Making Sense of the Trade War: Viewing the Barriers From Both Sides

Two boats bearing Chinese, US flags

Mutianyu (慕田峪) is a particularly well-preserved section of the Great Wall of China, about 40 miles from the nation’s capital. During a rare free afternoon in Beijing earlier this month, I decided to ditch my e-mail mountain to visit one of the “New Seven Wonders of the World.” It was a wise decision. The day was clear, the crowds were light and the views were spectacular.

Construction on the Great Wall began more than 2,000 years ago, to protect China from outsiders. Standing atop the structure, I certainly didn’t see Mongolian hordes threatening invasion. But the Wall can be viewed a symbol of China’s longstanding aversion to foreign influences. A modern version of the Wall is used by Chinese authorities to control trade. At the moment, that barrier is under renewed siege.

The visit to Asia offered me the chance to get an Eastern perspective on the recent escalation of global trade frictions. As you might imagine, there is a significant difference of views with the West, which must be reconciled to avoid an all-out trade war.

The view from the Far East is that trade restrictions are not the main cause of global imbalances. The American saving rate is roughly ten times smaller than China’s, hence the asymmetry in trade flows

China’s protectionism

Like other countries in Asia, China has used exports as an avenue to economic development. Taking advantage of low labor costs, Chinese factories gained market share steadily from 1970 to 2000, and then went into overdrive after China was admitted to the World Trade Organization (WTO) in 2002. This mercantilist orientation generated substantial trade surpluses, both overall and with the United States.

Trade balance figures

Cries of foul escalated with China’s share of industrial markets. Over the years, detractors have claimed that China’s environmental laws are too lax, its support of local companies is too generous, and its currency is too cheap. China’s appropriation of intellectual property and its selective use of regulation to hinder foreign companies has also been a source of concern. What Beijing has called “capitalism with Chinese characteristics” is seen by many in the West as simple central planning and protectionism. 

To keep markets truly open, WTO members are expected to limit government restrictions on commerce and capital. China’s practices have been persistently viewed in the West as too restrictive. While the United States has been the tip of the spear, many countries feel strongly that China has not fulfilled its commitments to become more open. 

The US as transgressor

The view from the Far East is that trade restrictions are not the main cause of global imbalances. When countries that save a lot trade with countries that save very little, the first will inevitably develop a trade surplus. The American saving rate is roughly ten times smaller than China’s; hence the asymmetry in trade flows. As China has become wealthier, its collective consumption has grown. But consumption still represents a much smaller share of China’s gross domestic product (GDP) than it does in the United States. 

The Chinese further contend that the United States is a far bigger transgressor in the trade arena. In fact, the number of WTO cases naming the US as respondent is more than three times higher than the figure for China. (And this reading pre-dates the grievances that will almost certainly be filed by Canada, the European Union and others in response to recent trade actions taken in Washington.) The US administration has justified many of its actions on national security grounds, which Asian audiences see as a stretch. 

US is the country with highest trade complaints

For the last two years, China has been claiming the mantle as the world’s leading proponent of free trade. But that claim must be viewed cautiously. While tariffs around most of the world have collapsed over the past 30 years, the Chinese have sustained tariffs at relatively high levels. And while most nations have divested government ownership of leading companies, the Chinese continue to own and influence their national champions to a substantial degree.

The last thing China wants is a trade war. It would be a major distraction, and would threaten the steady economic growth that provides time to implement policy changes

The technology race

A prominent manifestation of China’s industrial policy is “Made in China 2025,” which seeks to make the country the world’s premier developer of robotics, artificial intelligence, e-commerce and the platforms required to operate them. These industries are poised to drive growth in the coming decades. To advance its aspirations, the Chinese government has taken stakes in leading companies and made it difficult for foreign technology firms to gain a foothold in the Chinese market.

Made in China 2025 also takes direct aim at a space currently dominated by the United States, which has strategic implications. So it is not surprising that the technology sector has been the target of initial rounds of US tariffs. Westerners also note this as a prime example of China’s anti-competitive practices, which they contend will only be corrected through aggressive action.

Developing countries in Asia endured a painful crisis in the late 1990s. They had been encouraged by international authorities to open their markets to greater flows of goods and capital, but had not taken steps to manage those flows during difficult periods. The Chinese use that episode to justify their continued control of trade, capital flows and their currency, even though China now ranks as the world’s second-largest economy.

This is a frustration to Western firms, especially financial companies that had anticipated opportunities in the arenas of credit, trading and investing. 

Most Chinese are prohibited from investing outside of the country. This has led to a series of financial excesses, with real estate a leading example. Last fall, China’s leaders pledged to reform the financial sector and clamp down on credit. They have been making progress, but there is much work to do. It will take a lot of time, political capital and money. 

The White House seems intent on pressing its points to the maximum, even in the face of corporate discontent and potential market disruption

Unpredictable America

As they walk this delicate path, the last thing China wants is a trade war. It would be a major distraction, and would threaten the steady economic growth that provides time to implement policy changes. With the pain of tariffs beginning to reach Chinese companies, the government has directed an easing of credit, an action that runs counter to the reform agenda. While President Xi Jinping is politically secure, it is not clear that China can wait out the Americans. China’s exports to the US are an important share of GDP, while US exports to China barely register. 

It would be an understatement to say that those I met with in Asia were confounded by the negotiating posture of the United States. They complained about the unpredictability of American action and wondered when provocation would give way to negotiation. I mentioned that the tactic of gaining a competitive advantage by annoying one’s opponent is described in Chinese philosopher Sun Tzu’s The Art of War, but this was of little comfort. 

Charts from Northern Trust report

No winners

Those with whom I met during the trip were alarmed at the US perspective that a trade war would be winnable. If things go to extremes, no one will be better off. American businesses will pay in their margins, and consumers will pay more for almost everything. Employment in the battling nations is likely to decline.

But the White House seems intent on pressing its points to the maximum, even in the face of corporate discontent and potential market disruption. 

Among the biggest losers in a trade war would be emerging Asian economies, who supply both China and the West with raw materials and finished goods. As seen from the air during my trip, the number of ships surrounding the major ports in Hong Kong, Singapore and Seoul is astounding. Should that traffic begin to ebb, the region would be in for some difficult times. 

The economic barriers separating America and China are rising rapidly. But I hold out hope that reasoned heads will eventually halt construction before another Great Wall is erected.