Media  International Exchange  2017.04.19

Will the U.S. and China go into economic warfare under the Trump administration? A problem for Japan rather than the two countries between which mutually-assured economic destruction is established

An article published in JBpress on February 23, 2017
Mutual assured destruction

There is a technical term in security called "Mutual Assured Destruction (MAD)." MAD assumes that if two opposing sides both have a massive number of nuclear weapons and that either side, if attacked preemptively by the other with nuclear weapons, would retaliate with equal force.

Unless one side making the preemptive strike completely destroys the other side's nuclear weaponry on its first attack, the other side would retaliate with nuclear weapons, also causing a devastating blow to the first attacker.

Therefore, both sides having massive numbers of nuclear weapons confirms that if either side makes a preemptive attack using nuclear weapons, both sides would eventually be completely annihilated. This concept is what is known as MAD.

Theoretically, direct military conflicts do not occur between countries in which MAD has been established. This is one of the important objectives of the nuclear strategy called nuclear deterrence.

MAD established in U.S.-China economic relations

Looking at U.S.-China economic relations, it seems that a similar relationship to MAD has been established.

If the United States wages an economic war against China by sharply raising the tariffs on goods imported from China or by taking steps toward imposing sanctions after certifying China as currency manipulator, China will also retaliate against the United States.

Some retaliatory actions that can be considered are boycotts of American cars and PCs, setting fire to and throwing stones at American supermarkets and department stores, and excluding American consulting, accounting and law firms from participating in the bidding process for projects run by Chinese government institutions and state-owned companies.

All of these problems have been faced by Japanese companies immediately after the emergence of the Senkaku Islands dispute.

The damage suffered by most Japanese companies due to these boycotts of Japanese goods after the Senkaku Islands dispute emerged lasted for two to three months or for several months at the longest, after which the incident calmed down.

Moreover, due partly to the local Chinese governments' desperate efforts to prevent the withdrawal of Japanese companies that had greatly contributed to supporting local employment and tax revenues, Japanese companies were not forced to withdraw in large numbers on account of the Senkaku Islands dispute.

However, if by any chance the economic war between the United States and China should grow serious, and such retaliatory measures as mentioned above are prolonged or escalated, it would be highly possible that American companies will be forced to withdraw from the Chinese market or scale down their operations. This will deal a huge blow to the U.S. economy.

If China takes severe retaliatory action against the United States, the Trump administration would probably impose harsher economic sanctions and wage a trade war against China. As a result, the economy of both countries will suffer serious damage, leading to lower growth rates and higher unemployment.

Anyone can easily imagine such a worst-case scenario. I may be justified in saying that mutually-assured economic destruction has been established in the relationship between the United States and China.

Differences between Japan-U.S. economic relations at the time of Japan-U.S. trade frictions and current U.S.-China economic relations

Looking at specific economic indicators (International Monetary Fund (IMF) World Economic Outlook, October 2016), China's gross domestic product (GDP) in comparison with the GDP of the U.S. was 61 percent in 2016 and is expected to reach 75 percent in 2020.

In the midst of the Japan-U.S. trade frictions in the 1980s and 1990s, Japan's GDP in 1990 was 52 percent of that of the United States (25 percent in 2016). China's GDP has already greatly surpassed this percentage and is rapidly approaching the same level as the United States.

In 2016, the amount of U.S. imports from China accounted for 2.1 percent of the U.S. GDP, while the U.S. trade deficit with China accounted for 1.4 percent. In 1990, U.S. imports from Japan accounted for 1.5 percent of the U.S. GDP and the trade deficit accounted for 0.6 percent. Comparing these trade imbalances, the impact of China greatly surpasses that of Japan in 1990.

Furthermore, the key difference between Japan and China is the high level of openness of the Chinese domestic market. The Japanese domestic market has been extremely closed since the high-growth period and Japan has been consistently reluctant to accept direct investment into the country by foreign companies.

In contrast to this, China has achieved rapid economic growth leveraging aggressive foreign investments brought about by the open market. China's inward direct investment in 2016 was 1.1 percent of China's GDP. On the other hand, Japan's inward direct investment in 1990 was a mere 0.06 percent of Japan's GDP.

As a result, only a few U.S. affiliated companies, such as IBM Japan Ltd, Coca-Cola (Japan) Co., Ltd., and McDonald's Holdings Co. (Japan) Ltd., succeeded in Japan. On the other hand, car sales in China last year by U.S. companies, mainly General Motors Company and Ford Motor Company, reached 2.96 million vehicles (Japanese car sales were 3.79 million).

Wal-Mart Stores, Inc., operator of the leading American supermarket Walmart, has opened 439 stores in 189 cities in China as of the end of 2016. Other leading U.S. giant corporations reaping huge profits from the Chinese market include Apple Inc. (smartphones, PCs), Caterpillar Inc. (construction machinery), Corning Inc. (glass), Pfizer Inc. (pharmaceuticals), and Procter & Gamble Co. (detergents, cosmetics, etc.).

If it had been Japan that had boycotted U.S. products in the 1990s, the United States would not have been affected, but if China were to start boycotting U.S. products today, the losses for U.S. companies would be incalculable, also causing a serious impact on the U.S. economy itself.

Additionally, Japan, being dependent on the United States for security, gives special consideration to Japan-U.S. relations. However, China is completely independent from the United States, and any U.S. squeeze similar to that on Japan will not have the same effect on China.

The possibility of China taking drastic measures in retaliation to tough measures taken by the United States is high. The Trump administration should give every possible consideration to this point.

Given the above U.S.-China economic relationship, it is expected that the governments of both countries, as long as they are cool-headed, will recognize that waging economic war would be too big a risk to take for either side and will mutually avoid such situation.

Should these two major countries ignore cool-headed decisions and plunge into an economic war, the world economy will be subject to a greater shock than the 2008 financial crisis, rekindling the European financial crisis and currency crises in emerging markets, with a distinct possibility of heading for another great depression.

In the hope that such situation will not occur, Japan, which has close ties with both countries, should assume the role of encouraging mutual understanding between both countries and cool-headed decisions to avoid such situation.

In the meantime, the U.S.-China Strategic and Economic Dialogue (S&ED) is held every year, and high-level exchanges occur between senior leadership figures representing the governments of both countries. There have also been personal connections stronger than those between Japan and China, as represented by those between Wang Qishan, member of the Standing Committee of the Central Political Bureau of the Communist Party, and Hank Paulson, former U.S. Secretary of the Treasury.

If the Trump administration and the Xi Jinping administration make good use of these connections, it is expected that mutual understanding can be sufficiently achieved.

Ways of Japanese economic strategy

Taking a look back at Japan's position, Japan is the third largest economic power in the world, maintaining particularly close relationships with both the United States and China. The shares of Japanese exports in 2016 by country were 20.1 percent for the United States and 17.5 percent for China, both countries, needless to say, being extremely important export partners.

In comparison with these two countries, Japan's domestic market (GDP) itself is small in scale (one-quarter of the U.S. and one-third of the Chinese markets) and furthermore is closed. Thus, a relationship of mutually-assured economic destruction does not exist between Japan and either of the two countries of the United States and China. If the same situation continues, then concerns remain about Japan's ability to deal with the risk of economic war contingent upon unforeseen circumstances in the future.

In order for Japan, which has a small domestic market, to have negotiating power similar to that of MAD with the United States and China, Japan will have to make greater contributions in the partner country's domestic market through employment tax revenues, and technological development by Japanese companies.

Japan must aim to establish a relationship in which the economies of both the United States and China would suffer serious damage should they exclude Japanese companies from their countries. In other words, the strengthening of win-win economic relations.

Perhaps, a similar relationship has already been established between Japan and China. Immediately after the Senkaku Islands dispute emerged, local Chinese governments adopted the attitude of properly protecting local Japanese companies to prevent them from withdrawing.

Since Japanese and Chinese media do not report these facts, they are not generally known, but measures taken by the Chinese government have played a great role in maintaining the stable economic relationship between Japan and China.

In order to further strengthen this relationship between Japan and China, it would be necessary for Japanese companies to continue expanding their investment in China. By so doing, Japan will be able to establish relations similar to MAD with no reliance on nuclear weapons by strengthening their win-win relations with China.

This will contribute greatly to maintaining long-term stability in the Japan-China relationship.

Although Japan and the United States are allies strongly bound by the U.S.-Japan Security Treaty, Japan's negotiation power is weak since Japan is dependent on the United States for security.

At least economically, continued efforts must be made to maximize the win-win relationship so that Japanese companies may be valued as being absolutely necessary to the U.S. economy by the U.S. public.

(This article was translated from the Japanese transcript of Mr. Seguchi's column published by JBpress on February 23, 2017.)