Media  Global Economy  2018.09.06

US-China trade war, a hurdle set too high by Trump - "Threat" to raise tariffs may work on allies but not on China

The article was originally posted on Webronza on August 22, 2018

The Vice Minister of the Ministry of Commerce of the People's Republic of China (MOFCOM) will be visiting the US from August 22 to 23 to hold talks with the Under Secretary for International Affairs of the United States Department of the Treasury (USDT). It has also been announced that trade talks will be held at meetings of the November APEC Economic Leaders' Meeting, etc. that will be attended by the leaders of both the US and China.

Foreign diplomacy and domestic affairs are like two sides of the same coin

People might think that foreign diplomacy and domestic affairs are different things, but in fact they are like two sides of the same coin.

If there were no beef producers in Japan, probably no one would object to eliminating tariffs on beef. The elimination of tariffs would only lead to the advantage of lower beef prices for consumers and no disadvantage related to reduced beef production. Even the Ministry of Agriculture, Forestry and Fisheries of Japan, which is well-known to provide stiff opposition to tariff elimination, has accepted a reduction and elimination of tariffs on products that are not produced within the country.

Diplomatic results must be convincing to those concerned as well as to the public. If the results were expected to ultimately damage certain industries, domestic measures would have to be taken to elicit the support of those industries.

Until today, efforts had always been made when negotiating trade liberalization measures, such as tariff reductions etc., to minimize any expected negative impacts on vulnerable domestic industries. If there were any concerns over the impact of such measures after the implementation of any agreement, domestic measures were always taken. Some cases of this include the liberalization of products such as beef and oranges, the Uruguay Round of the General Agreement on Tariffs and Trade (GATT), the Trans-Pacific Partnership (TPP) negotiations, etc.

Long ago, in the textile negotiations to reduce Japanese textile exports to the US in exchange for Okinawa's reversion to Japanese administration, measures were taken to buy up unneeded looms and provide relief financing to the textile industry. In areas other than trade, when the 200-mile fishery zone was established, restructuring measures were taken to reduce fishing vessels and bail out fishermen who had lost their fishing grounds.

In the current US-China trade war, the Trump administration has also taken a 12 billion dollars agricultural bailout to protect farmers against China's raising of tariffs on US soybeans and other farm products. In this way, foreign diplomacy is never separated from domestic issues and is carried out considering the needs of the people concerned within the country.

"Tariff" threat that was effective against the European Union (EU)

President Trump has often been saying to his supporters that "tariffs are a good thing because threats to raise tariffs can extract concessions from trading partners that cannot afford them."

A good example of this is the agreement with the EU. Trump emphasizes that when he proposed to raise tariffs on cars imported from the EU, the EU "promised to work towards zero-tariffs on non-auto industrial goods and increase soybean imports" if the US stopped raising automobile tariffs. He would also probably say that when he proposed raising tariffs on Japanese cars, Japan responded with lower tariffs on beef. There is no question that Trump is employing tariff increases as a means to extract concessions from trading partners.

The EU's promise to expand soybean imports have so far been meaningless or without any substance. Where's the beef? (refer to "Trump's bailout of agriculture having the opposite effect"). However, touting this promise may remain effective for use in stump speeches to current Republican Party supporters who believe whatever Trump says, at least until after the midterm elections.

Regarding the negotiations starting on August 22, Trump would likely want to say that "China, just like he envisioned, has come to the table to negotiate matters in exchange for tariff increases." However, China's situation is different from that of the EU, which is in a political and military alliance with the US.

US-China negotiations will not work the same way that they did with the EU

Firstly, the EU acquiesced when Trump asserted that US tariffs on European cars would be raised, though tariffs have not been imposed. Trump only used the specter of tariff increases as "threats" to gain benefits without conceding (this is how he can explain it to his supporters).

However, with China, both the US and China are imposing retaliatory tariffs and have entered into a full-scale trade war.

China would likely claim that the US' one-sided tariff increases obviously violate the rules of the World Trade Organization (WTO) and that if China were to stop raising tariffs, the US should also undo its tariffs. The context of the negotiations is different from that with the EU.

The trade negotiation style that Trump has in his mind is that of the 1980s and 1990s taken against Japan. Being under the umbrella of the Japan-US security pact, Japan could not forcefully resist the US, having to ultimately submit to most of its demands. The current United States Trade Representative, Robert Lighthizer, also served as an official in the US-Japan trade negotiations of that era.

At first, Trump may not have anticipated that China would retaliate. He probably thought that China would simply concede as the EU had if he merely just threatened that the American economic superpower would raise tariffs. It was a big miscalculation.

Consequently, negotiations now take the form of the US also having to make some concessions in exchange for China's conceding of intellectual property rights, etc. It would be difficult to have Trump's supporters understand such concessions, as Trump has been repeatedly saying to them that China was the one at fault.

Conversely, if negotiations end up with only China making concessions, Xi Jinping in return would not be able to explain this favorably to China's Communist Party and public.

Is it possible to significantly reduce the US trade deficit with China?

The more important thing is that the US-China trade war will not come to an end as long as negotiations produce results that make it difficult for Trump to advocate to his supporters and the American public that "China has conceded."

Trump himself has set two high hurdles as negotiation goals. He will have to show the American public that China has cleared these hurdles.

The first hurdle is to significantly reduce or eliminate the trade deficit with China.

Trump's view is simple. In bilateral trade, the US is a winner if it is in the black, and a loser if in the red. What's more, if in the red, Trump blames the trade partner for taking advantage of the American people's generosity.

The US will probably demand that China lower its tariffs in order to expand the amount of goods that China imports and that the US exports. However, this would mean that China would have to unilaterally reduce tariffs, since US tariffs are already low. Moreover, unless a free trade agreement is concluded between both countries, China would be compelled to promise tariff reductions to other countries as well. If other countries then also increase their exports to China, US exports to the country may not necessarily see any significant increases.

Conversely, what measures would there be to reduce US imports and China's exports?

If the US sets higher tariffs than it has promised the WTO, it would be in violation of WTO rules. Furthermore, the WTO forbids voluntary control such as that exercised by Japan with its car exports to the US in the 1980s (although it may be a gray-area within the WTO, it is not impossible to impose export duties).

The only remaining measure is currency. If exchange rates were to have a "weaker dollar and stronger yuan," China's exports would be curbed. This will virtually have the same effect as the US imposing additional tariffs of the same rate on all Chinese exports to the US and China lowering tariffs of the same rate on all US exports to China (items currently with low tariffs may have minus tariffs).

However, this is nothing else but making monetary policy subordinate to trade policy. Moreover, China would be deprived of major macroeconomic tools such as interest rate control, and would not accept such a demand that would wrest away one of the nation's sovereign rights.

The power struggle between the US and China cannot be hidden

The second hurdle is to forbid China's negligence of intellectual property rights and demand for technology transfer on foreign investments. To solve the issue, the US has probably decided to have the United States Department of the Treasury, and not the Office of the United States Trade Representative, negotiate with China.

As a way of solving this issue and trade deficits, there may also be the method of concluding a US-China free trade agreement on a similar level as the TPP agreement on tariff elimination as well as intellectual property rights and investments. However, if the US has nothing to concede, the agreement will end up with only China conceding. It is also doubtful whether China has the system to accept such a high level agreement, essentially meaning that it would be difficult for China to accept any agreement.

This issue has deep roots. China's rise, with the Asian Infrastructure Investment Bank (AIIB) and the One Belt, One Road initiative, has come to threaten the US' hegemony. Amid such an environment, a belief in the "China threat" theory that the US might one day be usurped by China is gaining ground among those in the US Congress and among American intellectuals, with China hard-liners gaining force as a result.

Furthermore, China has set the "Made in China 2025" program to establish itself as the world's top hi-tech manufacturing center by 2025. There is strong criticism that in executing the program, China intends to steal technology from the US through illicit means using investments, etc.

In other words, this is one aspect of the power struggle between the US and China. Trump must secure an agreement that would persuade the American people. Illusive tactics like those used in expanding EU soybean imports will not take effect.

Given the situation, I would have to say that it would not be easy to achieve an agreement that would enable the Trump administration to persuade the American people and likewise enable Xi Jinping to persuade the Chinese people. In addition, since one of the negotiation points this time around is trade balance, for the two leaders, who consider trade surpluses to be good and trade deficits to be bad, it would mean that what one side gains the other loses. In other words, they are playing a zero-sum game, not a win-win game that is beneficial to both sides. This situation makes it difficult to solve the issue.

Nonetheless, the Trump administration has decided to receive the Chinese negotiating team. It is thought that the administration would create a sense of weakness and urgency in shaking hand with China as soon as possible. I would like to explain such situation in my next report.

(This article was translated from the Japanese transcript of Dr. Yamashita's column in "Webronza" on August 22, 2018.)