The Trump administration is reportedly deliberating imposing a set of economic measures to punish China. The timing is telling: It suggests that the Trump administration is looking for an effective expression of its mounting frustrations with China, including over the expanding bilateral trade imbalance, its resistance to reversing unfair trade practices, and its reluctance to do more to rein in North Korea’s nuclear and missile programs, despite President Trump’s persistent public and private prodding of President Xi to do so.
A LEVERAGE DEFICIT
Through punitive economic measures, the administration will aim to signal to Beijing that patience is up and that China confronts a choice between working constructively with Washington on trade and North Korea, or facing the risk of heightened bilateral friction. Such a strategy appears to rest on two assumptions about U.S. leverage over China.
The first assumption is that China is highly dependent on the U.S. export market to sustain its economic expansion. Therefore, the thinking goes, the United States has untapped leverage over China as long as it proves willing to tolerate bilateral friction. In reality, China’s exports to the United States account for less than 5 percent of China’s GDP, and an even smaller amount (roughly 3 percent) when only value added is measured. While the U.S. market remains significant for Chinese exporters, the role of the U.S. market in contributing to China’s economic growth isn’t what it was 20 years ago. And, as China’s economic growth model shifts away from exports and investment toward a greater reliance on services and consumption, the relative importance of the U.S. market for China’s economic growth will continue to shrink.
The second assumption is that the Chinese need stability in the U.S.-China relationship, particularly ahead of their once-every-five-years Party Congress this fall. Therefore, according to this thinking, the United States should set a price for preserving stability, and threaten to “punish” China if it balks at paying up. While sound in theory, this assumption breaks down in practice. If Beijing felt an imperative to uphold U.S.-China stability, it presumably would have delivered meaningful outcomes from the 100-day economic plan and made concessions necessary to present the appearance of a smooth U.S.-China Comprehensive Dialogue (CED) this July in Washington. Instead, Beijing chose to stand by its longstanding bottom lines and accept visible friction with Washington as the consequence. The 100-day economic plan came in below expectations, and the CED ended with an uncharacteristic absence of bilateral agreement on outcomes or next steps. This suggests there are limits to the price Beijing is willing to pay for the appearance of stable U.S.-China relations, and the limits appear to be below Washington’s expectations.
TRUMP’S ECONOMIC TOOLKIT
Nevertheless, the Trump administration appears determined to hit China. So, what might the Trump administration do?
Most widely discussed is a challenge to China’s intellectual property policies. The administration is reportedly about to launch an investigation to examine whether China’s intellectual property protections and technology transfer requirements on U.S. firms operating in China constitute unfair trade practices that burden or restrict U.S. commerce. If the administration reaches such a conclusion, the president has the legal option through an arcane authority from Section 301 of the Trade Act of 1974 to unilaterally seek remedies, ostensibly to press China to remove its discriminatory policies. Potential remedies could include sanctions on Chinese exporters or further tightening of export controls of sensitive dual-use products to China.
There also has been much discussion of some action on steel, where the administration has initiated an investigation into whether steel imports pose a national security threat to the United States. Quick action on steel is problematic for several reasons. First, the United States primarily imports steel from Canada, Mexico, South Korea, and Japan—only a tiny amount is imported from China. Since it is a widely traded commodity, any dumping by China in third markets depresses prices, but that is not a problem that can be addressed by U.S. tariffs. Second, the fundamental problem of the industry is excess capacity, a lot of which is in China. This requires a worldwide solution, and in fact Trump got tough language about this inserted into the leaders’ communique from the G-20 Hamburg Summit in July:
“We urgently call for the removal of market-distorting subsidies and other types of support by governments and related entities. … we call on the members of the Global Forum on Steel Excess Capacity, facilitated by the OECD … to rapidly develop concrete policy solutions that reduce steel excess capacity. We look forward to a substantive report with concrete policy solutions by November 2017, as a basis for tangible and swift policy action.”
Given the G-20 agreement to come up with a plan by November, it would be counterproductive for the United States to impose unilateral tariffs before seeing whether the multilateral route yields any real progress.
Trump could consider protectionist measures beyond steel, probably at the end of the 301 investigation. During the campaign, he called for a 45 percent import tariff on Chinese products. Something more modest, like 10 or 20 percent, would get China’s attention. As noted above, however, China’s economy is not that export-dependent anymore, so there are ways it could compensate for the loss of demand.
A protectionist policy would hurt the U.S. economy as much as the Chinese.
A protectionist policy would hurt the U.S. economy as much as the Chinese. Given today’s complex value chains, a “Chinese” product has lots of value added from the United States, Japan, South Korea, and other partners. Some U.S. firms would be hurt, U.S. allies would suffer, and consumer prices would rise. One thing we are sure of is that China would retaliate, buying less American output such as aircraft, agricultural products, and tourist services. At a broader level, protectionism shifts jobs from one sector to another, but is not generally a net creator of employment. Previous U.S. forays into protectionism—such as the Smoot-Hawley tariffs or Reagan’s voluntary restraint agreements with Japan—were followed by increases, not decreases, in the U.S. trade deficit. Talk of getting tough with China on trade runs into the classic problem that small actions are mostly symbolic and big actions hurt the U.S. and world economies.
The administration also could announce a new set of sanctions against Chinese entities that do business with proscribed North Korean entities. That would build on the Treasury Department’s June 29 announcement of sanctions against a Chinese bank, a Chinese shipping company, and two Chinese nationals that were accused of helping North Korea evade international sanctions. New designations would create a ladder of sanctions actions against incrementally more significant Chinese actors. The administration could highlight the action as the equivalent of killing two birds with one stone—responding to North Korean intransigence and getting tougher on China at the same time.
TREAD CAUTIOUSLY
In closing, the Trump administration confronts familiar frustrations with Beijing’s obstinacy on a range of priorities. Previous administrations likewise have been disappointed by Beijing’s limited cooperation on purportedly shared priorities. When faced with similar circumstances, past administrations have largely opted against broad-brush punitive actions that would have undermined the broader economic relationship. A variety of factors contributed to those decisions, including a recognition that the Chinese market is important to the U.S. export sector, an understanding of the limits of U.S. leverage over China, a general wariness of protectionism, and a recognition that the economic relationship traditionally has served a stabilizing function for the broader bilateral relationship. While many members of the business community likely would applaud efforts to push back against unfair Chinese trade practices, not all sectors of the U.S. export community will benefit, and some may in fact become exposed to retaliation from China.
Additionally, there is the real question of whether the unilateral U.S. actions under consideration would cause Beijing to change its economic policies. It is more likely that Beijing would respond to multilateral pressure; the Trans-Pacific Partnership, for example, would have created a large, open market excluding China until it agreed to disciplines on inward investment, services trade, and intellectual property rights protection. Given the stakes involved and the need to ensure that any action generates more benefit than loss to the U.S. economy, the Trump administration should tread carefully before taking unilateral actions that could have broad and direct impacts on U.S. interests.