcing steel and aluminum tariffs that will bring far more pain on US friends than on China.

In short, it appears this administration’s trade-war motto is, “Aim, fire…and never ready.” In 1993, the United States conditioned most-favored nation trading status on improvement in China’s human rights situation. A year later, China called President Bill Clinton’s bluff. Folding, he extended the status. Since then the United States has not effectively advocated for human rights in China beyond individual cases. If the administration bungles this trade war and is forced to back down, China will have an open road and be much harder to rein in. The United States may find it better to avoid this path and hold fire for another day when the country is better prepared for what will surely be a monumental contest.