China-U.S.: A Trade War Of Attrition

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by: Global Risk Insights
Summary

On 10 May, 2019, the Trump administration raised tariffs on USD 200 billion worth of imports from China. This escalation of events caught observers by surprise. The Chinese side has retaliated with tariffs on American goods.

The recent escalation illustrates that contention between the two sides is not easily reconcilable.

Domestic non-economic factors equally raise the possibility of a protracted dispute.

In a war of attrition, the two sides involved evaluate the benefits of victory in isolation from the costs sunk in previous bouts of the battle.

On 10 May, 2019, the Trump administration raised tariffs on USD 200 billion worth of imports from China. This escalation of events caught observers by surprise. The Chinese side has retaliated with tariffs on American goods. With these developments, the trade dispute devolving into an economic war of attrition between the two behemoths is now a possible outcome.

On 10 May, 2019, the Trump administration raised tariffs on USD 200 billion worth of imports from China. This escalation caught entrepreneurs and policymakers by surprise. The ratcheting up of the tariff rates from 10% to 25% on roughly half of all Chinese exports to the US has been justified on the grounds that the Chinese side backpedalled on certain concessions. The US has been urging China to cease forced technology transfers and roll back anti-competitive subsidies. This became part of the discussion during the eleventh hour of negotiations.

The Chinese side has, naturally, denied this charge, and has retaliated by raising tariffs on USD 60 billion worth of American imports. With these developments, the possibility of the trade dispute devolving into an economic war of attrition between the two behemoths is now a likely scenario.

Revocation of tariffs

The recent escalation illustrates that contention between the two sides is not easily reconcilable. China's Vice Premier Liu He has revealed that the most prominent sticking point pertained to the removal of tariffs.

On the one hand, the American side insists that tariffs should remain in place, until China enforces the desirable changes. These demands include jettisoning forced technology transfer and market-distorting subsidies, and importing more from the US. Trade hawks in the Trump administration such as Lighthizer and Navarro appear to be firmly back in the driver's seat. This reduces the possibility of swaying American negotiators on this count.

On the other hand, the Chinese side is bargaining for a restoration of status quo ante with respect to tariffs. China cannot tolerate protracted tariffs. Business confidence in the economy has reacted adversely to them, insofar as they have become emblematic of the USA's disaffection. This was particularly true with the tech industry, for example. Tech is a priority sector for China with competitiveness in low-quality manufacturing declining and the population aging.

Data from China's National Bureau of Statistics touched basis on four high-tech industries. Strictly speaking, these include industrial robots, integrated circuits, automobiles and smartphones. The data reveals that output growth of these industries has cascaded subsequent to the first volley of tariffs. Tariffs directly impacted only the first two of these industries. As such, the data suggests that these sectors were largely disturbed by political uncertainty. It has been reasoned, for example, that the trade war is less an economic dispute than an American attempt to contain China's rise.

Therefore, removal of tariffs is considered imperative to a restoration of confidence. Any trade deal that fails to specify whether and when tariffs will be removed is anathema to it. Therefore, a non-starter for Chinese negotiators.

Non-economic considerations

Domestic non-economic factors equally raise the possibility of a protracted dispute. While it was largely acknowledged that exigencies of electoral politics in America would generate incentives for the Trump administration to strike a quick deal, less attention was paid to domestic conditions in China. With Premier Liu's recent comment that a trade deal must "not undermine China's sovereignty and dignity," it would appear that China's domestic imperatives predispose her to an unyielding stance. There are two main consumers of this rhetoric: the general public and party elites.

With respect to the former, the Chinese establishment arguably appears to factor in public perception of the negotiators' performance. This is to the extent that concessions are perceived as an abrogation of patriotic duty. As a result, China's negotiators appear less willing to make such concessions.

Chinese leadership and policy-making

While some China-watchers have expressed skepticism over the veracity of this patriotic pressure, a recent academic study has found that public opinion in China regarding foreign policy, and particularly the US, tends to be hawkish. This can become a salient factor in managing international disputes, if it escapes the grasp of Chinese administrators. In part, Premier Liu's statement indicates this reality. It is true that China's leaders may dubiously cite domestic pressures to justify intransigence during negotiations. In the case of the ongoing trade war, however, there is more reason to believe that such pressures are operative.

In the eyes of party elites, however, loss of dignity pertains primarily to American demands that China jettison her industrial policies and subsidies, something that is considered emblematic of China's development model and of her commitment to "socialism with Chinese characteristics". These were recently declared as "core interests" by People's Daily, a Communist Party mouthpiece. Holding steadfast on this sticking point is, therefore, also likely driven by President Xi. The President seeks to maintain ideological consistency in the administration's conduct, conveying this to the Party cadre.

Blinking first

In a war of attrition, the two sides involved evaluate the benefits of victory in isolation from the costs sunk in previous bouts of the battle. This results in a prioritisation of victory for its own sake and a strategy that entails waiting for the other side to "blink" first. Reportage on the recent escalation suggests that such a dynamic is, in fact, unfolding in the trade war.

Chinese negotiators, for instance, reportedly interpreted President Trump's desire for lower interest rates as a sign of a stressed American economy. It also forecasted that the USA was on the verge of blinking. Similarly, American negotiators consider China's ongoing economic woes as likely to prompt a capitulation. This system of conflict is not conducive to resolution, which now must rest primarily on the agency of the units involved i.e. USA and China.

Much will depend, therefore, on the nature and extent of China's upcoming retaliation. With China running out of room to tariff imports from the USA, it is probable that retaliation will take place in other aspects of the bilateral relationship. It must be stressed that China imports only a third of what it exports to the US. While Chinese policymakers will endeavour to calibrate this move so as to preserve the likelihood of a resolution, it is reasonable to venture that the two sides will have more issues to negotiate going forward. Unfortunately, the mere likelihood of an agreement will do little to reassure economic stakeholders. Simultaneously, it is possible that business confidence may languish in the interim, as producers strive to plan costly diversifications in supply chains.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.