When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win.” This tweet of March 2 set out the aims and means of Donald Trump’s trade policy. The apparent victory over Canada and Mexico and the signing of a new trade deal will convince him he is right. But China is not Mexico.
The US president believes if a country sells more goods to a trade partner than it buys, it has “won”. He also thinks that if it buys more goods from a trading partner than it sells, it can “win” a protectionist war, because the other side has more to lose. These two convictions — bilateral mercantilism and asymmetric balance of pain — are his guides. His policy is to use the way in which the US “loses” to secure victory. Since the US is also the most powerful country in any bilateral relationship, it has to win.
Serious economists, back to Adam Smith, would insist that seeking a surplus with every trading partner is not “winning”. It is absurd. This is not even intelligent mercantilism, which would focus on the overall balance. Yet, particularly with free capital flows, overall balance is a foolish goal and one that trade policy cannot achieve. It is incredible that such primitive ideas rule the most sophisticated country on earth.
Put the sense of this to one side. Are trade wars easy for a superpower to win against countries with large bilateral trade surpluses? The answer is “yes and no”. Mexico’s exports to the US were 28 per cent of gross domestic product in 2017, while Canada’s were 19 per cent. US exports to Mexico were only 1.3 per cent of GDP, while its exports to Canada were 1.5 per cent. When countries are as asymmetrically dependent as Canada and Mexico, some sort of victory is likely. In a bilateral negotiation, the US was likely to get much of what it wanted (though it seems not to have got it all).
China is a different story. Its exports to the US are a substantially larger share of its GDP than vice versa, at 4.1 per cent, against 0.7 per cent, in 2017. China’s bilateral surplus was about 3.1 per cent of its GDP, which is far down from the 10.2 per cent in 2006. Imagine that the US imposed prohibitive tariffs on all its exports. One might think the effect would be to lower China’s GDP by 4.1 per cent. One would be wrong. US exports to China would also fall, as Chinese retaliation bites. Furthermore, a third of the value added in China’s exports is imported. Chinese exporters could also sell their goods elsewhere.
In the end, the fall in China’s GDP in such a trade war would be less than 2 per cent, other things equal. This is about four month’s growth. Moreover, it would not be hard for China to offset such a loss of demand. Meanwhile, the overall US trade balance would probably not change a wit, since that is determined by domestic supply and demand.
While Beijing prefers a deal, it will not pay a high price. All Chinese are taught about the “century of humiliation”. Xi Jinping, China’s president, is in a strong domestic position. Yet even he might not survive grovelling before a bully.
Mr Trump has made two characteristic mistakes. First, he has over-reached. China cannot deliver bilaterally balanced trade because it is unable to force Chinese people to buy goods they do not want. The point about US trade with China is not that its imports are so high: relative to GDP, they are much the same as the EU’s. The difference is the low level of its exports. That shows lack of competitiveness. Finally, China will not abandon hopes of technological upgrading. No power would.
Second, he has exaggerated US power. In other areas of trade policy, deals might be done. One could imagine changes in Chinese policy on intellectual property and exclusion of US companies. One could imagine a deal in which China gave up developing-country status, in return for being treated as a market economy. But to achieve these outcomes, or better, Mr Trump needs allies, especially the EU and Japan, whom he despises, maybe because they are not tyrannies. But it is not clear he wants such deals: if intellectual property were better protected, yet more US companies would invest in China. That seems the opposite of what he wants.
Mr Trump might surprise us by trumpeting the greatest trade deal in history in which he gets rather little. But suppose the conflict escalates instead, ending up with high bilateral tariffs. Who wins? The broad answer is nobody: trade is disrupted, the rules-governed trading system is devastated, relations between the US and China are damaged and the world becomes more perilous.
Yet, which side loses more? This is difficult to model, because no one knows what would happen. One possibility, analysed by the European Central Bank, is that the conflict goes global. Even the Trump administration might realise that trade diversion is working against them: they stop imports from China and get them from, say, Vietnam. So they go for a 10 per cent across-the-board tariff. The rest of the world retaliates with a 10 per cent tariff on the US. In this case, argues the ECB, the US loses in the short run and China even gains. In a trade war, the larger economy loses less, because the trade it loses is less important to it. The rest of the world’s economy is three times bigger than that of the US.
The US could get a deal on intellectual property and market liberalisation with China. But it cannot get a deal on balancing bilateral trade or stopping China’s economic development. It could get such a deal by co-operating closely with allies. If the US persists with pure bilateralism, it will not win. But it will do damage to itself, trade, the world economy and international relations. Trade wars are not good. With great powers, they are not easy to win either.