By Scott Kennedy
A month into U.S. President Donald Trump’s trade war with China, the conflict has generated only a flurry of rhetoric and threats, but further escalation looms. Both sides are close to implementing tariffs on another $16 billion worth of goods, and the United States looks prepared to impose tariffs on a further $200 billion worth as early as the end of August. So far, investors seem to see these tensions as temporary and believe that they won’t damage the overall U.S. economy. The stock market has barely budged, and futures prices for steel and agricultural goods caught up in the conflict show that traders expect prices to return to more normal levels within the next six to nine months.
Yet the most important question is not how long the trade war will last but whether the U.S. frustrations that sparked it in the first place will be addressed. Unfortunately, the Trump administration is only partially focused on the right issues, and so it has reached for the wrong weapons. The heart of the commercial conflict between China and the United States is not metals and beans or trade balances but the commanding heights of any economy: high technology industries. The dangers to U.S. high-tech prowess are only loosely connected to trade. That’s why tariffs should not be playing the starring role for which they have been cast.
DIFFERENTIAL DIAGNOSIS
One often hears that when it comes to the U.S.-Chinese commercial relationship, the Trump administration has the diagnosis right but the prescription wrong. That is largely true. The administration certainly deserves credit for raising the urgency of unfair Chinese practices. White House economic adviser Peter Navarro’s June report, “How China’s Economic Aggression Threatens the Technologies and Intellectual Property of the United States and the World,” is hyperbolic in much of its language, but it rightly identifies various Chinese actions that create an uneven playing field. Similarly, the Office of the U.S. Trade Representative’s recent Section 301 investigation into the misappropriation of intellectual property appropriately zooms in on threats to the United States’ competitiveness.
The Trump administration seems to appreciate the challenges that Chinese industrial policy targeted at high-tech industries creates for the United States, other advanced economies and the industries of the future. There are four main issues. The first comes from insufficient access to the Chinese market for exporters and investors. “Made in China 2025,” a government strategy to upgrade Chinese industry, and the larger 13th five year plan of which it is a part, focus on import substitution by creating specific targets for displacing foreign technologies. And as part of its One Belt, One Road project, China is pressing participating countries to buy Chinese high-speed trains, solar panels, and telecommunications equipment, which could reduce opportunities for American businesses beyond China.
The second consequence of Chinese policies is to undermine the value of intellectual property. China imposes long delays before awarding rights for foreign patents, copyrights, and trademarks; often insists on unfair licensing terms; demands that companies transfer technologies to Chinese firms in exchange for market access; buys foreign technology with a seemingly bottomless bucket of public money; and sometimes outright steals foreign commercial secrets.
The third problem is overcapacity. China’s state-backed financing and other policy incentives regularly attract waves of corporate investment that far outstrip reasonable expectations of market demand. The result is a fall in prices and profitability, with good and bad firms both suffering. Chinese state-owned firms are better able to endure these downturns than companies in market-based economies because the state has a habit of supporting them even in the absence of sufficient demand, destroying otherwise healthy foreign companies and their supply chains around the world. This phenomenon began in construction industries, such as steel and cement, but has spread to high-tech sectors that produce standard goods, such as solar panels and wind turbines. Electric cars are ripe to suffer the same fate.
The final problem is the poor governance of data. Beijing is able to collect, process, and use data of all kinds on a massive scale. At the same time, the government not only places huge constraints on the ways multinational companies use data and on cross-border data flows, it also tilts the balance between privacy and state security much too far toward the latter. This is likely to damage businesses and consumers that rely on global data, e-commerce, and other online services and the development of artificial intelligence applications, such as autonomous vehicles.
TREATING THE WRONG SYMPTOMS
Although the Trump administration’s complaints are in many respects on the money, its obsession with the bilateral trade balance has prevented it from finding genuine solutions. The administration regularly cites the U.S. trade deficit as the key problem to be resolved. According to a recent report, the U.S. bilateral deficit in advanced technology products with China grew from $109 billion in 2011 to $135 billion in 2017. But the great majority of the imbalance results from shifting global investment and transnational supply chains, not Chinese malfeasance.
Reduced U.S. exports are not the only, or even the chief, malady caused by Chinese high-tech policy. The damage is much broader. Devalued intellectual property, overcapacity, and the abuse of data all stifle business investment and profitability in the short term and smother the drive to innovate over the long term. This translates into slower productivity growth, fewer high-wage jobs, less consumer choice, and fewer new technologies.
In fact, by raising tariffs or striking a trade deal in which China expanded its imports, the United States could eliminate the trade deficit without touching Chinese industrial policy. But such steps would not address the most important consequences of China’s high-tech strategy. Conversely, constraining Chinese technology policies and allowing markets to play a greater role could well cause the United States’ overall bilateral deficit and its deficit in high-tech goods with China to rise. That is because a more open China would attract more foreign investment and some of that activity would result in more exports from China to the United States. The Trump administration, unfortunately, would likely balk at this outcome.
The chances of escalation are higher than most appreciate. The Trump administration is preparing tariffs on an additional $200 billion worth of goods, and Trump has threatened tariffs on all Chinese exports to the United States. If Chinese President Xi Jinping doesn’t then raise the white flag, it is not hard to imagine the administration revoking China’s most-favored-nation status under the WTO, a move that could send U.S. tariffs on Chinese goods skyrocketing well beyond the current levels of between 10 and 25 percent that Trump has imposed. China would likely follow suit. American businesses, workers, and consumers would suffer, raising pressure on the Trump administration to provide far more in relief than the $12 billion it has suggested handing out to farmers hit by the trade war. The danger would then be that the global economy would fracture as the world’s two largest economies cut ties with each other.
THE RIGHT MEDICINE
Tariffs, no matter how high, cannot fix the real problems produced by China’s aggressive approach to technology. At most, they can get China’s attention and bring it to the bargaining table. But at some point the focus must turn to more appropriate remedies.
To some extent, this will mean vigorously enforcing existing rules against dumping (the practice of selling goods abroad at a price below their domestic value), imposing countervailing duties to offset unfair subsidies, and strengthening safeguards against surges of Chinese imports. (The United States already has over 100 antidumping and countervailing duties against China in place.) It will also mean strengthening domestic rules to cut down on the leakage of technologies that would put national security at risk to China and other potential foes. Congress’ recent expansion of the scope of the Committee on Foreign Investment in the United States should help address this problem. Export controls on advanced U.S. technologies are also overdue for an update.
But much more needs to be done. The United States should push for new international rules that govern the development, production, and sale of high-technology products and services. The Trans-Pacific Partnership, which Trump abandoned last year, would have filled in a lot of the blanks in this area. Moreover, the WTO has long been negotiating an agreement on trade in environmental goods and is considering a similar deal on e-commerce. The United States should embrace and lead these and other international initiatives. Taking this path would be far more likely to work in a globalized economy than trying to negotiate a long sequence of laborious bilateral arrangements one after another, as the Trump administration proposes. The framework on trade announced last week between the United States and the European Union, for example, is not a sufficient substitute for a broad international coalition and multilateral actions taken to counter Chinese practices.
The United States also needs to do more to develop its own high-tech sector. The United States and other developed countries need to provide additional funding for basic research and for the infrastructure that will allow scientists and engineers to devise new technologies and businesses to deploy them. Governments not only need to incentivize the supply of new technologies, but also to encourage the demand for their adoption and diffusion. Western countries can’t expect to set the rules for technologies they don’t use. China’s emerging dominance in electric cars, for example, means that the industry—from raw material suppliers and battery makers to car manufacturers—is bending to Beijing’s preferences. The United States shouldn’t force every family to buy an electric car, but federal and state governments can radically raise emissions standards, eliminate fossil fuel subsidies, support companies that are building charging points, and offer incentives to develop and deploy better batteries, usable hydrogen vehicles, and more efficient power grids. Policies that promote technology pluralism and consumer choice—think tax incentives for shoppers, not subsidies for producers—will keep the United States in the driver’s seat.
The Trump administration is right to sound the alarm bells on China’s policies. At 20 percent of global GDP, China matters: when Beijing intervenes in the Chinese market, people on the other side of the world feel the effects. And high-tech sectors, which are unusually globalized, are particularly vulnerable. The stakes mean that getting U.S. policy on Chinese technology exports right could bring huge benefits—and that the costs of getting it wrong are even greater.
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