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Trade Wars and Tariff Threats

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Trade Wars and Tariff Threats

June 20, 2018
Economy, finance, and budgets
Politics and law

Milton Ezrati joins Seth Barron to discuss President Trump’s talk of tariffs, China’s vulnerability in a potential trade war with the United States, and the history of the global trade order.

A tumultuous recent meeting of the G7 nations, trade disputes with Canada, and tariff threats against China all point to a shakeup of world trade. While the global economy would likely suffer in a trade war, Ezrati argues that the U.S. actually has the upper hand in trade negotiations with Beijing.

Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and chief economist for Vested, a New York-based communications firm. His latest book is Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live.

Audio Transcript

Seth Barron: Welcome back to 10 Blocks. This is Seth Baron, associate editor of City Journal. President Trump has shaken up the world's stage, especially on the topic of trade. Trump has alternated between advocating return to protectionism and tariffs and demanding that all developed nations eliminate all barriers to trade. Styling himself as the consummate deal maker, President Trump has certainly sent our trading partners on their heels with his unusual negotiating tactics. What is the real story on trade and what should we expect? I'm joined now by Milton Ezrati, a contributor to City Journal. Milton is a nationally regarded economist who’s had a successful career in the financial industry. Retiring as the chief economist for investment manager Lord Abbott in 2015, he now serves as chief economist for Vested. Milton is the author of Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live. He writes frequently for City Journal and has published in a wide variety of other publications as well. Thanks for joining us today, Milton.

Milton Ezrati: It's a pleasure to be here.

Seth Barron: Well, in two recent CJ articles for City Journal, “Why China Can't Afford a Trade War” and “Trump's Tariff Gambit”, you laid out the current landscape of trade from the American perspective, and you made an interesting point about China. You said that China is somewhat vulnerable. How so? I always think of China as being the gorilla that we can't escape.

Milton Ezrati: Well in some respects it is. It's a manufacturing powerhouse, and the United States buys a lot from China. I pointed to the vulnerability because China needs trade much more than the United States. In fact, its whole economic growth model is based on producing a manufacturing surplus for sale to the world, and the United States is a big chunk of the world. So they produce an enormous surplus of goods, whether it's concrete reinforcement bars, jet engines, team logo t-shirts, an iPad, an iPhone, assemblies. They need someone to buy them. They're useless to the Chinese unless they have a buyer, and the buyer is outside the country. So they are very much dependent on trade. They do not have a balanced economy, and in that respect, I said China needs the trade more than the United States. That's not to say the United States wouldn't suffer horribly in a trade war, but China is in a more vulnerable position because otherwise you just have things rusting in yards or piling up and becoming a storage problem.

Seth Barron: What percentage of the Chinese economy is export based?

Milton Ezrati: More than 20 percent of the Chinese economy is export based, and actually, I would suggest that it's actually higher than that. That's the standard calculation for gross domestic product, but the Chinese assemble a great deal. They import a great deal and turn around and sell it. And that number, that 20 percent, only captures the value-added, which is really very small. When you talk about jobs, when you talk about stability of their economy, it's a much larger percentage, although you can't measure that so readily.

Seth Barron: Now, China operates as kind of a command economy, right? Or it’s centralized more than the United States, correct?

Milton Ezrati: It's a communist country. It's planned.

Seth Barron: So I mean they've done things like build a dozen cities just out of thin air. Why couldn't they, say if they stopped exporting, just concentrate on building up a domestic infrastructure or domestic markets?

Milton Ezrati: Well they could, I suppose. But it would drive them into tremendous debt, and China already has an enormous debt overhang. If you're building and there is no one buying, and if you're going to try to jumpstart your economy by doing these major public works projects or building factories that produce for no buyers, they have to go for quite a period with no income. That means debt. China already has a huge outstanding debt: some of it private, some of it public, and some of it state-owned enterprises, and it's sort of a hybrid classification. So if they want to fill the gap from exports by building more empty cities and more train links to nowhere, that's going to bring them more debt and make them more vulnerable, ultimately.

Seth Barron: I've heard a lot, and I believe President Trump has alluded to this, that American companies, to do business in China, like high tech companies, are required to partner with Chinese companies and essentially turn over all of their trade secrets or their patents. To what extent is this technology transfer? Is this a real problem?

 

Milton Ezrati: It is. It’s not only a problem. That is the legal side of it. The Chinese also deal in industrial espionage, and I imagine other kinds of espionage as well. And it's not just U.S. companies. It's European companies and Japanese companies, and they want to get into that market either to sell their products or to take advantage of the relatively inexpensive labor. They are forced to do this, and they transfer the technology to China.

Seth Barron: So what can the United States do about that?

Milton Ezrati: Well there's not much we can do except to deny them the access, and I guess Trump is trying to do that with his tariff. Although it's a particularly clumsy way to go ahead, and I don't want to pile onto Trump, everyone calls him clumsy, but in this case I have to agree with them. It's kind of a clumsy way, or definitely a clumsy way to do it. We have been trying very hard to pressure the Chinese through these tariffs and other means to protect our intellectual property. It's very hard with the Chinese, but I would add that the Chinese put themselves at a disadvantage trying to get technology this way because it means that they're waiting for us for the next app. They've set themselves up to depend on us and the Japanese and the Europeans, and I suppose other countries that develop their own technology. They have set themselves up to wait for us for the next app, and of course that puts them always a little bit behind because by the time it's being applied in firm, it's already passé, and there's something else coming down the road. So again, the Chinese development model has put them at a position where they are dependent on us for their inputs or for their revenue, and I'm not suggesting the Chinese are weak, but they are vulnerable in a way that we are not.

Seth Barron: So what is the state of Chinese R&D? Do they spend a lot on research and development, and where is that going? Will they, at some point, surpass us or match us in terms of biotech, nanotech?

Milton Ezrati: They are spending a great deal, and they're trying to build on what they get from us, either in these transfers or outright theft. They are not stupid. They are moving ahead. This brings us to another problem with the Chinese command economy is that they move in a centralized direction. In March, the Chinese, at the party conference, they said their goal, and they listed the kinds of areas they were going to be in: smart cars, jet engines, biotech. It was all a list of the headlines from today. That means that they are already behind the curve because the headlines of today are not the things people will be working on in 10 years. So I'm not suggesting that the Chinese won't be able to make tremendous technological strides. They certainly have in space and certainly missile technology they have as well. But they are again following, their whole model is to follow us, maybe build on what they can get from us, and perhaps do some of their own research. But the vulnerability here is that it's completely centralized, so they're not moving in many directions at once. One of the glories of our system, and I say our I don't mean the U.S., I mean the capitalist system or the market-based system, is people are moving in dozens of directions, thousands of directions at once, most of which will fail. But we are going to tap the future that way. If you concentrate and build all these empty cities to pick a physical manifestation of what happens when you centralize, you're likely to miss the mark and create a great deal of waste in the interim.

Seth Barron: I see. They're like a giant ship that takes forever to turn I guess.

Milton Ezrati: Well they are, and they can only go in one direction at once. Whereas if you want to draw the ship analogy, you could say that the United States particularly, and Europe to some extent in technology, is a fleet of smaller ships all trying different routes, all trying different means to get from one place to another.

Seth Barron: Now China has set a goal for itself: “Made in China 2025”. What is that, and what are they trying to do?

Milton Ezrati: Well it is effectively this attitude of becoming an even bigger manufacturing giant than they are. It tends to be a little more high-tech. So China made their initial strides and economic growth by building cheap toys, some of them toxic at one time, and now they're trying to be a little more value-added, a little more high tech, and that's what concerns. This speech at the party conference talked about biotech to some extent, it talked about jet engines, it talked about hybrids, it talked about self-driving cars, and green technology, which china desperately needs. Those sorts of things, as I mentioned, are in the headlines today. That's where they're going. So if there's somebody working in some place in Austin, Texas, or Silicon Valley or downtown Manhattan on a new application that will revolutionize the way we think about things, the Chinese will be behind the curve because they're picking up today's headlines.

Seth Barron: I'd like to ask you just a little bit about debt. I've always heard this joke, like if you owe someone a thousand dollars, you're in trouble, but if you owe someone a million dollars or a billion dollars or a trillion dollars, they're in trouble. Well we owe China one or two trillion dollars, but who's in trouble? What can they do with that? I mean, are we reliant on them or they reliant on us?

Milton Ezrati: Well, they're reliant on us to pay them back. Now if the Chinese want to punish us, and everyone tells me, and I hear this over and over again in various conferences, “What if they sell the debt?” Well, what if they sell the debt? There will be a buyer. The yields will go up. In other words, the United States will have to pay more to place the money, but it's not like they're going to sell the debt and we have to pay them back. They can't demand payment before the contract says, “The United States pays them on the debt”. If they sell it, they have to sell it to someone else to be rid of it. They can't come and say give us back our money. We may have to pay a higher interest rate. The United States now is actually paying, as a portion of the budget, almost a record-low amount to support the debt. Of course it would strain our budget. We'd have to pay more interest ultimately. That’s all the Chinese can do. The Russians have already begun to sell U.S. government debt, probably because it's not as good an investment as they thought. The Chinese could do the same. It would burden us. It would marginally increase the strain on the U.S. budget to pay that interest to someone else. The person that bought the debt at a lower price, that is a higher rate of interest than the Chinese did. They would take a great loss in the process.

Seth Barron: The Chinese would?

Milton Ezrati: Yes, the Chinese would.

Seth Barron: Oh. Let's go to the other side of the world now. Well the G7 conference, which just broke up last week or two weeks ago, left everyone with the impression that Trump had just torn up the so-called post-war order. Now you said some very provocative things about the post-war order in your piece. Can you elaborate on what you think about the post-war order and what it means?

Milton Ezrati: Well there is no post-war order. There are a lot of people, a lot of our trading partners, who have said that you're going back on the post-war order that the United States built. I think there was a headline in the New York Times that said that Trump upends the post-war trade order. There have been at least two post-war trade orders. Shortly after the Second World War, in fact for decades after the Second World War, the United States pushed for widespread trade reduction, universal trade reduction. Under the general agreement to terrorism trade, which is the precursor for today's World Trade Organization, Washington effectively forced other nations, used its economic heft to force other nations, to reduce tariffs and to reduce trade restrictions universally across the board. The last of these was the Doha round. They were called rounds, these negotiations. The Doha round, which failed early in this century, but really that post war ordered died in the 1980s when the United States and Europe in particular started to move toward what are called PTAs, or preferential trade agreements. And these are what NAFTA is and the European Union is, and the trans-pacific partnership wanted to be. They do seem to make trade freer, but it's only for the signatories. For the people outside these agreements, sometimes when they're done, the tariffs or the barriers get higher. The European Union is a perfect example. They have tremendous barriers for agricultural goods that the United States has been trying to break into you for years. That wasn't always true. But when the European Union formed its proprietary trade agreement, or refined it, they kept U.S. agricultural products out. NAFTA, for instance, which everyone talks about, is a great free trade agreement. It's great for Canada, the United States, and Mexico. We have free trade. The rest of the world is excluded, and they do not get the same rights. They do not get the same preferences. So as the world moved from this universal approach that was done actively under the Truman, Eisenhower, Kennedy, and even Johnson administrations, it moved in the 80s toward these preferential trade agreements. The old order died, and we have a new order. Now Trump seems to be playing on both sides. Forgive me; this is a big subject for me. I get excited about it. Trump seems to be moving on both sides. He talks about wanting to play the preferential agreement but get the United States a better deal, which is the renegotiation and NAFTA, and the talk about the trans-pacific partnership as a bad deal. There's that, but when he left the conference he did say a throwaway item. He said, I want to reduce tariffs and trade protection; I want to reduce trade barriers and subsidies across the board, around the world, everywhere. This was a hint that his real objective, or at least one of his objectives, and who knows where he really wants to go, is to go back to the original trade order that the United States pushed. I don't know where he's going, he doesn't confide in me. I don't think he confides in anybody. He might not even confide to the man in the mirror, but he doesn't confide in me. But he certainly has upended the status quo, but there is no post-war trade order to upend. It's been upended.

Seth Barron: Okay, but in terms of the tariffs that exist, Trump said, well we have a terrible position visa v the other members of the G7. And everyone in the media, or many people in the media, said he's lying, he's misrepresenting things. But what is the status of our, I mean you said we have free trade with Canada, but then it seems like well when it comes to dairy products there are exceptions. In your piece for us, you went through the different levels of trade and so forth between the different countries. I wonder if you could elaborate on that.

Milton Ezrati: Well Canada is an example, and this was actually put in the original NAFTA agreement. There are quotas effectively. Canada will take so much dairy into Canada, U.S. dairy into Canada, and when we get above a certain amount, then the tariffs skyrocket. That was written into the preferential trade agreement, and Trump may be referring to that. My summary on this is that both parties are right. When the Europeans and the Canadians say, well you have a lot of tariffs too, the United States has outrageous tariffs on sugar and other commodities, they're correct. And when we say to them, you have tariffs on your precious commodities, we're correct. We tend to be a little more selective in terms of when we describe ourselves, and they, when they describe themselves. So yes, there are tremendous tariffs built into this. Every country tries to tilt the tray, the playing field, for a favored industry. And Trump is right, and they're right. And he's not wrong in what he points to, but he's very selective.

Seth Barron: Well looking at both the G7 and China, people are talking about the possibility of a trade war. Do you think we're going to have a trade war and what would that mean?

Milton Ezrati: Well I'm hoping we don't have a trade war. I don't think we are because that's just too unthinkable. If we get into a trade war it could be devastating for the global economy. I don't think anybody in the G7 or the Chinese or President Trump wants a trade war, and I think everyone is well aware this would be devastating. Some countries would do better than others. I compared the United States with China. The United States actually is better positioned than most in a trade war, but that doesn't mean it wouldn't hurt us terribly. We would have a recession, and if Mr. Trump is listening, it would it would reflect badly on your electoral chances if we had a trade war. So I'm hoping we don't have a trade war. What worries me is not that people are aiming at a trade war, not that Trump is a lunatic and wants trade war, not that the Chinese want a trade war, they certainly don't. They know how vulnerable they are. My fear is that like military confrontations, these things can take on a life of their own and go to where no one wants to go. That's the fear in this environment. Trump and all the other people who say they're going to retaliate are playing a very dangerous game, and Trump, yes, he started this game.

Seth Barron: Wow. Well that was an illuminating conversation. We would love to hear your comments about today's episode on Twitter, @City Journal with #TenBlocks. If you like our show and want to hear more, please leave ratings and reviews on iTunes. Thanks for listening, and thanks Milton for joining us.

Milton Ezrati: It's a pleasure to be here

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