Why China should walk away from a trade war, and toss the US some concessions while it’s at it
Andy Xie says while China can afford a trade war and Donald Trump cannot, China’s new global role calls for a more magnanimous posture, which could include opening up its markets further
The trade war, or rather the simulation of it, between the United States and China is escalating. In response to Donald Trump’s proposal to subject US$50 billion worth of Chinese goods to tariffs on April 3, China responded with similar tariffs on US$50 billion in American imports. Trump is raising the stakes again by considering another US$100 billion in Chinese imports.
Nothing concrete is happening yet. What’s going on is like two fighters in a kung-fu novel talking about how they would hurt each other: “I put a knife in your arm, you put an ice-pick in my thigh; I punch your tummy, you kick my crotch.” Maybe the purpose is to decide who gets what without a fight. That would be efficient.
It’s how negotiations should proceed. Both parties should bluff all the way to the end, become fully aware of each other’s cards and reach a deal at the last minute. It’s crazy to shoot at each other just for the sake of it. China and the US shouldn’t go down in a hail of bullets like two alpha males in a Hollywood film.
Trump would be insane not to negotiate. In a trade war, the US stock market would plunge 50 per cent and Trump’s rural support would evaporate. The Republican Party would lose the midterm election and the Democrats would have a hold on Trump afterwards. While Trump often behaves like a madman, he isn’t one. He has hired hordes of lawyers to get through the sticky stuff all his life. His talk of further tariffs is probably a bluff.
In the long term, China needs trade more than the US and, hence, should do more to ease tensions. But, in the short term, China is in a much better position to withstand a trade downturn and a stock market collapse, having distanced the labour market from corporate profitability and consumption from the stock market. If global trade declines by 20 per cent, the average Chinese wouldn’t feel the pinch. But both the wealthy and the working class in the US would suffer. After nursing an asset bubble for 10 years, a trade war would send the US’ wealthy back to 2008. The labour market would be squeezed hard by rising interest rates and declining demand.
It would be insane for Trump to start a trade war, but crazy stuff sometimes happens. When Trump talked about tariffs on goods worth US$100 billion, was it his stable genius or testosterone talking? The man is 71. He might want to go out in a blaze of glory, even if he likes luxury too much. Just in case, the stock market is pricing in a 10 per cent chance that Trump doesn’t care any more.
In my view, China shouldn’t escalate the issue. The current proposal has already stymied Trump. He won the presidential election by less than a 100,000 votes in the Midwest. Soybean and ginseng tariffs will do the trick. The US has a bigger stick, because it imports three times as much from China as it exports, but China has enough cards in hand.
Theatrics aside, the trade imbalance between China and the US is real and rising. It comes down to two opposing economic models. The US stimulates consumption in a downturn, while China stimulates investment. When the economy recovers, China has more capacity for supply and the US greater consumer demand, increasing the imbalance between the two.
Economists often blame the imbalance on the difference in savings rates. But savings rates can change with policy. US monetary policy decreases the savings rate by creating financial bubbles, replacing real savings with fake savings. Meanwhile, China’s investment policy squeezes household disposable income and increases the national savings rate through the government and corporate sector. Unless the two change, the problem will only worsen.
China must take more responsibility for holding together the global economy than the US. China is bigger than the US in trade and gross domestic product on a purchasing power parity basis. China has four times as many people as the US but is poor in natural resources. China’s prosperity is far more dependent on trade than the US. The US is so rich in resources that it is the only major economy that can close its doors. Recognising this puts China’s policy into perspective.
Four decades ago, China began its “reform and opening up” policy, looking outward for ideas and market opportunities. China’s policy has always been about seizing the moment for some advantage. But China is now so big that if it arbitrages every opportunity, the consequences would rock the world. For global stability, China must itself be where the world finds opportunities. It is no longer about China joining the world. Global harmony requires China to let the world in. China shouldn’t just open its goods market, but also its capital and labour market. Because of the country’s size, global equilibrium requires it.
Whenever China enters a market, because of its size, everyone else has to exit. Opening up its labour market would soften that blow. China should be able to absorb a 3 per cent addition of foreign-born labour, or about 30 million foreigners.
After policy normalisation, China would still have much a higher savings rate than the US or any Western country. There is a fundamental difference in savings behaviour between the East and West. Twenty-five per cent of Japan’s population is over 65 and the country still has a higher savings rate than any Western country. Hence, capital will always be cheaper in the East.
Lastly, some of China’s high tariffs on goods are self-defeating. For example, the 25 per cent tariff on auto imports hasn’t created competitive domestic carmakers. Instead, German and Japanese automakers that make cars onshore have made huge profits. China should take the high road and lower tariffs to the US’ level of 2.5 per cent.
Trade is better than war. Countries can sleepwalk into catastrophes. Europe started the first world war over trifles, world war two was just testosterone running amok. It takes wisdom, not huffing and bluffing, to maintain peace and prosperity in the world. China’s wisdom lies in knowing how to handle floods – by channelling, not blocking. It must put this wisdom to use in managing the world.
Andy Xie is an independent economist