Why the China-U.S. Tariff War Will Fizzle Out

6 Min Read By: Dennis Unkovic

IN BRIEF

  • The economic and political factors influencing the current trade dispute between the United States and China do not favor the United States.
  • China is in a better position than the United States to hold out during a trade war.

This article is adapted from the recent Asia Ascending: Insider Strategies for Competing with the Global Colossus, published by the American Bar Association.


President Trump surprised many observers in August 2017 when he abruptly ordered the Office of the United States Trade Representative (USTR) to initiate an in-depth investigation into China and the need for protecting intellectual property (IP). The USTR confirmed that 40 million jobs in America were at risk because they were, either directly or indirectly, attributable to IP industries. The president utilized section 301 of the Trade Act of 1974 as the tool to target what he viewed as China’s unjustified actions harming certain U.S. industries. Interestingly, the president used section 301 in the same way it had been utilized two decades earlier to target Japanese trade practices.

Six months later, after it was announced that China’s 2017 trade deficit with the United States had exceeded $375 billion, the issue came to a very public boil. The trade deficit with China now dwarfs the size of the trade deficit with Japan during the 1990s. The Trump administration’s reaction to the trade deficit was to impose high tariffs on some Chinese goods with the threat of higher tariffs on a broader range of goods if significant changes were not implemented. As we all know, China retaliated.

Although unlikely to resolve quickly, I predict this high-profile clash—“trade war” may be too strong a label—will fizzle out over time. There are two key factors influencing the current trade dispute between the United States and China: economics and politics.

First, consider the economic factors. Although neither China nor the United States is willing to publicly admit it, both countries are so closely intertwined economically that neither can afford to engage in an all-out trade war without triggering severe fiscal consequences on themselves and the overall global economy. Examining the major components that make up China’s $375 billion deficit with the United States, it appears that $77 billion is comprised of Chinese-made computer sales, and another $70 billion comes from the sale of cell phones assembled in China. Although these electronic products are sourced from China, many are sold throughout the United States under product names that are not necessarily recognized by U.S. consumers as originating in China. Add in over $50 billion in shoes and clothing coming from China, and these three categories alone comprise half of the current Chinese trade deficit with the United States. It is difficult to imagine U.S. consumers willingly sacrificing their computers, mobile phones, and inexpensive clothing in exchange for a lower trade deficit with China. Most U.S. consumers do not care about the trade deficit; it just isn’t important to them in their daily lives. However, it is a fact that prices for these goods will skyrocket, and their availability will become a real challenge, if a trade war continues throughout 2019. From China’s perspective, there is no question that losing the U.S. market for just these three categories of products will leave a vast hole in China’s export capacity and harm Chinese manufacturers.

Now look at it from the standpoint of U.S. exporters. Of the $130 billion of U.S. exports sold to China during the same period, $16 billion was for U.S.-built aircraft; $10 billion was for American automobiles; and another $13 billion was for soybeans. Although the Chinese obviously consider all of these U.S.-made products as important and desirable, none are irreplaceable. Airbus SE, Europe’s Aerospace Consortium, would be delighted to dethrone Boeing as an aircraft supplier to China’s growing aviation market. Automobiles coming from the United States could be easily substituted by Japanese and European models. In addition, China blocked imports of U.S. soybeans in retaliation as the trade dispute escalated (although China has since backed off somewhat and promised to buy U.S. soybeans, but this can still change). In short, although the Chinese would definitely be hurt during the first six to twelve months of an escalating trade war, in the end China can and will find alternative purchasers for its exported products, albeit at lower prices. Without question, U.S. companies now exporting to China and with active Chinese operations will continue to feel pressure from Chinese authorities.

Next, think about the implications of the politics of a trade war between China and the United States. Much of the ongoing trade confrontation depends on the political wills of Donald Trump and Xi Jinping. As I describe in my recent book Asia Ascending, Xi Jinping today is the single most powerful political leader in the world. This is due to the unprecedented power and influence Xi has amassed over China during the last half decade. The best way to understand this is to picture China as a three-legged stool: the first leg is the Communist Party, which makes all policy and governmental decisions; the second leg is the centrally controlled Chinese economy; and the third leg is the immensely influential Chinese military. Few Americans understand or appreciate that Xi Jinping is China’s first leader since Mao to have complete mastery of all three legs of the stool. During the 19th Party Congress, Xi extended his existing term for at least another five years. Even more important, Xi has no identified successor(s), and is thus likely to rule over China for a very long time. So although China would definitely suffer during an extended trade war with the United States, Xi Jinping has the ability to sit back and play a long waiting game until a settlement is negotiated. On the other hand, if President Trump expects to run for re-election in 2020, he can expect to encounter significant criticism and political opposition if the current trade war extends beyond the next six months. The president is under tremendous pressure to arrive at an acceptable accommodation with China as he attempts to solidify his political base for re-election.

The bottom line is that because China is truly such a centrally controlled economy, it is in a better position than the United States (with its current highly politicized atmosphere) to hold out during a trade war. In addition, as the owner of almost 20 percent of the U.S. public debt, China can play the “no longer underwriting” card and begin to sell off its current U.S. debt holdings, which would inevitably drive up interest rates and accelerate a downturn in the U.S. economy.

Without question, China presents many serious challenges to the United States that must be proactively addressed. These challenges include China’s efforts to gain or purchase Western intellectual property by any means possible and China’s ongoing manipulation of its currency to its own benefit. These are problems that must be resolved between China and the United States over time. The United States can and should continue to use sections 301 and 201 of the Trade Act of 1974 as one approach to make China more open; however, an all-out trade war is not the right way—at least for now.

ABOUT THE AUTHOR

Dennis Unkovic

A partner with Meyer, Unkovic & Scott LLP, Unkovic focuses his practice on complex corporate
transactions and foreign direct investment, including M&A, joint ventures and international

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