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Why China Can’t Afford a Trade War

eye on the news

Why China Can’t Afford a Trade War

Beijing is more economically vulnerable than it appears. June 5, 2018
Economy, finance, and budgets
Politics and law

China and the United States have agreed not to impose tariffs on one another—that is, not to engage in a trade war—at least while they negotiate a trade settlement. If the White House is to be believed, China has agreed to increase “significantly” its purchases of American goods, especially agricultural products. This is welcome news: China-U.S. trade, for all the restrictions and conditions placed on it (mostly by Beijing), reflects an economically symbiotic relationship. A trade war would damage both countries. But Chinese concessions up front are also significant because tacitly they acknowledge weakness, even as China tries to present an image of trading dominance.

Beijing’s clearest difficulty lies in its export-oriented growth model, which many in the West erroneously see as a strength. Because China overemphasizes manufacturing, it produces surpluses that get wasted unless its state-owned firms can sell them. Without buyers, stacks of rebar, jet engines, and the like will rust in factory yards, and iPhones and millions of team-logo t-shirts pose a storage problem. The structure depends on prosperity elsewhere to absorb Chinese products. Reports on China’s recent economic growth surge underscore this dependency: even China’s own statistical bureau pointed to the acceleration of growth in the United States and Europe as the cause of its spurt.

Observers who fear Chinese manufacturing capacity point to the West’s vulnerability in this area. Because the United States and other developed economies have lost so much productive power to China, they would face shortages should Beijing decide to withhold supplies. Chinese refusal to export its products would hurt the West, perhaps even precipitating a recession, but inflicting this pain would come at great cost to China. Its export-oriented manufacturing would stagnate, and so, accordingly, would its export-dependent economy. Socially, China would suffer as well. Beijing fears a recurrence of the riots that rocked the nation during the great recession of 2008-09.

Grand planning always carries the tendency to overreach. In the early years of this century, when China’s exports of cheap toys and shoes propelled its economy to double-digit growth, the nation’s planners assumed that the pattern would last indefinitely. They built huge infrastructure projects and factories, and housing for millions of new manufacturing workers. Then the economy changed. Vietnam used its lower average wage to overtake Beijing in shoe and clothing manufacturing. China then had to deal with the excesses of its building program and with the associated debt burden. When the hot industries of the moment give way to something else—as they inevitably will, either to changing demands or competition from other economies—China will again have huge surpluses and productive facilities that the world will no longer need.

Competitive markets can also create excesses, of course. The housing crisis of 2008-09 offers a painful example. But the risk imposed on individual players in competitive economies provides a check on how far excesses can go, relative to what can happen in a centrally planned economy. Grand economic plans can dazzle observers. In the past, they have filled the notebooks of astonished journalists returning from China, as they did for those returning from Japan in the 1980s. But once things change, that impressive marshaling of effort leads to more waste and a greater need for adjustment than in market-based systems, where caution and the absence of the ability to command resources so thoroughly limits how far out of alignment things can get.

Central planning keeps Chinese technology a step behind. In a strident two-hour talk given last month to the National People’s Congress in Beijing, Chinese Premier Li Keqiang repeatedly stressed industrial policies, emphasizing the “Made in China 2025” plan that emerged not long ago from the National Development and Reform Commission, the country’s planning agency. The plan intends to “speed up work to build China into a leader in manufacturing” by investing billions in “big data” and “robotics,” as well as “semi-conductors” and “aircraft engines.” Li gave special mention to “clean cars.”

But China has no tradition of technological innovation. In fact, China insists on technology transfers from Western and Japanese partners, and has likely engaged in industrial espionage to steal the intellectual property of foreign firms and governments. These activities no doubt have kept China closer to the technological edge than it otherwise might be. As with other projects, central government planning has created impressive applications, most recently in robotics and artificial intelligence. But all this transfer and theft keeps China dependent on others for each upgrade. And because applications always wait until after the initial breakthrough, the practice ensures that China will remain behind the West.

The trade talks could yet go awry. Washington has made clear its willingness to impose tariffs if negotiations don’t work out. Should that happen, Beijing would almost certainly retaliate. But the prospects of reaching a compromise look good. The Trump administration, for all its bluster, knows that the U.S. economy would suffer in a trade war—and Beijing, well aware of its comparative weaknesses, doesn’t want one, either.

Photo by Thomas Peter-Pool/Getty Images

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