China has muscled, conned, bullied, grabbed, extorted, and feigned its way to the top of the global supply chain over the last twenty years.

It took no prisoners—just market share, intellectual property, and liberties in the valuation of its currency. It used a massive trade surplus to buy foreign assets, coralled foreign companies into joint ventures with Chinese firms where they lost their technology to the Chinese partner, and gave away just enough to keep foreigners dreaming—in the spirit of their supposed trade regulations—of their fair share of the huge Chinese market.

With President Donald Trump hosting Chinese leader Xi Jinping at his Mar-a-Lago resort in Palm Beach, Florida, today, many are waiting to see if this dynamic will be fought against. Trump talked tough on China throughout his campaign. Whereas previous administrations tried to engage and dialogue with China—an approach that business groups say has largely failed—this administration pledged to play hardball.

And for good reason, according to a report by the Information Technology and Innovation Foundation (ITIF), a Washington, D.C.-based non-partisan innovation think tank. “China has doubled down on its innovation-mercantilist strategies, seeking global dominance across a wide array of advanced industries that are key to U.S. economic and national security interests,” the report says. 

For China, unlike the United States, growth is not the real issue. Rather, growth and economic stability are only important in that they help the Chinese Communist Party (CCP) maintain its grip on the country.

Chinese citizens escaping poverty, and stronger international competition in tech sectors, are good things. But for the CCP, the prosperity of its people is a mere afterthought; the notion of fair trade a curiosity. Its gaze is fixed on its own survival, with all the rest being collaterals, incidentals, and extras.

To quote former United States Trade Representative Charlene Barshefsky, the U.S. “has to rethink the way it engages with China. We have these very fancy dialogues—there’s ninety of them—and I characterize these dialogues with China as the way China manages the U.S., not actually the way the U.S. produces results on the ground for companies and for exporters to China.” Barshefsky spoke during a March 6 event at the Council on Foreign Relations in New York.

And so China has gorged on the markets with little in its way but some timid bilateral discussions, difficult-to-enforce World Trade Organization rules, and a Western alliance in disarray.

Is There a Sheriff in Town?

On both sides of the pro- and anti-trade spectrum, most experts seem to agree China can’t be left unchecked for another decade. It is now to be seen how the United States is going to play its role in the global trade community, while dealing with the rampage of often hostile Chinese investments in sensitive U.S. markets, the towering trade imbalance, and the ongoing signs of currency manipulation (though China has shifted from undervaluing the RMB to propping it up.)

So far, no real effort has been made to stop Beijing on its looting spree, whether that be forcing technological transfer from Western companies that want market access, or straight up theft in the form of cyber espionage. Facing this reality, the patience of the United States in waiting for China to “learn to behave” has been baffling. In 2016 alone, 27 countries brought 119 trade sanctions against China. The previous U.S. administrations however, which saw China eat away at the U.S. market share across a myriad of sectors ever since China’s WTO ascension in 2001, remained mostly mute.

The March 16 report by ITIF points out the inherent weakness of WTO rules that have been negotiated between 160 countries: if one player lacks the goodwill to respect the rules, little can be done to enforce them. The ITIF sees a larger role to be played by domestic legislatures when inking deals with China.

But while the tools to act against China’s “innovation mercantilism” might not have been perfect, both WTO provisions and domestic U.S. regulations have in fact been in place all along. The question remains why they have never been put to use.

For example, citing concerns about surges of imports at the time of China’s WTO ascension, Barshefsky recalled that the U.S. “inserted a China-only provision which lasted twelve years … to allow the president to unilaterally stop imports in any given sector if those imports were disruptive to the U.S.” She added: “The relief was provided only once.”

Barshefsky made the point that “there was concern there would be job loss; there was a specific mechanism to deal with it. It wasn’t used.” The 12 year provision she referred to has recently expired, so new mechanisms will need to be worked out.

Her colleague Edward Aiden, a Bernard L. Schwartz senior fellow at the pro-trade foreign relations think tank CFR, on his side called the failing of previous administrations to trigger the 1988 Foreign Trade Act “a political disaster.” The Act stipulates that if a country is found to be manipulating its currency, intense negotiations are to be started, followed by sanctions if the negotiations fail.

This points to the bigger role the United States could play in global market regulation.

Under the banner of “Constructive, Alliance-backed Confrontation,” the ITIF argues that the United States, as the world’s biggest player, should gather its allies—such as Australia, Canada, Germany, the European Union, the United Kingdom, Japan, and South Korea—and form a front against China.

It further calls for much stronger cooperation between the U.S. private and public sectors to fight abuses, a more “focused, targeted, centralized” approach by giving more control to the federal government, and more resources to the U.S. Trade Commission.

Of the Carrot and the Stick

Since the new administration took the reins, the first concrete signs of the course it would steer regarding trade was stepping out of the Trans-Pacific Trade Partnership (TTP), a deal between 12 countries on both sides of the pacific.

China was implicitly excluded from the deal by technical means, and would have been at a disadvantage in region as a result. If it wanted in, it would have had to play by the rules and meet certain rigorous administrative, labor, environmental and other standards.

If China managed to get into the TTP, however, it would likely would have been another fiasco on par with China’s ascension into the WTO. If history teaches us anything,  international trade deals for China are simply opportunities to take advantage and bend the rules.

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There are practical limitations on compliance monitoring and enforcement of such deals, and the Chinese regime is expert at navigating such loopholes. The U.S. Chamber of Commerce in a recent report on China’s industrial policy “Made in China 2025: Global Ambitions Built on Local Protections,” makes this extremely clear.

“Many of the challenges associated with China’s industrial policies—for example, government procurement, subsidies, data, licensing, and national security—would unlikely be effectively addressed through an investment treaty or agreement given the architectural limitations of such agreements.”

Now with the TTP carrot gone, it remains to be seen if the Trump administration is prepared to use the stick.

Whatever the case, Peter Navarro, economic advisor to the Trump administration, has not been mincing words so far when it comes to China. Taking the stage at a business conference, Navarro hinted at a much bolder stance toward China’s trade imbalance and currency manipulation.

Referring to China’s worrisome access to sensitive segments of the U.S. market, he said, “Suppose that it’s not a benign ally buying our companies, our technologies, our farmland, and our food supply chain, and ultimately controlling much of our defense industrial base. Rather, it is a rapidly militarizing strategic rival intent on hegemony in Asia and of course world hegemony”.

If the United States can rally its partners behind a renewed, no-nonsense, results-based trade system that doesn’t rely on trusting China’s promises, Beijing’s brazenness may finally be contained, and stability returned to global trade.

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A vendor picks up a 100 yuan note above a newspaper featuring a photo of US president-elect Donald Trump, at a news stand in Beijing on Nov. 10, 2016. Trump has talked tough on trade — and his policies might actually help China. (Greg Baker/AFP/Getty Images)A vendor picks up a 100 yuan note above a newspaper featuring a photo of US president-elect Donald Trump, at a news stand in Beijing on Nov. 10, 2016. Trump has talked tough on trade — and his policies might actually help China. (Greg Baker/AFP/Getty Images)

Donald Trump talks tough on China and has appointed trade hawks Wilbur Ross and Peter Navarro to key positions in his administration. He has threatened to slap a blanket tariff on Chinese goods and talked directly to Taiwan’s President, previously regarded as a major diplomatic offense.

According to “Road to Ruin” author James Rickards, this is Trump’s way of opening the negotiations with China to reach a mutually beneficial trade relationship.

“[He] is saying to China: ‘Here is where we are going to start, what have you got for us? Are you willing to be more flexible on foreign direct investment, are you willing to treat U.S. companies in China more fairly, are you willing to stop the theft of intellectual property?’ If China makes concessions on these points he can say ‘fine, now my tariff is [lower].’ It’s the art of the deal; people don’t understand that about Trump,” Rickards told the BBC.

However, in any deal, the other party also has some negotiating chips on the table and China, for example, can hurt American companies exporting to China or American companies operating in China.

So who has the upper hand in the negotiations? According to a report by research firm Geopolitical Futures (GPF), the United States would suffer some damages in a trade war but would come out on top in the end.

“China would feel the impact of U.S. protectionist measures more than the U.S. would feel any economic retaliation China has at its disposal,” the report states.

What’s at Stake?

The most important point for both countries is the symbiotic relationship between China the exporter and the United States the importer. Between Chinese workers who produce cheap goods and U.S. consumers who buy them.

According to the U.S. Census, the United States imported $483 billion worth of goods from China in 2015. Since China joined the WTO in 2001, the United States was the top importer of Chinese goods in all but one year.

In an extreme thought experiment, about 15 million Chinese workers in the export sector could lose their jobs if Americans stopped importing from China altogether, a nightmare for the Chinese regime, which depends on employment to keep the people happy and itself in power. 

On the other hand, the United States depends on China for cheap imports. More than 90 percent of all imported umbrellas and walking sticks come from China for example, and 22 percent of all the stuff the United States imports.

Sourcing these products from somewhere else or producing them onshore will be difficult and almost certainly make them more expensive. However, this is a nuisance compared to 15 million unemployed Chinese. 

“U.S. dependence on Chinese goods is a matter of convenience,” states the GPF report.  The analysts say the United States has ample spare capacity in manufacturing to eventually make up for the shortfall.

According to the Federal Reserve (Fed), total industrial capacity utilization in the United States was only 75.1 percent in October of 2016.

“Of course, increasing capacity would not be easy. One caveat is that many of these industry groups have seen their capabilities atrophy after years of dismal performances. But these industries are much like muscles, atrophying in bad times but strengthening in good times,” states the report.

One example is the furniture industry, where Americans bought 17 percent of all sales from Chinese exporters in 2015. U.S. capacity utilization for furniture was only 75 percent during most of the year. If the United States ramped up production to 100 percent in an unlikely scenario, it could make up for all of the Chinese imports, albeit at a higher price. The same principle is true for many other industries from textiles to synthetic rubber and has the benefit that it would decrease American unemployment. 

Monopoly Power

In the discussion about trade with China, we frequently hear that China has a monopoly for Rare Earth Elements (REE), a critical component for many digital products. If push came to shove, China could simply cut exports to the United States like it did to Japan in 2010.

According to GPF, however, this is another classic example of price rather than actual availability. In 2016, China produced 89 percent of global REEs. However, the United States had its own company producing REEs up until 2015, when Molycorp Inc. had to declare bankruptcy because it could not compete with the low Chinese prices.

GPF estimates that potential production by Molycorp would be enough to satisfy U.S. REE demand, again at a higher price than the current ones from China and with a time lag.

“The result would not be a catastrophe and actually would spawn a capacity for REE production in the United States or another country, such as Australia, from which the United States could import,” states the report. 

Retaliation 

What happens if China retaliates and slaps tariffs on American products exported to China?

According to GPF, the last time that happened it didn’t end well for China. When President Obama imposed a 35 percent tariff on Chinese automobile and light truck tires in 2009, China retaliated by slapping a tariff on U.S. chicken meat. 

The U.S. tire tariff’s impact was limited: Imports from China fell by 50 percent until 2015 only to be replaced by South Korean and other manufacturers. This shows the limit on how many jobs can come back to the United States but also demonstrates that the United States is not dependent on China for goods supply.

The same goes for multinational corporations which may have to shift production to other Asian countries should China chose to make life difficult for them. 

The tariffs left their mark on the tire industry in China, however. “China’s capacity utilization in the various tire segments industry has fallen to between 50 and 60 percent. Hundreds of tire factories have closed their doors, and Chinese tire makers are cutting prices to the bone just to stay competitive in the market,” states the report.

And the U.S. chickens? Exports doubled from 2011 to 2016 and total poultry production in the United States increased during the whole period. 

“It is likely that future retaliatory measures would yield similar results: a short-term impact for the U.S. followed by a recovery,” states the report.

Trade Off

Although Apple could shift production somewhere else, it would take time and cost money. Starbucks, which makes 5.7 percent of its global sales in China couldn’t just replace a market of more than a billion consumers. The same is true for Boeing, which earned 13.1 percent of its 2015 revenue by exporting to China, the fastest growing airplane market.

However, there are many Chinese multinationals operating in the United States (for instance, FOSUN) or banking on the United States to become their next big market (Alibaba).

According to the GPF report, both countries would lose in a full-blown trade war, but it is the United States that holds the upper hand. Donald Trump understands this, which is why he is pushing China to get a better deal for America. If China also understands it’s in a weaker position, it will be able to avoid a lose-lose scenario. 

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