What is the future for US-China trade?
President Donald Trump has spent his first days in office focusing on trade relations with China and the US’s more than $300 billion trade deficit. Trump aspires to renegotiate this relationship as a way to create jobs that will make America great again.
Why is there a problem with American jobs? The US has evolved from a manufacturing to a service economy and is now an integral part of globalization, but many American workers have been left behind. Middle class wages have been stagnant in real terms for the last 15 years. Trump’s economic plan is more about bilateral versus multilateral trade agreements and protectionist policies like tariffs, both of which are contrary to globalization.
“The issue that’s come about is not really a recent phenomenon,” says Fariborz Ghadar, Professor at the Smeal College of Business at the Pennsylvania State University. Tepid global growth since 2008 has fuelled the growing protectionism, with Brexit, Trump’s election and a struggling Chinese economy helping to unravel the global economic interconnectedness. Since the Great Recession, a reduction in tariff rates and the spread of new free trade agreements has slowed as well.
While the conversation is long overdue, the US-China relationship is a complicated one. Overreaching in trade negotiations can have unintended consequences, says Amir Bagherpour, co-founder and Chief Political Scientist at giStrat, as the relationship embodies American trade barriers, Chinese trade barriers, American manufacturing, Chinese manufacturing, diplomatic cooperation, military confrontation risk and the price of goods. “[The US is] looking for a rebalance with limited consequences, but this could escalate into a trade war or a military confrontation in the worst case,” Amir adds.
China is growing
China is an economy with far larger clout than most countries and looking to build a greater political influence throughout the world. The country has evolved from an emerging market to a developing nation despite incomplete market reforms. The Chinese economy is now second behind the US economy — China’s GDP in 2015 was at $11 trillion in current dollars and the US was at $18 trillion, according to the World Bank.
“[China’s] economy has become less export dependent over the past five years and is more dependent on their own consumption,” says David Dollar, Senior Fellow at the Brookings Institute. With a developing middle class, consumption has become one of the driving forces of their economy, which presents opportunities for US firms to sell goods and services.
That 45% proposed tariff
Tariffs are protectionist measures that historically have not been good for a country’s economy in the long term. “Free trade has been a pretty bipartisan dominant part of US economic thinking since the Great Depression,” says David. “Prior to the great depression, we imposed very high tariffs, but our export industries declined and there was no net benefit to the US.”
A US tariff on Chinese imports would impact both economies negatively since China would likely retaliate with a similar action. In general, Chinese practice is to respond in the same arena, but that could always change.
Tariffs also affect companies. “The moment the tariff goes up at 10%, you’ll see the stock market attack companies that rely heavily on business relations with China,” says Patrick Van den Bossche, Partner and Board member with A.T. Kearney. The stock market will likely go down pretty quickly as investors up until now have counted on Trump improving the business climate. “These kinds of things on a global scale, you can’t plan out until you understand how everything is connected,” he adds.
The stereotype is that an American company will move its factories to China, but most US foreign investment is in the service sectors. “A lot of our important service sectors are global, but China is very restrictive about letting in those sectors,” says David. As a result, the US is missing a lot of opportunities.
Making a direct investment in China for a US company is hard to do, and companies can do it indirectly by building joint ventures with Chinese companies and by following the Chinese governments guidance on where to locate. “They have always been a little bit directive,” says Patrick. “Many companies will say they want to put a plant in one location and they’re directed to different areas to get something passed.” Companies that don’t do that may face antitrust sanctions, like GM’s joint venture currently is.
The US encourages investment with subsidies, and Chinese companies have invested recently in rural areas in Alabama and Texas where the locals haven’t seen investments in years, like the $1b+ new plant of Tianjin Pipe Corporation in Gregory, TX. “The moment they say that they’ll put down a plant and employ people, the local authorities could care less that it was a Chinese company,” says Patrick.
Are trade deficits bad?
If a country accumulates a trade deficit because they’re getting a lot of dollars, that trade deficit can correct itself through inflation, but China doesn’t want that to happen because this deficit keeps people at work. China has to recycle these dollars, and “at some point, they have to come back to the US because that’s where dollars live,” says Robert Salomon, Associate Professor of Management and Organisations at New York University’s Stern School of Business. The Chinese buy US treasuries, of which they currently hold about $1.0493 trillion. By buying US debt, which keeps rates down and makes things cheap for Americans, they subsidize the US consumer.
“It’s fine if you want to eliminate the deficit, but the reverse will happen,” says Robert. “As that money flows out and we start levying tariffs, interest rates will rise and things will get more expensive for Americans.” When Americans stop spending, companies don’t profit and then they don’t hire as much, creating the reverse effect.
American middle-class incomes
Blaming trade as the cause for a lack of wage growth is natural because of the number of shut down factories. While Trump has been pushing to bring back more manufacturing jobs, manufacturing has become automated and doesn’t require much labour. The US is a manufacturing power, but building plants require significant investment.
When looking at re-shoring and companies that are building new operations in the US, quite a few of those were from China. “There’s about $30 billion that Chinese companies have invested here over the last five years,” says Patrick. “In the US, there are about 100,000 to 120,000 people that are employed in manufacturing plants owned and operated by Chinese companies — if there’s a trade barrier, who knows what will happen to those jobs.”
The real issue is that having a dynamic open economy with a lot of change requires an effort to train people, says David, but moving from job to job and taking the time to get trained is a challenge for workers in a country still grappling with health care. A dynamic open economy has a lot of change that raises incomes, but there’s also a lot of anxiety and you need public policies to support that.
Renegotiating trade deals doesn’t do enough if the goal is to help the middle class. While Trump believes that the US isn’t getting a fair deal when it comes to trade, his aggressiveness is really a retreat, says Amir. “There’s a fine line between a retreat and selectively engaging — he’s very clear that this is protectionist and isolationist. The US is voluntarily relinquishing itself of its global power and that’s what Trump is doing. We’re no longer taking the lead — you’re in this for yourself.”