Is a trade war brewing, and why?
There are fears a global trade war could be on the horizon - what is driving protectionism, as described by the International Monetary Fund’s MD Christine Lagarde, and the resulting tit-for-tat tariff changes?
In January, President Donald Trump announced tariffs on washing machines and solar panels; the first of many tariffs on a variety of goods announced by both Trump and Chinese President Xi Jinping.
While Trump would like to reduce the US trade deficit with China that reached $375 billion in 2017, the proposed tariffs are an attempt to address China’s intellectual property (IP) and technology transfer policies.
Are tariffs the solution?
The trade imbalance and alleged unfair treatment of US companies in China are clear issues for the US economy, but are tariffs the solution? Trade brings countries together, but there’s more to the relationship between the US and China – trade, manufacturing and the price of goods are all important, but the US relies on China for diplomatic cooperation. China is also a large holder of US debt.
“When you put a tariff on a Chinese good, you’re taxing a US consumer to make them buy something domestically produced,” said Johan Gott, principal at A.T. Kearney. “It’s a double-edged sword where you hurt your own and the other country’s economy. The heart of the issue is a way for the US to tell the Chinese government that we don’t like how you’re doing business and this is a way to do that.”
The Section 301 tariffs imposed by the US government are intended to address IP infringements which have been an issue for the US business community for years, if not decades. Even so, trade has introduced lots of products to Americans and Chinese consumers alike and has been a sign of the progress between the US and China.
Disrupting this relationship could be at a great cost. Trump has the power to institute tariffs at will, and markets have become volatile as the country waits for action or inaction on his part.
An end to ‘Made in China’?
As of early April, both countries have targeted about $50 billion worth of the other country’s products. China proposed tariffs on 106 products, and the US targeted about 1,300 Chinese exports that are part of China’s “Made in China 2025” industrial plan.
These tariffs will increase costs for consumers and be absorbed by corporate profits. Increased prices of US goods in China will provide incentive for Chinese consumers to buy elsewhere, with the same effect expected for American consumers.
There’s a scenario where you can swap suppliers and buy from Brazil and not the US.
Along with higher prices for electronics for US consumers, there’s also a considerable impact on US agricultural products, of which China is a large buyer.
“There’s a scenario where you can swap suppliers and buy from Brazil and not the US, for example,” said Johan. Since many of the agricultural states tend to vote Republican, “it hits states with Trump’s core voters, which is another attractive aspect of the Chinese to strike back.”
Foreign Indirect Investment in China
American companies choosing to do business in China have difficulty making a direct investment. To break into the Chinese market, a company has to do a joint venture with a local Chinese company.
As there were over 51,000 state-owned enterprises in China at the end of 2015, according to the OECD, these joint ventures are typically not with private companies but rather, the Chinese government.
There’s another big catch to setting up these joint ventures. “In order to sell in China, many companies have to surrender their patents,” said Charles Kane, CPA, Senior Lecturer of Technological Innovation, Entrepreneurship and Strategic Management at MIT Sloan School of Management. “China uses such patents to create competition in their own market with Chinese-based companies.”
China has a lack of legal due process, and those patents can be abused, used and reused. For those American products that are manufactured in China, similar Chinese-manufactured products are sold within China to service their own citizens, but they are sometimes sold overseas, explained Charles.
The Chinese reengineer the patent to take advantage of a huge long-term investment.
Companies with limited competition are better able to maintain control of their patents. Boeing is part of a duopoly, for example, and as such, is the only company that’s been able to do business in China and continue to hold their patents, said Charles: “They had the leverage to insist upon not giving up their patents, and the Chinese had no alternative because there’s no other companies in the world [that manufacture commercial airlines] except Airbus.”
Different industries are impacted more than others, like biotech or drug manufactures. “When they produce a patent in the drug industry, the ingredients are part of the patent and the Chinese reengineer the patent to take advantage of a huge long-term investment,” he said.
The Problem of US IP
China has opened its markets but is not yet a pure free market because of various restrictions. An American company choosing to do business in that market is doing so on its own volition and agrees to these restrictions.
For one reason or another, American companies make a choice to turn over their technology to get access to the Chinese market.
Not every country shares the US patent or copyright regime, and these tariffs could be construed as the US imposing its IP law on other nations, said Edward Stringham, President of the American Institute for Economic Research and Davis Professor of Economic Organizations and Innovation at Trinity College.
Many have argued in the past few years that American IP laws are overly strict and attempt to grant a monopoly status based on first to file.
The Apple and Samsung lawsuit, for example, is an extreme case that continued for years before settling. “They’ve given up and agreed to stop suing each other, and American courts have decided they were too strict in enforcing the IP laws,” said Edward. “Maybe it’s an international trend where it’s not necessarily the case that how courts ruled in America should be enforced everywhere.”
How IP is treated in the US has been slowly changing because sharing technology secrets can drive innovation. In 2014, Tesla gave its patents to the public domain to encourage other companies to advance its technology and build electronic cars. Opening patents will help Tesla make electronic cars more mainstream.
The same idea has existed in the software industry since the late 1990s, as many companies make their source code available for others through open-source software (OSS). This allows others to study, change and enhance software in a collaborative, public manner.
Read part two of this article: Can businesses build relationships that politics can't?
About the author
Andrea Murad is a New York–based writer. Having worked on both Wall Street and Main Street, she now pursues her passion for words. She covers business and finance, and her work can be found on BBC Capital, Consumers Digest, Entrepreneur.com, FOXBusiness.com, Global Finance and InstitutionalInvestor.com.