Trade War Begins: Why China’s Growth Doesn’t Work For America Anymore

From Snow To Nixon To Trump

From June to September 1936, Kansas City native Edgar Snow interviewed Mao Zedong and other senior leaders of the Chinese Communist Party at their headquarters in Bao’an, in the northwest province of Shannxi. Snow crossed through Chiang Kai-Shek’s blockade against the Communist guerrillas, though “no one”, Snow recounted, “had voluntarily penetrated that wall and returned to write of his experiences”. Snow published the instantly famous and now classic Red Star Over China (1937).

Snow’s research gave westerners the authentic narrative that Mao was neither to be dismissed as a radical revolutionary nor viewed as a strictly military leader. Rather, Mao’s project was top-down reform of China’s ancient, unequal political economy. That narrative worked in China, too, and still does today: poverty reduction through Party-led central planning justified Party dominance of all aspects of life.

America ‘lost’ China when, on Oct. 1, 1949, in Tiananmen Square, the Chairman proclaimed the founding of the People’s Republic. For the next 23 years, Red China was on the other side of a Cold War that turned hot in Korea (1950-53) and Vietnam (1964-73). But, thanks to Snow, there was at least an explanation. Through all the upheavals of modern Chinese history – the Great Leap Forward (1958-62), Cultural Revolution (1966-76), and Deng Xiaoping’s reforms (1978) – the CCP achieved what no other government in human history had (albeit at a hideous human rights cost): the movement of hundreds of millions of citizens out of poverty.

Thirteen days after Snow died, Chairman Mao and President Richard Nixon changed Snow’s narrative. The theory of their Feb. 28, 1972, Shanghai Communiqué was that all nations would benefit from direct, peaceful Sino-American relations.

Thanks to President Jimmy Carter, formal recognition of the Mainland came in 1979.

This second narrative said Chinese integration into the world trading system would be a win-win game in which capitalist principles of comparative advantage could operate freely to maximise production efficiencies and consumer welfare from Kansas City to Kunming. China’s entry into the World Trade Organization on Dec. 11, 2001, supposedly ensured the CCP would subordinate its interests to multilateral trade law, for example, faithfully implementing its WTO accession commitments, and scrupulously complying with legal cases it lost.

Fast forward, 82 years after Snow sat with Mao, to July 6, 2018: President Donald Trump changed the narrative. He imposed under Section 301 of the Trade Act of 1974, a 25 percent tariff on $35 billion worth of Chinese imports into the United States, effective July 6, with more levies in the offing on up to $500 billion of Chinese goods, and the CCP immediately counter-retaliated.

This third narrative is that CCP’s economic behaviour, not to mention military intentions, erode America’s economic vitality and thereby undermine its national security.

Three Questions

The game, the Chinese-American Trade War, now is zero-sum, as are all wars. And, as with all wars, three questions must be asked about this one.

• How long will it last?
• What are its underlying causes?
• How can it be fought effectively?

The answers are sobering.

Long Enough To Rethink Business Strategy

Because of the change in the narrative, a long time.

‘How long’ is difficult to quantify. History teaches that promises of a swift end to a conflict are often unkept. The European Union fought most of the rest of the world over bananas throughout the 1980s and 1990s. Canada and the United States have been whacking each other with softwood lumber since 1982. Lord knows when the decades-long Boeing-Airbus or Bombardier-Embraer Air Wars will end.

The prudent historical inference for businesses to draw is to re-think their models.

• Is there exposure to imports, exports, or foreign direct investment in China?
• What alternative sources of supply exist?
• Are alternative sales markets appealing?
• Are alternative production venues viable?

Even if, perchance, hostilities cease with a truce or treaty, the re-think will prove useful. That’s because the new narrative is a testament to enduring Chinese-American tensions.

Theft, Subsidies, State Control, Censorship

The narrative itself answers the second question.

No longer does the United States see the Chinese system of economic growth as a tolerable process whereby the CCP cuts subsidies, exposes state-owned enterprises to market forces, vigorously enforces intellectual property rights, and permits ever-wider yuan-dollar trading ranges. That maddeningly gradual process was bearable as long as American leaders calculated the consequences of massive social upheaval in China that undermined CCP rule as too adverse to the global economy, and too chaotic for the American military to contain.

And, to make the process more palatable for almost everyone, the Party relied on the American business community: it outsourced jobs and incomes to China, a manufacturing and export platform with seemingly endless cheap labor and lousy environmental regulations, but itself and its shareholders profiting from the ‘most favoured nation’ market access its Chinese-origin exports received after the country’s WTO accession and stocking American shopping malls with affordable products.

It is designed to keep the CCP in power by keeping the Chinese economic juggernaut on track – an ironic turn from Snow’s days of the Party serving the people. The Trump administration calculates the cost as skyrocketing beyond the hollowing out of America’s industrial base to threaten the vital source of American economic growth, IP, and thereby imperil the nation’s technology-based military edge.

The administration has exposed the CCP’s Made in China 2025 industrial policy as warmed-over Marxism, a plot in which the CCP does not necessarily own or control all of the factors of production (as true communism would have), but does direct the Chinese economy in 10 strategic sectors: advanced information technology; advanced basic materials; advanced rail equipment; agricultural machinery; aircraft; electric power equipment; marine engineering; new energy vehicles; pharmaceuticals; and shipbuilding.

The directives are arrestingly mercantilist, with market share targets for Chinese companies at home and abroad, and $300 billion worth of subsidies to help them hit the targets. For example, by 2025, domestic firms should produce 95 percent of the equipment, and 60 percent of the high-tech machines, used by Chinese farmers, revenues earned by Chinese airlines should be at 200 billion yuan by 2025, Chinese aircraft manufacturers should hold a home market share of 10 percent, 80 percent of civil space industry equipment should be sourced from Chinese manufacturers, and 40 percent of the sales of Chinese railway train producers should be overseas.

Those merchants – America’s corporate elites (and their political lackeys) – have profited from their unholy alliances with the CCP.

So, too, has Trump. He’s made eyeglasses, shirts, home items (ceramic vases, kitchen items, lighting fixtures, mirrors, and wall decorations), and hotel amenities (bath towels, body wash, laundry bags, moisturisers, pens, pet collars and leashes, shampoo, show bags, shower caps) in China.

Vulnerable to Section 301 tariffs on imports, and/or Chinese counter-retaliatory tariffs on exports, his fellow merchants peddled their arguments against the Section 301 action. They told him some American importers will pay 25 percent more for Chinese merchandise, which could mean higher prices at home, even for consumers in his political base. They warned him some American producers may shift (more) facilities to the Mainland to jump China’s counter-retaliatory tariffs, threatening jobs of workers in that base. They were less inclined to admit their self-interest.

Never mind, tweeted the President, perhaps cognizant from his global business experience of the truth of President Thomas Jefferson’s words: “Merchants have no country. The mere spot they stand on does not constitute so strong an attachment as that from which they draw their gains.” Trump was elected to put his country ‘First’, which means standing for economic strength without which the nation is insecure.

Two Trump administration documents, the details of which deserve attention, spell out why that defence with Section 301 is necessary.

The first is a 215-page investigation report, issued on March 22 by the United States Trade Representative. Summarised in the USTR’s language:

• “China uses joint venture requirements, foreign investment restrictions, and administrative review and licensing processes to force or pressure technology transfers from American companies.”
• “China uses discriminatory licensing processes to transfer technologies from U.S. companies to Chinese companies.”
• “China directs and facilitates investments and acquisitions which generate large-scale technology transfer.”
• “China conducts and supports cyber intrusions into U.S. computer networks to gain access to valuable business information.”

The second is a 35-page report, issued on June 20 by the White House Office of Trade and Manufacturing, which contends that in addition to protectionist barriers, subsidised overcapacity, and cloud computing restrictions, China seeks to “acquire key technologies and intellectual property from other countries”, and “capture the emerging high-technology industries that will drive future economic growth and many advancements in the defence industry”.

A third document, which did not receive the attention it deserves, links American economic and national security. In his April 18 testimony to Congress, Pacific Commander Admiral Philip Davidson, wrote:

… [T]he United States advocates for a free and open Indo-Pacific, supported by regional partners and allies that respect international law, freedom of navigation and overflight, and the free flow of commerce and ideas. ...[I]t is increasingly clear that China wants to shape a world aligned with its own authoritarian model and inconsistent with these principles. Through coercive diplomacy, predatory economic policies, and rapid military expansion, China is undermining the rules-based international order. We must be willing to cooperate with China where we can, while consistently and unapologetically confronting China when it engages in behavior that undermines the international order or harms U.S. interests in the region. (emphasis added)

Make Nice

As for the third question, the most obvious answer is America can fight the Trade War more effectively with its allies, which means it needs to stop alienating them.

Start with the EU. As seriously as America takes IP protection and enforcement, the EU does so even more seriously. The EU, for example, champions the moral rights of authors in its copyright laws and protects geographic indications on a range of exquisite food and beverage items. The alignment of interests extends to topics like overcapacity in the steel and aluminum industries, orderly privatisation of state-owned enterprises, and appropriate levels of euro-yuan exchange rates. So, the two are natural allies.

The legal basis for the Chinese-American trade war is a decisively unilateral one. Section 301 does not call for America to work in tandem with anyone else when it goes after the acts, policies, or practices of a foreign government. That’s fine with Trump, but it shouldn’t be.

The statute does not preclude collaboration, and the President ought to take note of what happened on July 3 in Brussels, in advance of the July 16-17 Chinese-European Summit in Beijing.

As strained as Trump’s ties are with EU leaders, they still held open the possibility of ‘making nice’ in the face of the CCP’s trade behavior. The loss of face for the CCP was immense, and the irony delicious: here was a Party, wont to recount the shameful 19th-century history of China being carved up by western imperialists into spheres of influence to justify its place on the 21st-century stage, trying to divide and conquer the West.

Forecasting Snow

The Section 301 action has replaced an expectation not widely doubted since the Shanghai Communiqué with a doubt about Red China not widely discussed since Snow’s time: from “China being connected to the rest of the world is a global good” to the “CCP spearheads disruptive trade practices to keep itself in power”.

What commentary might Snow have written on this new narrative?

Assuredly, he would have agreed with the motto of the Edgar Snow Memorial Foundation, housed at the University of Missouri in Kansas City: “We believe there is no more important global relationship in the 21st century than that between the United States and China.” And, optimistically, he might have recalled Mao’s comment to him that a “Chinese anti-Fascist pact with capitalist democracies is perfectly possible and desirable”.

Raj Bhala is the inaugural Brenneisen Distinguished Professor, The University of Kansas, School of Law, and Senior Advisor to Dentons U.S. LLP. The views expressed here are his and do not necessarily represent the views of the State of Kansas or University, or Dentons or any of its clients, and do not constitute legal advice.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.