Slaughter & Rees Report: The U.S.-China Trade War—The End of the Beginning

Tuck School Dean Matthew J. Slaughter and co-author Matthew Rees provide three main lessons from the U.S.-China trade war’s first phase and a potential solution for lasting peace between the world’s two largest economies.

The day before President Franklin Delano Roosevelt died in April 1945, remarks were prepared from him to the American people about the finally visible end of World War II.

Delivered the next day posthumously, these remarks spoke not of the end of the war. Rather, they were simultaneously more aspirational and more realistic. “The work, my friends, is peace. More than an end of this war—an end to the beginnings of all wars.” Thus did FDR exhort all listeners to prepare for securing a broader, more-lasting goal.

FDR’s context is useful for understanding the world’s biggest economic story of the past two years: the trade war between the United States and China. January 15 brought the end of the beginning of this historic trade war, when at the White House U.S. President Donald Trump and Chinese Vice Premier Liu He inked the Economic and Trade Agreement between the United States and the People’s Republic of China: Phase One.

Running 86 pages (in English) across eight chapters, Chinese terms of this so-called Phase One Agreement included new mechanisms (e.g., enhanced patent rights for pharmaceuticals) and penalties (e.g., enhanced crackdowns on pirated luxury goods) to better protect the intellectual property of U.S. companies; new market access for several sectors (e.g., insurers and fund managers) via elimination of foreign-ownership restrictions that U.S. financial companies have been facing; and new promises to buy even more agricultural goods from U.S. farmers. U.S. terms of the Phase One Agreement include not levying even higher tariffs on certain U.S. imports of Chinese goods; lowering some existing tariffs on other such imports; and agreeing to stop labeling China a “currency manipulator”—a charge that was largely baseless (as we have been writing as far back as 2007).

In this missive, we Matts encourage you to see three main lessons from this trade war’s first phase. We then argue that a course should be charted toward the aspirational goal of the world’s two largest economies finding sustainable commercial peace based on more, not less, integration.

Lesson #1: Trade wars are not easy to win.

Nearly two years ago, in March of 2018, President Trump declared that “trade wars are good, and easy to win.” While trade wars are rarely good, and are not necessarily easy to win, there is some good in this Phase One Agreement. The Chinese government has made a set of promises that enhance the long-standing, well-substantiated concerns of American companies that in China they were not being granted sufficiently full and fair market access, protection of intellectual property, and national treatment.

But whether these particular Phase One promises end up being delivered on remains to be seen in the years ahead. Moreover, this set of promises does not encompass the full range of U.S. concerns. In particular, the agreement is largely silent on the widespread market-distorting support that the Chinese government continues providing to many Chinese companies through channels such as preferential regulation and capital subsidies. And, perhaps most fundamentally, this Phase One Agreement does not fully deliver on the broadest goals of trade wars that President Trump laid out even before his March 2018 declaration. Recall the stirring-yet-stark declarations from his inaugural address.

“The oath of office I take today is an oath of allegiance to all Americans. For many decades, we’ve enriched foreign industry at the expense of American industry … We’ve made other countries rich while the wealth, strength, and confidence of our country has disappeared over the horizon. One by one, the factories shuttered and left our shores, with not even a thought about the millions upon millions of American workers left behind. The wealth of our middle class has been ripped from their homes and then redistributed across the entire world. But that is the past. And now we are looking only to the future … From this moment on, it’s going to be America First … Protection will lead to great prosperity and strength.”

There is no evidence, for example, that the trade war thus far has returned the “millions upon millions” of jobs that “left our shores” because of globalization.

Lesson #2: Trade wars are hurtful to many, but in the aggregate they can be absorbed when waged amidst a robust overall economy.

The U.S.-China trade war has hurt substantial parts of the American economy. Start with U.S. companies and families paying higher import and consumer prices. China did not “pay for” the tariffs by lowering its export prices to U.S. Rather, as several academic studies have documented, trade-war tariffs largely boosted U.S. import prices, with higher U.S. prices in turn cutting into the profit margins of the importers and those other companies in their supply chains—and also cutting into the paychecks of some workers, too. Another new study has analyzed an additional important cost of higher U.S. import prices: U.S. companies whose global supply networks include now-more-expensive imported intermediate inputs have been forced to curtail their now-less-competitive U.S. exports to foreign customers. Indeed, companies facing at least one tariff increase in the trade war account for 84 percent of total U.S. exports.

U.S. companies whose global supply networks include now-more-expensive imported intermediate inputs have been forced to curtail their now-less-competitive U.S. exports to foreign customers.

Concentrated costs have extended to farmers and many other companies hit by China’s retaliatory tariffs on U.S. exports. And the overall greater uncertainty and dampened confidence of U.S. business leaders across all sectors dampened overall U.S. economic growth via less capital investment. A recent Federal Reserve study estimates that economy-wide uncertainty cut U.S. growth in gross domestic product by nearly one full percentage point. Indeed, the latest estimate by the U.S. Bureau of Economic Analysis is that U.S. nonresidential private-sector capital investment has been contracting for three consecutive quarters.

All this damage has mattered a great deal to the many particular companies, workers, families, and communities hit. Indeed, the total magnitude of foregone output and income may well be a few hundred billion dollars. But relative to the overall U.S. economy, in which 2019 GDP still managed to grow by 2.3 percent and totaled $21.4 trillion, these trade-war costs seem more modest.

Indeed, many central indicators of U.S. economic performance have been robust amidst the trade war. Last year closed with U.S. unemployment at just 3.5 percent, the lowest in 50 years after a cumulative 2018 and 2019 increase in U.S. payroll jobs of 4.8 million. Overall consumer prices in 2019 rose by only about 2 percent. And last year continued the recent trend of less-skilled U.S. workers enjoying faster wage growth than their more-skilled counterparts. Over the past three years, U.S. adult workers with without a high-school diploma enjoyed an average annual increase in nominal wages of about 6 percent—nearly double the 3.2 percent enjoyed by U.S. adult workers with a college degree or higher.

Yes, the U.S.-China trade war caused substantial damage. But this damage did not derail the overall U.S. economy.

Lesson #3: Trade wars are not easily predictable in terms of their political consequences.

Whether the economic costs of the U.S.-China trade war translate into political costs or gains—for President Trump, senators, and representatives in particular—remains to be fully seen. But early political costs have already been incurred. A new academic study coauthored by our terrific Tuck colleagues Emily Blanchard and Davin Chor (and by Chad Bown, also terrific but at the Peterson Institute for International Economics) estimates that the combination of the trade war and efforts to undo the Affordable Care Act may have cost Republicans as many as 13 of the 40 seats they lost in the 2018 House of Representatives elections.

How will voters assess President Trump for launching this historic trade war and reaching its current truce? The most recent poll by the Financial Times and the Peter G. Peterson Foundation found that “46 per cent of Americans felt that the US should not resort to tariffs in trade disputes with its largest trading partners, and another 31 per cent believed that while tariffs may have been appropriate for China, the trade war with Beijing had gone on long enough. Only 23 per cent felt that the US should continue its hard line with China regardless of economic consequences.”

On the other hand, “51 per cent of Americans believe Mr Trump’s policies have either ‘strongly’ or ‘somewhat’ helped the economy, the first time [since this poll’s inception last October] a majority of respondents signalled their support for the president’s economic agenda.” At the same time, in the three battleground states of Michigan, Pennsylvania, and Wisconsin, this support was lower—in the range of 39 to 46 percent.

So what is to come after the end of the beginning? Many wise minds—such as the Economist in its recent cover-story leader—foresee many years of further decoupling between the U.S. and China.

Carried far enough, decoupling would bring substantial economic harm to the United States, to China, and to the world. The important distributional pressures of China’s integration into the global economy of recent decades notwithstanding, overall and on average China’s integration into the global economy has been good for America, good for China, and good for the world. More integration, not more decoupling, is what holds the potential for further such gains.

Thus do we two Matts humbly propose that to build to a sustainable economic peace, from this current end of the beginning leaders in the United States and China should chart a course toward the vision of creative new connections.

To build to a sustainable economic peace, from this current end of the beginning, leaders in the United States and China should chart a course towards the vision of creative new connections.

Indeed, as we draft this missive the urgent need for fresh integration is tragically playing out with the rapid spread of the deadly coronavirus. To stop the coronavirus as fast as possible requires global cooperation, not decoupling: health experts in China, in the United States, and in many other countries need to be sharing their ideas, their practices, and their resources.

Less important in terms of humanity, but very important in terms of global economics, is the open question of whether information-technology companies, standards, and regulations between the two countries can somehow coexist with all the commensurate gains from global integration—or whether the trend of decoupling will end with the two countries operating completely distinct IT systems. A recent analysis in the Wall Street Journal of what may come framed the question thus: “Imagine two countries with completely different sets of hardware and software for the internet, electronic devices, telecommunications, and even social media and dating apps. That is the direction the U.S. and China are headed in—a world where the two global powers have mutually exclusive technology systems.”

We don’t mean to know all the answers to the thicket of difficult questions, which range from intellectual-property protections to even national security and human rights. But we do know that IT protectionism looms as the largest obstacle on the course to a stronger economic peace between China and America.

In the spirit of finding that new course, perhaps leaders will be able to summon anew the art of the deal. Here is an illustrative example. At the epicenter of devolving IT protectionism sits Huawei, the Chinese juggernaut that in many ways is leading the world’s 5G race technologically—but that is rightly feared because of the threat that its IT systems might be harnessed for espionage and worse.

What to do? How about the intriguing solution that one global leader has proposed: have Huawei freely share its essential 5G systems with the United States and other nations, to enable companies in America and elsewhere to understand, test, and perhaps supplant Huawei’s current lead.

What artist is proposing this deal? None other than Huawei founder Ren Zhengfei. Mr. Ren explained this bold proposal, which Mr. Ren averred “comes from deep within my heart,” with the following logic that blends both commercial and strategic considerations.

“For any company, if they are too overwhelmed by their own past, they are likely to lose their lead. I am concerned that our next generation of leadership may be overwhelmed by the success of our company. Right now, I hold the sole whip in my hand. If I hand that whip to the U.S., a strong competitor would push our employees to always be vigilant. If my employees can’t sleep, then I can sleep.”

In the U.S.-China trade war, we have reached the end of the beginning. Early evidence of what follows—economically, politically, and otherwise—starts appearing in the days ahead, as the Democratic caucuses and primaries commence in Iowa and here in Tuck’s New Hampshire. Time to work.


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