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Retaliation Nation
US President Donald Trump sits with Chinese President Xi Jinping during a bilateral meeting, April 6, 2017 (JIM WATSON/AFP/Getty Images)
(JIM WATSON/AFP/Getty Images)

Retaliation Nation

Irwin M. Stelzer

There is something dispiriting about the debate over trade policy, and the problem does not lie with Donald Trump, or his tweets, or his on-again, off-again threats to various trading partners, or his fickle choice of partners to head the negotiating queue: EU to the front, Brexiting Britain to the rear, Angela Merkel trumps Theresa May, presidential promises notwithstanding. No, the problem lies with the belief that in the world in which we live and make our livings, free trade remains a global system that produces the efficient specialization of labor and allocation of resources that the textbooks promise. Rather than face reality, too many defenders of free trade adopt the ostrich position, leaving themselves exposed to attack by fact-wielding critics.

Defenders of free trade—denizens of think tanks, Republicans representing corporate interests, farmers, establishment elites—contend that if the president carries out his threat to impose high tariffs on some of our trading partners, he will start a trade war, at huge cost to American interests and the international economy. Current trade practices and imbalances notwithstanding, they want more of existing policies. “My concern is that they’re [the Trump team] making it too difficult to enter into trade agreements,” says Senator Cory Gardner (R-Colo.). “Mr. Trump’s portrayal of trade deficits entails crucial departures from economic reality,” scolds Peter Goodman in the New York Times. To which the Economist adds, “The Trump administration’s trade strategy is dangerously outdated,” which I suppose is better than departing from economic reality.

The problem with all of this is that it is impossible for Trump to start a trade war. As Secretary of Commerce Wilbur Ross so aptly put it, “We’ve been in a trade war for decades. .  .  . The only difference is our troops are now coming to the ramparts.” It took the threat of a border-adjustment tax to get policymakers to focus on the fact that our trading partners load a 20 percent value-added tax on goods we try to sell in their markets, while we impose only minor taxes on the stuff we import. But set that aside as an error in U.S. tax policy rather than a barrier imposed by our trading partners.

Instead, do a quick survey. Ask a German manufacturer how well he would do if the euro, a seriously undervalued currency for Germany, kept low by inefficient southern European industries, were replaced by the deutsche mark, which would certainly soar. Ask a European farmer how well he would do if the protection provided by EU rules were removed: According to our Department of Agriculture, “the U.S. agricultural trade deficit with the EU is the largest of any trading partner and contrasts sharply with that of other major U.S. trading partners.” Ask a Japanese auto manufacturer how he would fare in his home market if non-tariff barriers to the importation of made-in-America vehicles were removed.

These are minor skirmishes in trade wars that have been going on for far longer than Trump has been in the White House. The real battle is with China, which Trump threatens to lumber with a 45 percent tariff, or accept in lieu thereof the head of Kim Jong-un, preferably delivered on a beautiful made-in-China platter. Some two-thirds of our trade deficit is generated by our dealings with China, a centrally directed economy with goals other than the efficient allocation of international resources. Two such goals are relevant to our trade policy. The first is to preserve Communist party control of the politics and economy of China. To do that in a nation in which there is no democratic outlet for discontent requires providing jobs, at almost any cost. If that means selling goods at prices below the cost of producing them, so be it. If it means subsidizing excess coal mining, refinery, and steel capacity (turning out more steel than the rest of the world combined), that is a small price to pay to maintain a grip on power and, not incidentally, damage American industries. If that means shoring up banks that have been required to make loans to manufacturing enterprises that have no hope of repaying them, so-called zombie companies, turn a blind eye to the rising mountain of duff IOUs on bank balance sheets (bankruptcy is a rarity in China, avoided by funneling billions into state-owned enterprises).

China’s second goal is to dominate the industries of the future. The quickest route to that goal is to steal intellectual property (IP), subsidize the home-town boys, and make it somewhere between difficult and impossible for American firms to peddle their wares in China.

Start with IP. It has long been known that China steals American intellectual property: Our moviemakers complain that you can buy a pirated DVD of a new film on the streets of China for $1 before it is released in theaters in the United States. A report issued earlier this year by the Commission on the Theft of American Intellectual Property—a bipartisan nongovernmental group co-chaired by former Utah governor Jon Huntsman Jr., who served as U.S. ambassador to China from 2009 to 2011—states that mainland China and Hong Kong account for 87 percent of counterfeit goods seized by the U.S. Customs and Border Patrol. Their share of trade secrets theft, estimates the commission, is not far behind.

Theft and subsidies to zombie companies are the least of our worries. More troublesome are the techniques China has publicly and unashamedly announced it will employ to assure its dominance of industries of the future. According to a report by the European Union Chamber of Commerce in China, emerging industries will benefit from $300 billion in low-interest loans from state-owned banks and financial institutions, and the government will finance foreign acquisitions of key startups and high-tech companies. The goal is to become 80 percent self-sufficient in those industries that will be the major drivers of economic growth and high-end jobs in the years to come. Bolstered by subsidies, low-cost capital, and stolen IP, Chinese companies would become “global champions” of sufficient scale to wrest export markets from China’s trading partners. This is not mere surmise by some old China hand interpreting tea leaves. In March, Premier Li Keqiang in his annual speech to the National People’s Congress made the regime’s policy clear: “We will accelerate R&D on, and commercialization of, new materials, artificial intelligence, integrated circuits, new energy, bio-pharmacy, 5G mobile communications, and other technologies, and develop industrial clusters in these fields.” The plan goes on to list aircraft manufacture and electric cars as targets.

Finally, China either excludes American firms from its market or sets conditions that make entry too costly to contemplate. In its overt version this barrier takes the form of a requirement that China’s state-owned enterprises “buy Chinese” even when they could lower costs by purchasing imported products. For the regime the trade-off is clear: accept the inefficiency involved in avoiding dissent that might arise from job losses in return for perpetuation in power.

In its more subtle form, exclusion is accomplished by setting onerous requirements on firms seeking to do business in China. In a letter recently sent to Cui Tiankai, China’s ambassador to the United States, more than 50 congressmen responded to China’s claim that it is wide open to American firms to expand in China, citing Amazon’s proposed entry into the cloud computing business. They pointed out that such entry would come at the price of turning over all intellectual property to China. Many American manufacturing firms have been required to do just that as the price of entry, and soon found that China had set up a competing company that, backed by the buy-China policy, proved to be a formidable competitor.

Theory tells us that free-market economies allocate resources more efficiently than can a centrally planned economy, that markets process billions of bits of information more effectively than even the brightest of bureaucrats. And such has proved to be the case. But that theory no longer translates to the international arena, at least within a time-frame reasonable policymakers should be using. National power, not efficiency, is China’s goal. The Chinese hope with their Great Firewall to block access to three out of our four FANGS, Facebook, Amazon, Netflix, and Google (Netflix has been allowed in after agreeing to a licensing deal with a Chinese search engine). If they are successful, these Internet giants—along with Boeing, General Electric, and our renewable energy industries—will become mere case studies in business schools seeking reasons for their disappearance.

Perhaps most ominous, the spoils of a Chinese victory extend beyond racking up large trade surpluses. For one thing, such a win would further destabilize American society by consigning millions more workers to the scrap heap. Studies by David Autor, David Dorn, and Gordon Hanson (MIT, University of Zurich, and University of California, respectively) conclude, “Alongside the heralded consumer benefits of expanded trade are substantial adjustment costs. .  .  . Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences.” Nicholas Eberstadt and Charles Murray have alerted us to the social and economic consequences of such a shock. Difficult though it may be, those costs must be considered when deciding how much pressure we are prepared to put on China to end its trade practices. High tariffs have their costs, both in the prices we pay for goods and in forgone economic growth. But so do the social and economic consequences of accepting the current pattern of world trade. A policy that does not consider those consequences in the continued hunt for cheap sneakers in Walmart is a long-term threat to the acceptability of anything approaching an efficient world trading system, and to continued general acceptance of our system of free-market capitalism.

There are other costs of acquiescing in China’s planned march to dominance of key manufacturing sectors and industries of the future. Such a policy would weaken our ability to defend ourselves in a military confrontation should it come to that. Secretary Ross argues that we already are no longer able to manufacture steel of the quality that the military needs for its vehicles and weapons, such as the Mother of All Bombs recently deployed to wipe out a network of terrorist tunnels in Afghanistan.

Finally, the consequences of a continuation of current trends are likely to prove irreversible. Unused factories deteriorate. Laid-off workers lose the skills needed by a workforce capable of competing in global markets—and retraining programs have not proved to be successful in restoring old or teaching new competencies. There are areas in which lost ground can be made up—refreshing our military is one such—but further ground lost in a trade war is likely to be irretrievable, especially once China scales up the new industries it plans to grow by means not normally considered when listing the efficiency advantages of free trade.

None of this means that we should never, ever enter into trade deals. It was a terrible mistake by both Hillary Clinton and Donald Trump to repudiate the Trans-Pacific Partnership, which for all its failings would have allowed us and our regional allies, which together account for 40 percent of world commerce, to set the rules of trade in the Asia-Pacific region. And, not incidentally, bind our allies to us with what old Polonius called “hoops of steel,” preferably steel that is not manufactured in China’s subsidized mills. It would equally be a mistake to abort rather than modernize NAFTA, and to refuse to negotiate bilateral trade deals that incorporate reasonable anti-cheating provisions, or multi-nation deals such as the one the president is now pursuing with the 28- and soon to be 27-nation European Union. Hard-line protectionists might remember that just as a cigar is sometimes not merely a cigar, a trade agreement is rarely merely a trade agreement; it is a statement of a willingness to do all sorts of business together, of which only one is exchanging goods and services.

Which is what the recent much-trumpeted deal between Xi Jinping and Trump is all about. After an agreeable bit of dinner-table diplomacy at Mar-a-Lago, the president’s team came up with a deal that would end China’s ban on U.S. beef and our credit-card companies and rating agencies, and allow cooked Chinese poultry to be imported here. More important to Xi, Trump agreed not to treat investment in America by Chinese entrepreneurs any differently than investment coming from other countries, never mind the security implications. These concessions will have no measurable effect on our trade deficit with China, and might prove unenforceable. China’s ban on U.S. beef ended last September, since when not an ounce has been sold there, and the barrier to our credit-card companies has been in effect long enough to allow Chinese companies to build almost impregnable market positions. But this is not about our beef and their chickens; it is about North Korea and persuading Xi to rid us of this meddlesome and dangerous dictator. Unless Trump receives some major help on that score from the Chinese, it is fair to conclude that Xi’s study of Sun Tzu’s Art of War has done him more good than our president’s study of the Art of the Deal.

No discussion would be complete without mention of our own distortions of the way in which trade allocates markets and wealth. For the benefit of a handful of farmers we subsidize sugar production at the cost of billions of dollars and lost jobs in the confectionery and other industries; for the benefit of Boeing (and to remain in the subsidization competition) we have the Export-Import Bank; the list goes on. But these pale in comparison with the distortion-producing effects of China’s trade policy.

Those who fear that retaliation might trigger a trade war—or heat the existing one to a trade-stifling boiling point—would do well to unshelve their undoubtedly dog-eared copies of The Wealth of Nations. Adam Smith, hardly the voice of mercantilism and protectionism, advises, “The case in which it may sometimes be a matter of deliberation how far it is proper to continue the free importation of certain foreign goods is, when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country. Revenge in this case naturally dictates retaliation. .  .  . There may be good policy in retaliations .  .  . when there is a probability that they will procure the repeal of the high duties or prohibitions complained of.” As for the consumer who would end up paying more when a nation retaliates by raising tariffs, “The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods.”

Yes, any nation we might decide to penalize will probably find ways to damage the exports of politically noisy and important American constituencies—apple farmers in Washington howled loudly when we placed restrictions on Mexican trucks, and we reversed course. Still, if we don’t retaliate against barriers to our goods and services, we will be accepting the status quo and the trade deficits and social consequences that go with them. If retaliation is good enough for the Great Scot, it should be good enough for us.

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