No Winners: The Failed Trade War between the United States and China

Note: This essay (Chinese version) is an extended and revised version of a speech given at the European Parliament during a public debate on 5G, cybersecurity, and trade disputes on 16. October 2019.

Since July 2018, the United States wages a unilateral trade war against China. The current truce and verbal phase-one agreement between the American and Chinese government, which has been announced on 13 December 2019, is not a point of progress, but one of preventing further harm. Both sides have agreed to suspend another tariff hike and intend to partially lift tariffs already imposed on $375 billion worth of Chinese goods and $120 billion worth of U.S. goods, respectively. Both sides aim to sign the phase-one agreement in January 2020, and China has also verbally agreed to buy more goods from the United States. This time of truce provides for a moment of reflection on the reasons for the trade war and whether it has met the United States and the Trump administration’s objectives.

The trade war is part of President Trump’s protectionist “America First” economic campaign, which has also included the cancellation and renegotiation of trade agreements as well as a series of punitive tariffs imposed against other major trade partners. Already before President Trump’s inauguration in 2016, successive U.S. administrations waged a war against the WTO, which has intensified under the Trump administration. As a consequence, WTO’s dispute settlement mechanism ceased to operate on 11 December 2019. The “America First” campaign has been a central part of President Trump’s 2016 election promise. The goal has been to reduce the country’s immense overall trade deficit and the huge $419.2 billion deficit with China and bring manufacturing and jobs back to the United States. On a deeper level, the Trump administration has also attempted to impose fundamental structural changes on China’s political and economic system, with some U.S. China critics ultimately seeking to contain China’s development altogether. On both levels, the Trump administration has failed. The Trump administration could not reduce the overall trade deficit, revitalize its manufacturing industry, redirect investments away from China and back to the United States, and impose deep structural changes upon China. Unlike the election promise, the U.S. trade deficit had swollen to $878.77 billion between 2016 and 2018, which was the largest in the nation’s 243-year history. Despite the trade war and three years of “America First” policies, the 2019 gap might be the same or even higher than the historic 2018 gap. Unilateralism, protectionism, and containment are ill-equipped strategies for rebalancing the global order and acknowledging the rise of China. They endanger global economic growth and development, and much need cooperation to achieve the Sustainable Development Goals.

Since 1975, the United States has maintained a trade deficit with almost all of its trade partners. Over the past four decades, the United States has imported more products than it has exported. During the same period, on average, the United States also maintained a current account deficit, which means that the country must borrow foreign capital to finance its imports. There should be no doubt, such overconsumption and overspending have made the United States the primary engine of global growth as well as the most attractive country for foreign investors. Once globalization picked up in the 1990s and 2000s, this resulted in tremendous wealth and tremendously increased living standards not only in the United States, but also in many other parts of the world, including Europe and China. Looking to Asia, before the United States began running an increasingly large trade deficit with China, the United States already ran a large trade deficit with Japan and then with the Four Asian Tigers: Hong Kong, Singapore, South Korea, and Taiwan. From the 1960s to the 1990s, the Asian Tigers, like Japan before, underwent rapid industrialization and maintained high growth rates, eventually becoming high-income developed economies. However, since China’s reform and opening in 1978, the U.S. has also taken over the Asian Dragons’ trade surpluses, and the United States has steadily increased imports from China. As a share of GDP, U.S. imports of Chinese goods rose from 0.2% in 1980 to 2.6% in 2018. The only time the United States had a trade surplus with China was in 1975, when exports exceeded imports by $12.4 billion. Especially during the 1990s and the beginning of the 2000s, China’s economic growth increased rapidly, as did its trade surplus with the United States. Today’s the United States is China’s largest export market, and China is the third largest export market for the United States after Mexico and Canada. China is also the third-largest market for U.S. services, after the United Kingdom and Canada.

In the past, trade deficits were no issue for the United States as long as the country maintained its comparative advantage and competitiveness. The division of labor based on comparative advantages has been a cornerstone of modern industrialization and the underlying structure of international trade. In the capitalist pursuit of maximizing profits while minimizing costs, the United States has outsourced manufacturing and assembly to countries with cheap labor forces and less restrictive labor and environmental regulations. Obviously, China and other late emerging economies became preferred outsourcing destinations for the United States and Western Europe, which instead focused on research, innovation, and high-margin service sector growth. A key indicator that the United States has followed this strategy relentlessly is its import of intermediate or half-finished goods, which are assembled into finished goods in the United States. Such goods make up 60% of U.S. imports and mainly include electronics, transportation, and machinery parts. Although the import of such parts contracted by 52% during the 2008 financial crisis, after the crisis, imports doubled again, highlighting that outsourcing continued unabated, as did much the country’s overspending and overconsumption.

At the beginning of its 1978 reform, China increasingly became the assembly center providing the United States and Europe with low-value goods. The West greatly benefited from its outsourcing spree as well as from selling its high-value goods to China’s rapidly growing industries and increasingly affluent middle class. In contrast, millions of cheap rural and urban workers became absorbed by China’s newly emerging manufacturing economy. As a result, China contributed to human rights like no other country before by lifting more than 850 million people out of poverty, contributing over 76% to global poverty reduction (World Bank). Absolute poverty still exists mainly in some of China’s western provinces, but China is on the path to fully eradicate poverty by 2020 and thus attain the first target of the U.N. Sustainable Development Goal ten years ahead of schedule. However, as global wealth skyrocketed, so did economic inequality.

China has moved up the value-added chain with fulminant speed. China has become the second largest economy and provides jobs for 770 million people. China is no longer only the assembly center of the Western world, but directly competes against the United States and Europe in high-technology areas such as 5G, IOT, artificial intelligence, robotics, quantum computing, and biosynthetics. China produces the half-finished goods that go into final products in the United States and Europe. Structurally, China can draw on complete supply chains, a highly skilled labor force, modern infrastructure and cities, and a fairly efficient bureaucracy. Since 2013, when President Xi Jinping came to power, China’s economy has undergone vigorous reforms against the backdrop of the aftereffects of the 2008 financial crisis caused by the United States, sluggish growth in Europe due to its fiscal and debt crisis, a slowing global economy, and severe environmental pollution within China. President Xi needed to shift the economy from quantitative to qualitative and encouraged more sustainable growth. He initiated supply-side reforms to overhaul the state-owned sector and modernize the financial sector. China began more vigorously to transform from its factor-driven economy to an efficiency- and innovation-driven economy, and it still is in the midst of that transformation process. Its total R&D spending is on the path to surpass that of the United States in 2019. China calls this process and ambition to become world science and innovation leader “Made in China 2025,” which the West has denounced as a protectionist domestic industrial policy. In capitalism, however, the transition from a factor- to an innovation-driven economy is strategically an inevitable process because only technology innovation ensures long-term competitiveness and helps to overcome the diminishing returns of a factor- or efficiency-driven economy. The West went through similar economic development stages while building its nascent technologies and industries. During the 20th century, technology innovation not only contributed to wealth and dignity, but also to system survival or, in the absence thereof, collapse. The West had largely accepted China’s catch-up strategy over the past decades as long as the West could sustain its comparative advantage over China. As China has moved up the value-added chain and relentlessly focuses on innovation and technological independence still without liberalizing its political system, the United States, the European Union, and — for the first time — NATO have labeled China a “strategic competitor”, “systemic rival” and a “challenge” to the Western alliance. Despite significant progress, however, a country with 1.4 billion people cannot rely on foreign technologies and surrender to the forces of global capitalism. Otherwise, this would mainly emulate the U.S. model of market foundationalism, which has been severely disruptive and unsustainable.

Now, the United States’ trade war against China is one of the key symptoms of a historic reconfiguration of global power and rebalancing of global trade relations. The Trump administration’s willingness to reach a phase-one trade agreement stems from the miscalculation that the trade war would bring back jobs and manufacturing businesses, reduce the trade deficit, and induce significant change in China’s system. On the contrary, the trade war has not made Beijing surrender to U.S. aggression, but has mainly endangered bilateral trade and put the U.S. economy under pressure, which could jeopardize President Trump’s reelection in November 2020. Accordingly, in the first eleven months of 2019, the total trade volume between the U.S. and China fell 15.2% (Reuters) and in the first ten months the U.S. trade deficit with China dropped 14.6% from $344.8 billion to $294.5 billion year-on-year (US Consensus Bureau). However, the overall U.S. trade deficit has roughly remained the same over the same period. Thus, the U.S. deficits with other countries have increased, which compensates for the decline of the deficit with China. Likewise, the manufacturing jobs, which amounts to 8.1% of civilian employment in the U.S., have remained the same since 2016, yet manufacturing activities have contracted and the volume of new orders has reached the lowest level since 2012 (U.S. Institute for Supply Management). Foreign direct investments (FDI) to the United States also help to boost innovation and create jobs. However, the flow of FDIs to the United States has dropped sharply over the past two years especially the investments from China (OECD).

In addition, U.S. importers and consumers have absorbed the higher prices. For, China’s exporters tend to maintain prices, either because they cannot offset the tariffs costs or are confident that downstream purchasers cannot or will not accept another product from a different source. As the Trump administration passes the higher costs of Chinese goods to U.S. importers and consumers, U.S. consumers spend additional $600–900 per year on goods due to the tariffs. This also includes the effects of tariffs imposed on other regions and countries, such as the European Union and Japan, which have led to increased prices for intermediate and finished products of around 10–30%. Structurally, Washington’s putative tariffs also counter the impact of deregulatory policies, like the tax cuts and the jobs act of 2017. According to the National Foundation for American Policy, all U.S. tariff costs might well exceed the total benefits of all deregulatory efforts carried out by the Trump administration since 2017. If the trend continues, all tariffs costs are estimated to be triple the value of the benefits of all deregulatory efforts. Hence, whatever trade deal the United States negotiates, it will take years for the U.S. economy to compensate for the tariff costs (American Economic Association and National Bureau of Economic Research).

In contrast, China appears to be more resilient against U.S. punitive tariffs, which on average increased from 3.1% to 21%. While the trade surplus with the United States has strongly declined but remains on a relative high level, China could still widen its overall trade surplus to 377.6 billion from 294.1 billion during the period from January to November 2019. While exports to the U.S. have dropped 12.5% and imports from the U.S. have slipped 23.3%, China has significantly increased exports to and imports from the ASEAN countries by 18.0% and 11.8% respectively. There are several explanations for China’s resilience and ability to rebalance trade so rapidly. According to the Peterson Institute for International Economics (PIIE), China has increased counter tariffs from 8.0% to 20.7% on $120 billion worth of U.S. goods. To mitigate the negative impact of higher prices for China’s importers and consumers, the Chinese government has sought to increase tariffs on goods that Chinese importers can potentially source from other countries and regions. For those third countries and to lower the burden for the importers, Beijing has decreased existing tariffs from 8.0% to 6.7% on average. In comparison, the United States has found it much more difficult to find alternative countries from which it can source goods due to China’s increased competitiveness and the U.S.’ reliance on China.

In addition, although Washington might have primarily sought to punish China’s state-owned sector, 90% of the companies in China impacted by the tariffs are from the private sector, and over 60% are foreign-owned companies — that is, mostly U.S. and European multinational companies and smaller businesses. Foreign businesses are severely impacted by both Beijing’s counter tariffs on U.S. goods and U.S. tariffs on goods imported from China. Two third of U.S. imports from China come from foreign-owned companies (PIIE). According to a survey carried out by the European Union Chamber of Commerce in China, large firms have been largely able to side-step the intended impact, while smaller firms must endure the impact by absorbing the costs or passing them on. Only 6% of the surveyed companies responded that they have moved or are in the process of moving productions out of China — mainly to Southeast Asia and India. In contrast, 68% of European businesses have decided to stay in China. Although a rather small number of businesses have shifted investments out of China, roughly the same number are increasing their investment in China, adopting an onshoring strategy to avoid U.S. tariffs altogether. A survey conducted by the U.S. Chamber of Commerce in Shanghai confirms similar experiences, but U.S. firms tend to be more pessimistic and more likely seek to change their investments in China. Over a quarter of 333 firms, who participated in the survey, have redirected investments originally planned for China to other locations in the past year. Such development suggests that the trade war has not only failed but also overshot its goal. It threatens the business models of large Western multinational companies and severely disrupts global supply chains.

Nevertheless, the trade war has taken a psychological toll on China’s consumer and business confidence. China was in shock when the Trump administration imposed the first round of tariffs in 2018. Initially, stocks markets in Shanghai and Shenzhen plummeted, but they rebounded fairly quickly. However, business confidence remains pessimistic, and Chinese exporters hit by U.S. tariffs experienced increased pressure on their profit margins and liquidity despite Beijing’s carefully orchestrated countermeasures. However, the effect of the trade war could have been worse without Beijing’s long-term structural changes. According to a McKinsey & Company report, China has reduced its exposure to the world. China has significantly increased its domestic consumption to 76.2% as share of GDP and thus decreased its overreliance on exports and investments over the past years. China’s exports to the United States decreased from 11% to 4%, and its total export as share of GDP decreased from 36% to 18%, which is significantly below the OECD average of 29% — with export ratios as high as 50%, as in Germany’s case — but still higher than the United States’ export ratio. Still, those structural changes — in addition to China’s comparative advantage and increasingly innovation-driven economy — have helped the Chinese government mitigate some of the trade war’s negative impacts and provides space for negotiation. China’s economy could also benefit from the 6.0% depreciation of the RMB. However, it is unlikely that the phase-one agreement will improve confidence and release the pressure on China’s economy. According to PIIE, average US tariffs on imports from China will only drop slightly from 21.0% to 19.3%, even after the agreement is implemented, which is expected for February 2020. US tariffs would be still six times higher than before the trade ware. With 11.4% of global trade, China is the world’s largest trading nation and will remain vulnerable to US unilateralism.

In addition to the trade war and despite the truce, U.S. continues to rage a war against the international rules-based trade system and especially the WTO. The anti-WTO campaign, which is also directed against China, already began before President Trump’s election in 2016. WTO members, including the European Union, India, and China, have made proposals to reform the WTO’s dispute settlement understanding and working procedures in the past. However, successive U.S. administrations have refused to engage in any reform. As the United States has continued to block the appointment of the Appellate Body and its judges, the WTO’s dispute settlement ceased to be operational on 11 December 2019. The Appellate Body, which is WTO’s core function, can still hear new appeals, but it can no longer settle disputes between countries. The Trump administration assumes that the United States will be better off not in a rules-based system, where an international court makes nationally binding decisions, but in a power-based system through which it can impose tariffs and other punitive measures directly if Washington feels unfairly treated. The United States strongly supported the establishment of the WTO in 1995 and, later, China’s accession to the WTO in 2001. The United States benefited tremendously from low trade barriers and, thus, easier and cheaper access to other markets as long as the United States could sustain its comparative advantage as an innovation-driven economy. Since China has moved up the value chain, successive U.S. administrations have prioritized filing complaints and, eventually, blocking the WTO’s reform and appointment procedures. The United States and the European Union argue that China does not follow the WTO’s rules, and they no longer accept China’s status as a developing country, which would otherwise formally allow China to continue protecting its domestic economy.

Although the European Union does not agree with the Trump Administration’s unilateral and protectionist approach, it still agrees with the criticism raised by the Trump administration. In 2016, China’s FDI in Europe reached a record high and had increased over 17 times from 2010 to 2016. This was a symbolic moment and a warming about China’s competitiveness and unstoppable rise and the West’s relative decline. Since that time, the European Union increasingly joined the U.S. criticism of China’s insufficient reforms concerning issues such as foreign investment restrictions, state subsidies, and the role of state-owned enterprises, intellectual property rights protection and enforcement, public procurement, non-tariff measures and other technical barriers, reciprocal market openness, and the transparency of currency management guidelines. The West has also accused Beijing of failing to implement and enforce previously agreed-upon reforms, especially in relationship to China’s WTO membership. China’s lack of an independent judiciary causes the West to doubt the sustainability, transparency, and robustness of China’s reforms. President Xi is rather seen as a successor who has slowed down and rather reversed the reform process. As a consequence, some bipartisan political voices in the United States and in the European Union, supported by the general public and media, no longer trust China’s reforms and intentions and label China as a national security threat. As of the end of October 2019, more than 200 Chinese companies and organizations, including Huawei, were on the U.S. Commerce Department’s entity list, which are foreign parties that are subject to export controls. The European Union has also introduced an EU-wide screening coordination policy to restrict Chinese investments in Europe. Although many of these claims are legitimate and their implementation would benefit China’s economy and development in the long run, the trade war and its imposed speed and scope of change are the wrong approach to rebalancing international trade and achieving a new equilibrium between the three economic blocs of China, the United States, and the European Union. Such an aggressive approach remains ignorant of China’s idiosyncratic development that remains best suited for the country, especially against the backdrop of an uncertain and volatile future and a liberal democracy that responds ineffectively to today’s disruptions. China will make concessions concerning trade, but it will stay firm concerning its technology roadmap and political system.

Now, the WTO’s breakup is symptomatic of the relative decay of the old international order led by the United States and the Western nationalist, protectionist and populist regression toward an unattainable past. The breakup of the WTO is also an opportunity to deeply reform the international trade order and define an efficient and effective multilateral, rule-based system that gives more weight to the rise of China and the Global South. The new order must balance the demand for growth, digitalization, social cohesion, and stability with the preservation of the environment. This new institution must level the playing field and erode profits derived from anticompetitive practices while encouraging markets and competition. It must find a mechanism to balance national interests and global trade and openness as well as the different stages and speeds of developments. Tariffs must be avoided, and dispute must be brought back to an international dispute settlement mechanism. However, the development of such a new multilateral order will take 10 to 20 years. In the meantime, we risk slipping into a new dark era in which might once again makes right. This period will be likely one of steady high tariffs and other forms of protectionism and slow global economic growth and development. This era is less determined by of a clash of civilizations than a clash of capitalisms. Still, the pursuit of profit and technological progress remains the most powerful way to increase efficiency and wealth, but the powerful blocs have diverging approaches to dealing with disruptions and defending their interests.

Not only the trade war, but also the fierce competition over technology leadership, increasing technology nationalism and decoupling, the proliferation of cyber technologies used for espionage and low level cyber–physical disruptions, already undermine the opportunity for international cooperation and governance. On this downward spiral, the United States has not only become the main source of global instability and uncertainty, but also risks becoming isolated and severely compromising its technology leadership. China is not responsible for the behavior of the United States but bears a great responsibility for altering the global, Western-led order. Its system has worked well for China, but for emerging economies, it might have negative effects, as such countries lack China’s culture and history of enlightened authoritarianism. China must also prove that it is able to deal with periods of low growth and recession, which the country hasn’t experienced since reform. Europe with its new “geopolitical commission” remains sandwiched between a protectionist United States and an assertive China, as it lacks integrity and unity, but Europe is most experienced with the benefits and drawbacks of a multilateral order. China’s rise will be the most significant game-changer for the future of the global order, but the United States and Europe do not understand the implications of China’s rise in the same way. While the West fears the differences, the three powers have more similarities. What unites them is the pursuit for shared prosperity, dignity, and sustainability, as well as for a new multilateral order.

Note: This article (Chinese version) is an extended and revised version of a speech given by Thorsten Jelinek at the European Parliament during a public debate on 5G, cybersecurity, and trade disputes on 16. October 2019. Thorsten Jelinek is as a director and senior researcher at the Taihe Institute.