Why Donald Trump’s trade war is aimed at foreign direct investment in China

Zhigang Tao and Mary Hui say Trump is hurting American firms that have outsourced to China in the hope of bringing manufacturing back to the US. Beijing has to give US firms reasons to stay

PUBLISHED : Monday, 20 August, 2018, 2:02am
UPDATED : Monday, 20 August, 2018, 2:37pm

The US-China trade war may seem to revolve around the United States’ colossal trade deficit with China, but it actually hinges on investment. Grasping this is key to making sense of why each country is acting the way it is. To better understand the dynamics of the trade war, let us turn briefly to China’s economic history.

The roots of today’s trade war reach back to the late 1970s, when China launched expansive economic reforms and threw open its doors to foreign investment. It set up so-called special economic zones, where tax incentives were offered to attract foreign investment. From 1978 to 1999, China basically served as a low-cost production base for foreign multinationals.

China’s entry into the World Trade Organisation in 2001 was a watershed – it removed uncertainty over tariffs on China’s exports. China has become one of the world’s largest recipients of foreign direct investment, thanks to a wave of multinationals offshoring and outsourcing to the country. Since then, its exports to the US have accelerated.

It follows quite naturally, though it is less known to the general public, that 41.58 per cent of China’s exports to the world in the first six months of 2018 were made by foreign multinationals, according to data from China’s General Administration of Customs. In other words, China’s huge trade surplus with the US is mostly enjoyed by foreign multinationals. China’s logic has been to first attract foreign investment, then export to the world.

Perhaps US President Donald Trump recognises this. What worries him might not be the US trade deficit with China, but the overwhelming amount of American direct investment in China, which hollows out the American manufacturing heart as China develops a full spectrum of manufacturing capability and overtakes the US in technological innovation.

The US trade deficit in part reflects the benefits that American firms enjoy in China, in the form of lower production costs. Chinese currency appreciation is generally bad news for foreign multinationals, as their production costs go up.

Similarly, as Trump imposes tariffs on Chinese imports, it hurts American firms by raising their costs. So Trump’s trade war is hurting America so as to force China to back down, a threat that is not that credible in the short term. But this strategy has its long-term logic.

Banking on the appeal of China as other economies contracted during the global recession, the Chinese government offered multinationals a deal: share your technology in exchange for having Chinese government contracts. This technology-for-market-access strategy has worked extremely well, as evidenced by China’s rise in key industries including high-speed rail, aviation, automobiles and wind turbines.

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What many people don’t realise is that, through attracting a huge amount of direct investment from all over the world, China has moved away from labour-intensive products to capital-intensive products, paving its way to world dominance in manufacturing.

Knowing that American multinationals use China as a low-cost production base from which they export intermediate and final goods back to the US, what really worries Trump is China’s ability to attract investment globally. American firms benefit from the rise of China in the short term in the form of lower costs, but will ultimately suffer in the long run as China becomes more competitive. This is why Trump wants to bring manufacturing back to the US.

To this end, his economic policies since 2017 have been highly consistent. He introduced reforms that lowered tax rates for business corporations. He tried to repeal Obamacare so as to reduce the burden on businesses. He withdrew from the Paris climate agreement, believing that it would save over two million jobs, primarily in manufacturing. And he has openly encouraged tax policies to attract foreign firms like Taiwan’s Foxconn to invest in the US, while criticising American firms like Harley-Davidson for relocating to other countries.

Trump wants China to lower its tariffs on US imports: American firms won’t have to channel direct investment into China in order to enjoy the Chinese market, if exporting to China does the same trick.

So what should China do? The best bet is to prevent Trump from taking manufacturing back to the US. How? By making it difficult for the American firms to access the Chinese market unless they invest in China.

So long as the American firms realise the importance of the China market and know that exports to China may face uncertain tariffs, they will choose to continue investing in China.

Tesla, which has reached an agreement with the Chinese authorities to build a car plant in Shanghai, is the perfect example. China will need to embrace and invite more such foreign investors to thwart Trump in the continuing trade war.

Zhigang Tao is professor of economics and strategy and director of the Institute for China and Global Development at the University of Hong Kong. Mary Hui is a writer based in Hong Kong