The Taiwan Banker

Through sustained economic pressure, the Donald Trump administration aims to challenge China's model of state capitalism and reduce imbalances in bilateral trade U.S. President Donald Trump enjoys confrontation. It's a quintessential part of his character. While Trump's detractors warn that he will harm America's interests, when it comes to trade with China, his forcefulness is an asset. Unlike his predecessors, Trump is willing to use America's leverage in the commercial relationship to press Beijing to change course. And there is much that needs to change: from outright theft of U.S. intellectual property by Chinese actors to Beijing's brazen mercantilism. In April Trump said, "Trade wars are good, and easy to win." The U.S. president knows how to deliver a soundbyte for the media. Remember that he hosted a prime-time reality television show ("The Apprentice") from 2004-2015 and for decades before that was a fixture in tabloid newspapers. Trump's quips ensure he stays in the headlines. But more importantly, he's right in at least one sense: Trade strife with China is preferable to the unhealthy status quo. The U.S. government estimates that American companies suffer aggregate IP losses of up to $600 billion annually. China is widely seen as the biggest offender, although we have yet to quantify its precise share of that theft. More than half of U.S. firms operating in China are concerned about IP theft, according to a survey by the Beijing-based American Chamber of Commerce in China cited in an April Marketwatch report. Equally worrisome are Beijing's barriers to foreign investment. U.S. firms have long complained of discriminatory treatment by Chinese regulators. Forced technology transfers remain common. To gain market access, U.S. firms agree to share their technology with local partners. Further, sectors which Beijing should have liberalized as a WTO member, including agriculture, finance, media and telecommunications, remain formally or de facto closed to foreign investment. Given Beijing's restrictions on foreign investment, its large trade surplus with the U.S. - which hit a record high of $31 billion in September - is no surprise. In a September report, The New York Times points out that Beijing habitually runs trade surpluses with the U.S. and European Union to balance its deficits with key suppliers of natural resources - Australia, Brazil and Saudi Arabia - and industrial machinery - South Korea and Japan. China's industrial policy is another point of contention with Washington. The Trump administration takes particular issue with Made In China 2025, Beijing's plan to dominate advanced manufacturing globally. The mercantilist policy lays out "self-sufficiency targets" in violation of WTO rules against technology substitution. China watchers say that Beijing was shocked when the Trump administration invoked Section 301 of the U.S. Trade Act and slapped a 25% tariff on $34 billion in Chinese imports in July. Reportedly, Chinese President Xi Jinping and his colleagues thought Trump was bluffing. Barring an eleventh-hour compromise with the Chinese - which seems unlikely at this point - Washington will impose a 10% tariff on an additional $200 billion in Chinese imports. The tariff rate may be later increased to 25%. Treasury Secretary Steve Mnuchin, a free-trade stalwart, has been pushing for a deal with Beijing. Trump is less eager. In a September 13 tweet, the U.S. president wrote: "We are under no pressure to make a deal with China, they are under pressure to make a deal with us."Trump has long espoused a protectionist stance on trade. He associates free trade with the loss of manufacturing jobs in America. In the 1980s, he attacked Japan for its large trade surplus with America, alleging that Tokyo was harming the U.S. middle class. Long after Japan's bubble economy had burst, Trump continued lamenting about Tokyo’s trade policies. In a 1999 he told CNN that the U.S. was "like a whipping post for Japan," according to a transcript of the interview cited in a March Washington Post report. In its 1980s heyday, Japan's export-driven economic model had much in common with China's today. Japan accounted for about 20% of the U.S.'s imports in 1989, roughly the same as China does now. Even more so than Beijing, Tokyo insulated domestic industries from foreign competition. Both countries have manipulated their exchange rates to the benefit of domestic exporters. Under heavy pressure from Washington, Japan in September 1985 agreed in the Plaza Accord to revalue the yen. Over the next two years, the yen rose against the dollar from 240 to 121. The Japanese economy fell into recession in 1986. Four years later, the bubble economy burst. By 1991, the trade imbalance with the U.S. had been erased. Chinese policymakers are determined to avoid a similar fate. This rationale informs their thinking on overall trade policy with the United States, not just the exchange rate. A March editorial in the state-backed Global Times entitled "China won’t repeat Japan’s Plaza Accord mistake" suggested that China could learn from Tokyo's experience. An August commentary in state-run Xinhua highlighted the "lost decade" that followed the revaluation of the Japanese currency. In reality, the revaluation of the yen alone did not hobble the Japanese economy. China's leadership knows that. Indeed, even the state media acknowledges other "mistakes by the Japanese government." But for China, the optics of the Sino-U.S. trade war are important. With a reputation as a strongman, Chinese President Xi Jinping must telegraph resoluteness in the face of U.S. pressure. To do otherwise could provide an opening for his enemies to strike. Since taking office in 2013, Xi has ruffled many a feather in the Chinese bureaucracy, purging rivals in a sweeping anti-corruption campaign, dominating high-level decision-making, and scrapping the Chinese presidency's term limits. If the Chinese are waiting for Trump to blink, they may be in for a long wait. The U.S. president is in broad agreement with the Cabinet's China trade hawks, Trade Representative Robert Lighthizer and Peter Navarro, Director of the White House National Trade Council. Both men want the U.S. to arrest China's mercantilist trade policies and IP abuses before irreparable damage is done to America's economic competiveness. “For over a year, the Trump Administration has patiently urged China to stop its unfair practices, open its market, and engage in true market competition," Lighthizer said in a July statement published by the USTR office. "We have been very clear and detailed regarding the specific changes China should undertake. Unfortunately, China has not changed its behavior – behavior that puts the future of the U.S. economy at risk."Navarro, an economist and University of California at Irvine professor who rose from relative obscurity to join the Trump White House, has long been a fierce China critic. He is the co-author of a 2011 book entitled Death By China - later made into a documentary - which accuses Beijing of holding global trade norms in contempt and cheating its way to economic ascendancy. "Lost so far in China's mockery of free trade have been millions of U.S. manufacturing jobs," he wrote. Navarro also has co-authored two books about the military challenges China poses to the world: The Coming China Wars (2006) and Crouching Tiger: What China's Militarism Means for the World (2015).To be sure, Lighthizer and Navarro know that Beijing is unlikely to offer Washington any major trade concessions. Under Xi Jinping, Beijing has halted major market reforms and moved to bulwark its contentious "state capitalism" economic model. In response to Trump's tariffs, Beijing has signaled an intention to expand the role of state-owned enterprises in the economy and double down on indigenous innovation. Yet Beijing's defiance will not mitigate the effects of the tariffs on the Chinese economy. China sold $430 billion in exports to the U.S. in 2017. 25% tariffs on more than half of that that amount will wreak havoc on Chinese exporters, who have no easy substitutes for the U.S. market. At the same time, the trade imbalance with Washington is so lopsided that China could only hit a maximum of $128 billion in U.S. exports with tariffs. If Beijing retaliates by sanctioning U.S. firms who use the country as a manufacturing base, those companies may relocate their supply chains outside of China. That is the likely endgame for the Trump administration. In a September 8 tweet, Trump urged Apple, some of whose products will be affected by the new round of tariffs, to "make your products in the United States instead of China." Trump said that Apple could enjoy "zero tax and indeed a tax incentive" if it built new plants in America. Trump's cavalierness towards Apple is instructive. Unlike his predecessors Barack Obama and George W. Bush, Trump won the presidency without the support of big corporate donors. In fact, most multinational firms backed his opponent Hillary Clinton. As a result, Trump has more freedom in his economic policymaking than Obama or Bush did. It will be imperative for Trump to use his powers wisely as Sino-U.S. relations enter a new and more contentious era. As U.S. firms' bottom lines get pinched, pressure on Trump is certain to intensify. The U.S. president must resist calls from Steve Mnuchin and the business community to deescalate the trade war unless headway is made on IP theft, forced technology transfers and state dominance of Chinese industry. Meanwhile, the U.S., Europe and Japan could work together through the WTO to challenge China's unfair trade practices. They could do so by enforcing WTO rules that China is violating, such as subsidizing state firms and closing its markets to foreign competition. In May, trade officials from the U.S., EU and Japan issued a joint statement expressing concern about the "non-market oriented policies of third countries" - a clear reference to China. The statement mentions "possible new rules on industrial subsidies and SOEs" as well as "the need to find effective means to address trade-distorting policies of third countries, including harmful forced technology transfer policies and practices." Beijing is well aware it has shirked some of its WTO commitments. Indeed, in the absence of strong pushback from the U.S., EU and Japan, China kicked the can down the road for many years. But now, facing Trump's tariffs and pressure at the WTO from its three largest trading partners, Beijing may have no choice but to reconsider the viability of its mercantilism.