China trade hardliners in the Trump administration, such as advisor Peter Navarro, have predicated their tariff campaign against China on the theory that hiking tariffs on more than $500 billion in Chinese exports to the United States (as proposed at the moment) will cause such pain to the Chinese economy that the government in Beijing will come back to the negotiating table willing to meet the administration’s demands on tariffs, subsidies for Chinese exporters, currency valuations, and intellectual property protection.
But what if that basic assumption is dead wrong? What if even though U.S. tariffs do impose some pain on the Chinese economy, it is a level of pain that President Xi Jinping and other Chinese leaders are willing to accept because that pain significantly advances their goal of gaining Chinese independence in key technology industries?
That’s the thesis of a post today on Bloomberg.com and the post by Michael Schuman is well worth considering since #1, I think it is right in its essentials, and #2 it turns everything about the U.S.-China trade confrontation on its head with really negative consequences for emerging market financial markets and economies.
Schuman’s argument goes like this.
Higher U.S. tariffs on $500 billion in Chinese exports (plus restrictions on some sensitive high-technology goods from the United States) Â provide the Chinese government with a perfect cover to raise tariffs on U.S. technology products and push ahead with its Made in China 2025 initiative. That plan targets global (and in many cases U.S.-led) high technology industries where China wants to seize global leadership. As part of that plan, the government will make significant investments into domestic Chinese companies in those industries, will encourage domestic companies to buy their technology products from those Chinese technology companies, and will limit foreign involvement in these key Chinese industries.
See any way that the Trump administration’s trade policies actually advance those goals?
The official China Daily put it this way: The trade war is a “blessing in disguise.” The newspaper didn’t put it quite spell out the details to this blessing but Schuman does: “Trump’s trade sanctions have given Beijing another excuse to drag its feet on free-market reforms, to support local companies and to harass and exclude foreign business —all things Chinese leaders are inclined to do anyway.”
As Schuman writes “The Communist Party prefers Chinese to buy Xiaomi phones and Geely cars, not iPhones and Buicks.” And Beijing wants those phones and cars–both domestic and foreign–made with an increasing percentage of domestically produced technology content.
There is, of course, a certain amount of bravado in pronouncements like this from China Daily. U.S. tariffs will reduce Chinese exports to the United States at a time when the Chinese economy looks vulnerable. It’s never a good time for economic growth rates to dip in China but this is a worse time than usual since the economy was already showing signs of slowing. And some of the tariffs that China has slapped on U.S. goods in retaliation will indeed hurt Chinese consumers. China can replace U.S. soy bean imports but it is likely to pay higher prices for those replacement soy beans.
But Schuman’s piece argues that China’s government has more incentives than the Trump administration may be counting on to accept that pain. It may be worth it to Beijing to take a tariff hit now because it will advance long-term goals.
If this argument reflects the thinking in Beijing, it suggests:
#1 that the U.S.-China trade war will go on for longer than Washington may be expecting and that there will not be any quick Chinese capitulation.
#2 that the Chinese government has sufficient incentives and sufficient resources to offset the pain of this trade war with domestic stimulus so we should be looking for moves from the People’s Bank to support the Chinese economy and Chinese markets sometime this fall.
#3. That developing countries that are already fighting to prop up their currencies by inflicting higher interest rates on their own economies don’t have the ability to match the stimulus moves from the People’s Bank. They may even find themselves in a deeper hole if any Chinese action weakens the yuan and gives China a bigger edge in global markets. In this scenario the emerging markets crisis will get worse before it gets better–even if there is a temporary bounce on any stimulus from the People’s Bank.
