Looming economic war

Print edition : June 21, 2019

President Donald Trump with Vice Premier Liu He, the lead Chinese trade negotiator, at the White House in Washington D.C., on April 4. Photo: SARAH SILBIGER/THE NEW YORK TIMES

A visitor operates an excavator, which is shown on the TV screens, by a remote control system via 5G technology, at the China International Big Data Industry Expo 2019 at Guiyang in Guizhou Province on May 27. Photo: Yang Wenbin/AP

Chinese Vice Minister of Commerce Wang Shouwen at the State Council Information Office in Beijing on June 2. Photo: Andy Wong/AP

In the U.S.-China tariff war, there is no economic gain to be derived by either side. But the U.S. is pushing ahead by bringing in the national security angle because the political stakes are too high.

THE tariff war with China unleashed more than a year back by the Trump administration in the United States threatens to turn into full-fledged economic war. The U.S. claims that China is engaging in unfair trade practices and adopting coercive measures against U.S. firms, undermining U.S. economic interests. China not only denies U.S. allegations, but in a White Paper released in early June dismisses U.S. claims that it reneged on agreements arrived at in the negotiations to end the war. In the press conference held to release the paper, China’s Vice Minister of Commerce Wang Shouwen noted that it is not uncommon for both sides to propose changes to the text of an agreement in the course of consultations. “Nothing is agreed until everything is agreed,” he reportedly said.

It is now increasingly clear that while the initial tariff spat was clothed by the U.S. in the rhetoric of generalised protectionism, which included a rewrite of the North American Free Trade Agreement (NAFTA) and exit from the Trans-Pacific Partnership, the war with China is special. It is aimed at forcing China to step back in its drive to become another economic superpower. The rhetoric against China is not just that it runs large trade and current account surpluses with the U.S. or that it is stealing technological secrets to bolster its competitiveness, but that the activities of its firms pose a national security threat to America. The issues go beyond the purely economic.

The real agenda of the Trump administration comes through from the way its economic war with China has evolved, in contrast with its measures against countries such as Canada, Korea, Mexico and Germany. Initial U.S. action against China, which started early 2018, was similar to that adopted vis-a-vis other countries that were deriving asymmetrical benefits from their trade with the U.S. In January 2018, the U.S. imposed quotas and tariffs on solar panel and washing machine imports, ostensibly to benefit U.S. manufacturing. This was followed in March 2018 with tariffs of 25 per cent on steel and 10 per cent on aluminium, which too were imposed on imports from countries other than China as well. Interestingly, while the tariffs on solar panels and washing machines were imposed on the grounds that imports were causing injury to U.S. industry, steel and aluminium were targeted on “national security” considerations, marking a transition in the justification provided for the new protectionism. These tariffs were not targeted solely at Chinese imports, and even when countries such as Argentina, Brazil or South Korea were granted exemptions, import quotas were specified. But the focus was China, especially on the grounds of threat to national security.

That became clear when the U.S. administration proposed tariffs on products worth $100 billion imported from China. In a first step to implement that proposal, tariffs of 25 per cent were imposed on $34 billion worth of imports from China in July 2018. This largely covered agricultural products. Then, in September, 25 per cent tariffs were imposed on $16 billion of imports from China consisting of products such as semiconductors, chemical and motorcycles. And in October tariffs on $200 billion worth of Chinese imports, which had been announced in July, were imposed.

Initially China’s response to this U.S. trade war was muted. It imposed duties on a set of U.S. exports to it (such as aluminium waste, pork and fruits and nuts) of a value of just around $3 billion. But soon, China decided that it needed to show it was not afraid of retaliating. When faced with the July 2018 action of the U.S., China’s response was more aggressive, with 25 per cent tariffs on $50 billion worth of imports from the U.S., also imposed in two stages in tandem with U.S. actions. Finally, when in October, the U.S. imposed tariffs on another $200 billion worth of Chinese imports, China responded with retaliatory tariffs of either 5 or 10 per cent on $60 billion of its imports from the U.S.

At this point, in December 2018, the Presidents of the two countries decided to call a truce, start negotiations and not escalate the trade war in the near future. But with a rider from the U.S. that if an agreement was not arrived at by March it would consider raising the 10 per cent duty imposed on a range of Chinese imports to 25 per cent. Initially, it appeared that talks were going well, but in a sudden turn after seven rounds the U.S. alleged that the Chinese had gone back on their promises. This triggered the current aggressive second phase of the economic war that has gone far beyond tariffs. On May 10, 2019, the U.S. administration did raise the 10 per cent tariff on $200 billion worth of imports from China to 25 per cent. With this the U.S. had imposed tariffs on imports worth $250 billion exclusively from China, whereas the tariffs on imports exclusively from the U.S. imposed by China covered products worth $113 billion.

The Huawei story

But now tariffs were soon accompanied by U.S. sanctions of various kinds. To start with the U.S. decided to impose a ban on use of Chinese telecom major Huawei’s technology in the roll-out of 5G within the U.S., claiming that this would be used for espionage purposes. In mid May 2019, the U.S. government issued an executive order legalising this threat to bar U.S. companies from using telecommunications equipment manufactured by Chinese companies such as Huawei and ZTE (Zhongxing Telecommunications Equipment). Thus, imports from Huawei of 5G technology have been banned on the grounds that the company is linked to the Chinese state. The U.S. has also been pressuring other nations to refrain from purchasing 5G equipment from Huawei, ostensibly on security considerations. Some like Australia and Japan have complied. Others like Denmark, Sweden and the United Kingdom, besides many emerging markets, are undecided or against the ban. The U.S. government also placed Huawei on the “Entity List”, which means that U.S. companies wanting to transact business with the Chinese firm would have to obtain a licence. Intel, Qualcomm, Xilinx, Broadcom, Google, and others have already announced that they will stop selling hardware, such as chips, and offering software services to Huawei. Firms outside the U.S., threatened with loss of business connections with that country, are also cutting links with Huawei. For example, the chip designer ARM has announced its decision to break ties with Huawei, citing its dependence on “U.S. origin technology” that makes it subject to the Trump ban. In the event, Huawei would be hard put to produce its own chips that are heavily dependent on ARM technology. In addition, with Chinese semiconductor production being a fraction of global supply, a major like Huawei is bound to be affected by the U.S. effort at targeted sanctions. According to reports, in 2017, Huawei bought as much as $11 billion worth of components, especially computer chips, from U.S. firms.

But this is not the only hit Huawei has taken. With Google withdrawing Huawei’s Android licence, Huawei phone users have been shut out from updates of their operating system and the benefits of Google Play. Demand for Huawei phones from new buyers is bound to shrink hugely. More than one mobile company has announced ending its tie up with Huawei. So, besides being hurt by loss of potential markets for its 5G technology, Huawei seems to be shut out of the mobile phone business from both production and demand sides.

It is not just Chinese firms that are hurt. The U.S’. actions can hit profits of U.S. firms exporting to and producing in China. Moreover, the fallout of the trade war would lead to loss of U.S. jobs. So, the stakes here are not purely economic, but strategic. Matters would get worse as the U.S. actions increase the pressure on China to retaliate, not least in order to bolster its image at home.

China's response

While the Trump administration has relied on the threat to national security angle to justify its hit on Chinese firms, especially Huawei, many see in it a direct effort to rein in growing Chinese superiority in a range of hitech areas that poses a challenge to U.S. supremacy. Recognising this, China too has decided to go beyond tariffs and trade. It has announced that it plans to prepare a list of foreign companies that work against the “legitimate rights and interests” of Chinese firms and corporate groups. A Commerce Ministry spokesperson declared: “Some foreign entities violate market norms, break the spirit of business contracts, block Chinese enterprises and use discriminatory measures for non-commercial purposes.” They are also seen as adversely affecting China’s national security. So a “non-reliable entity” list is being prepared to rein in such firms. The language indicates that this is retaliatory action. So, the war is poised to intensify. The message is that China does not want war but is not afraid of responding if dragged to war. The Chinese Ministry of Commerce has cautioned the U.S. that the standoff can become “the largest trade war in economic history to date”.

In principle, there are multiple ways in which China can retaliate to U.S. action in future. First, it could intensify its tariff response by expanding the range of commodities on which higher tariffs are imposed. That would reduce American exports to China. Second, it could increase restrictions on U.S. firms operating in China and catering to the Chinese market. That would hurt these firms, some of which are also likely to be affected adversely by U.S. tariffs, to the extent that they export output from Chinese facilities to the U.S.

Finally, China can consider using its holding of U.S. Treasuries to punish the U.S. China currently holds seven per cent of all outstanding U.S. Treasuries and accounts for 17 per cent of foreign holdings of those instruments. That China is reducing its holdings comes through from evidence that in March 2019 alone China sold $20 billion worth of securities out of the more than $1.2 trillion it held, even though its reserves were stable. If that is a first sign of China’s inclination to dump the instrument, it could lead to depressed bond prices and higher interest rates, undermining the low-interest rate monetary policy used heavily by the U.S. in order to spur its recovery. This will also raise the U.S. government’s cost of borrowing and restrain its plan to hike expenditures on infrastructure to spur growth.

In sum, China can hurt the U.S. as well. There is no economic gain to be derived by either side from this war. But the U.S. is pushing ahead because the political stakes are too high.

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