Why Not to Expect Much from US Trade Talks With China

Even though Mr. Market is now in a tizzy about the future of tech high-fliers, he was very happy last week when the US backed off from its trade war saber-rattling against China and the two sides agreed to talk.

The Administration still has its threat of a 25% tariff on $60 billion of yet to be determined Chinese goods in play, and has said it will launch a Section 301 trade action against China’s unfair technology licensing rules. Keep in mind that past Section 301 cases have served as bargaining chips to force trade concessions. Trump has said he wants the trade deficit with China reduced by $100 billion and also wants more reciprocity. Bear in mind that even a $100 billion improvement would only be a dent in a yawning trade gap of $375 billion last year.

As Treasury Secretary Mnuchin put it, per Reuters:

Mnuchin told Fox News that he was pursuing an agreement with the Chinese “for them to open up their markets, reduce their tariffs, stop forced technology transfer. These are all the things we want to do.”

The Administration is out to throw sand in the gears of China’s economic strategy. From the Financial Times:

But behind the tariffs is what analysts consider to be a broader objective from the White House to disrupt a high-level Chinese strategy, called “Made in China 2025”, that aims to make a number of companies world leaders in sectors such as robotics, semiconductors, aviation and computing.

A crucial element of Beijing’s development plan has been to partner with foreign companies or acquire overseas technologies that will help Chinese groups rise to global dominance in their respective industries. It is these companies the US is expected to take action against.

It is a awfully late for the US to be waking up to the Chinese buying as well as appropriating US technology. The Section 301 case is expected to target the well-established practice of Chinese firms requiring US partners to make substantial technology transfers as a condition of establishing joint operations. I am hardly connected, but I have been hearing for a very long time of Chinese companies also engaging in intellectual property theft, and I don’t mean bootlegging movies.

In addition to these priority areas, the US also wants China to let US firms take controlling stakes in financial firms, reduce tariffs on auto imports, and buy more US semiconductors.

The current state of play is that the Administration gave temporary waivers on its steel and aluminum tariffs to major trade partners like Canada and the EU so as to force the economic impact onto China. So even though Trump says he doesn’t do cooperation, this is effectively a joint action against China.

The problem is the Administration would not doubt like a fast win like the one it scored with South Korea in the form of renegotiation of some terms of a six year old trade deal that had become Trump’s poster child for “the US is getting screwed on bad trade agreements.” The US-South Korean merchandise trade deficit doubled after it was signed and Trump had threatened to scupper the deal entirely. The US oddly is keeping pretty mum, perhaps because Trump does not want to look like he relented. Or perhaps he intends to hold that talking point back till closer to the midterms so it won’t seem like old news.

I would not expect things with China to change much. Recall that when the US was faced with burgeoning trade deficits with Japan in the 1980s, it had a great deal of difficulty making any progress. The most effective tool was the blunt instrument of the Plaza Accord of 1985, an agreement among the then G-7 which drove the yen to the moon, with the overshoot so bad that the G-7 then entered into the Louvre Accord in 1987 to push the greenback back up.

While Japanese exports to the US fell as a result of the currency move, US companies made almost no progress in their pet aim of increasing exports to Japan. There were two major non-tariff barriers. One was the fabulously fragmented Japanese distribution system, which among other things helped Japan keep employment levels high. I recall US pharmaceutical companies desperate to buy 49% stakes in drug distributors as a way of improving access and not having much success (note that the idea of selling a company outright would be akin to selling your children, so that was another barrier to getting a foothold in Japan. Japanese attitudes towards M&A have changed since then). Another was that Japanese consumers had a very strong preference for Japanese goods, out of the often-accurate view that they were better made.

Mind you, the US had limited success despite Japan being a military protectorate. However, it was able to press Japan to deregulate its financial system rapidly. The result, as we’ve written elsewhere, was that the resulting speculation (which the Japanese then called zaitech) intensified the spectacular Japanese asset bubbles, making the bust even worse.

China has studied Japan’s economic history carefully and is mindful of its errors.

While it is obviously not possible to predict how things will play out, particularly with an erratic figure like Trump, the Chinese know that time is on their side. The more they look cooperative but find ways to draw out the talks, say by suggesting that they need to be comprehensive or multilateral to succeed, the more likely that they bog down or that the Americans decide they need to settle for some symbolic wins since getting any big prizes will be really hard. Remember, the Republicans are likely to take serious losses in the midterms and 2020 isn’t all that far away either.

Even if Trump were to impose his threatened tariffs, the impact on China won’t be significant and will also blow back to other trade partners. From the South China Morning Post:

If Trump were to slap a 25 per cent duty – as the US Trade Representative recommends – on US$50 billion worth of Chinese imports, we estimate the direct and first-order impact could be worth 0.1-0.2 percentage point of Chinese GDP.

While this impact could be amplified by a broader list of products, a higher tariff rate, and second-round effects, the order of magnitude is not large enough to derail the Chinese economy. In reality, this impact could be even smaller as the shock will be spread across the global supply chain.

Tech and electronic products, which are on top of the list for tariffs, are prone to supply-chain production, which involves countries specialising in parts of the production with inputs assembled at the end. China is well integrated into this process, with nearly 40 per cent of its exports in 2017 being processing trade with imported materials.

Hitting China on these products will create a negative spillover onto the likes of Japan, Korea and Taiwan. Even the US could suffer from the reverberation, with companies like Apple taking the lion’s share of profits from products that are assembled in China.

It’s hard to see how much progress the US can make without a major focus on upgrading and rebuilding domestic capabilities. We featured a post yesterday on how manufacturing entrepreneurship has fallen in the US due to a loss of skills. For instance, as reader Scott 2 pointed out:

The best engineering in the world won’t help your startup unless you can find a skilled machine shop, and they are disappearing quickly as the machinists retire and their children stare into their phones. It doesn’t help that trades aren’t learned in high school (actually discouraged) and a nice 5 figure sum is needed to get the training to use a 5-axis milling machine for which a starting wage is $15/hour.

It’s also going to be hard to push China around all that much given our dependence on them for rare earths, which is expected to lessen but will still be significant. As we pointed out in 2010:

In fact, the while the article does discuss US versus foreign engineering expertise in rare earths mining, it describes in some detail how difficult rare earths mining is in general (more accurately, not the finding the materials part, but separating them out) and the considerable additional hurdles posed by doing it in a non-environmentally destructive manner. Thus the rub is not simply acquiring certain bits of technological know-how, but also breaking further ground in reducing environmental costs.

And this issue has frequently been mentioned in passing in accounts of why rare earth production moved to China in the first place. It’s nasty, and advanced economies weren’t keen to do the job. China was willing to take the environmental damage.

Fast forward to an article in The Diplomat in August 2017:

Called “the vitamins of modern society,” rare earth elements play a critical role in our daily life — in both the economic and security domains. These elements are key components of a vast array of products, including smart phones, computers, light bulbs, electric cars, wind turbines, satellites, cruise missiles, and stealth aircrafts. Some elements, like neodymium and dysprosium, are highly demanded for the production of permanent magnets, which are used for sensors and motors of these products. The most noteworthy fact is that the more we go green and technology-oriented, the more important these elements become to our society.

Today, China enjoys a monopoly in the rare earths market. It is estimated that in 2016, more than 80 percent of rare earth elements produced in the world were excavated in China. The country is also believed to hold more than 30 percent of the planet’s remaining rare earth element reserves. While many stopped paying attention to rare earths after the dispute settlement at the WTO, the market has been preparing for more potential turmoil. For instance, Australian companies have been working to open rare earth mines in Australia and Tanzania for producing elements such as neodymium and dysprosium. Likewise, Canada, through collaboration with the national government and industrial associations, seeks to gain up to 20 percent of global rare earth production by 2018.

Having said that, a shuttered US mine is set to repopen….with a Chinese company as part of the consortium.

Let’s put this more tersely: if the US were serious about reducing its trade deficit, with emphasis on advanced technologies, it would have launched an industrial strategy. Now you might say we don’t do that. But in fact we do, just very selectively. Military spending is one way we do industrial policy on the sly. Why do you think Google is the world’s spymaster? That was no accident.

If we want more buying of US chips, rather than try to shove them down China’s throat, we might get the armed services and military contractors to eat more of our own cooking, through minimum content rules that phased in over time. Similarly, we also rely on the Chinese to make military uniforms and boots. The optics and the dependence are poor. There should be a way to repatriate some of the production and distribute other parts to countries that aren’t geopolitical competitors, like South Korea, India, and Vietnam.

The Chinese may make a clever concession or two to lower trade tensions a bit, but don’t expect Trump to make much headway. Remember, he hasn’t made much progress towards getting his wall done, and that’s a vastly easier project.

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  1. The Rev Kev

    Yeah, I can’t see these talks doing more than making cosmetic changes to the US/China relationship. I have read some of the demands that the Trump regime are making. I will list a few below and take a guess how China would see these demands-

    “Let US firms take controlling stakes in financial firms”
    Translation: Let the deep state, through its Wall Street cohort, plant financial time bombs and booby traps throughout the Chinese economy. Also, give them a say in how the Chinese economy is run.

    “To open up their markets”
    Translation: Stop the gradual development of Chinese home industries and throw them into intense competition before they are ready to stand by themselves.

    “Reduce their tariffs”
    Translation: Take a big hit in tax revenues while at the same time letting their home industries come under attack by foreign companies.

    “Stop forced technology transfer”
    Translation: When its the other kids bat and ball, you play by his rules. If foreign firms do not want to make a bucket load of cash in China under their rules, there is no gun to their head forcing them to set up shop in China.

    An odd sentence in this article was mentioning the reliance on China to make military uniforms and boots for the American military. They are apparently lighter and cheaper so this should not be a problem. That is, unless the Chinese are putting tracking devices in the heels of the boots. Remember, this site was pooh-poohing the British reaction to discovering that their post-Brexit passports will be printed on the continent. The optics for that are even worse.

  2. Ed Miller

    As a retired electronic engineer (IC designer) I can state that intellectual property theft is an ongoing concern, especially for companies whose revenue is largely in Asia. At my last company, which had(has?) operations in China, there were very strict measures put in place to firewall intellectual property. This included training of US staff plus monitoring by both legal and IT staff. In spite of this there were a few known cases of IP theft.

    For perspective, keep in mind that capitalism is sometimes described as theft of labor, which I would say must include intellectual labor. (Maybe theft of anything not nailed down!) I have read that the US became a steel making powerhouse by theft of English technology, for example. Theft in business is everywhere to some extent, and we humans seem to avoid wars by “playing by the rules”, which is intentionally quite vague.

    I think we can safely say that in today’s world we live in interesting times, but I just hope world affairs don’t get too interesting, as the ancient Chinese saying goes.

  3. Rates

    “Another was that Japanese consumers had a very strong preference for Japanese goods, out of the often-accurate view that they were better made.” The only thing America makes better is houses. The rest, they make better. God forbid if their convenience store bento boxes were to become popular in America. Those are IMHO even more high quality than the offering of some legit stores here in San Francisco.

  4. Sound of the Suburbs

    The US hasn’t worked out the problem lies at home.

    The half baked Washington Consensus was always going to be bad for the West with its high cost of living. It naturally gave a huge advantage to China and Asia where the cost of living is much lower.

    The US had skimped on its Ricardo.

    Ricardo made the arguments for the Repeal of the Corn Laws and the case for free trade through comparative advantage.

    We have one, but not the other.

    When the architects of globalisation were reading up on Ricardo’s law of comparative advantage they must have missed it.

    You need a low cost of living for free trade, which is why Ricardo campaigned for the repeal of the Corn Laws. The repeal of the Corn Laws was essential to usher in the era of Laissez-Faire, which I learnt in O-level History.

    Why did the jobs go to Mexico after NAFTA?

    The cost of living = housing costs + healthcare costs + student loan costs + food + other costs of living

    The cost of living is too high in the US, and this has to be covered in wages reducing profit. The US economy is not geared for a free trade world.

    “Income inequality is not killing capitalism in the United States, but rent-seekers like the banking and the health-care sectors just might” Angus Deaton, Nobel Prize Winner

    The interests of international capitalists and national rentiers are directly opposed.

    It’s always been that way apart from in neoclassical economics that they used for globalisation.

    It was obvious in the days of the classical economists.

    The aristocracy were economic parasites living off “unearned” income; they couldn’t miss it as it was a fundamental problem in the early days of capitalism. These parasites were always extracting rents from the productive capitalists and their workers, and the worker’s rents had to be covered in wages.

    The capitalist’s profits were being taken by these parasitic rentiers.

    Keynes was still aware, and called for euthanasia of the rentier.

    Then it disappeared for the West to make a mess of globalisation with real estate booms raising housing costs and the cost of living.

    Capitalism – back to basics

    Disposable income = wages – (taxes + the cost of living)

    Employees want more disposable income (discretionary spending)

    Employers wants to pay lower wages for higher profits

    The rentiers look to push up the cost of living (essential spending, e.g. housing costs)

    The government take taxes.

    The West didn’t understand the requirements of a free trade world. The cost of living and housing costs should have been going down to converge with those in Asia.

    The top jobs stayed, and the poorly paid, service sector jobs stayed as they had to be done locally. The jobs in the middle got off-shored.

    1. Sound of the Suburbs

      This is what Michael Hudson has been trying to tell everyone and he put me on this track.

  5. steven

    More than a century ago, English social critic John Ruskin is said to have observed “a logical definition of wealth is absolutely needed for the basis of economics if it is to be a science.” It appears he could have added “and government” to economics. We are now reaping the fruits of a half-century of ‘wealth creation’ by US politicians and bankers that has accelerated since the demise of the post-WWII Bretton Woods international monetary system in 1971. Discovering the global economy’s need for money outweighed elementary common sense (and the West’s financial oligarchy’s unwillingness to acknowledge it had been had and stop accepting more of the US’s “debts that can’t be repaid (and) won’t be”), US and increasingly other Western politicians have been accelerating their paper-hanging enterprise, engorging the financial assets of the West’s international monetary system with ever more U.S. and Western government debt.

    The only real suckers in all this were the West’s Lords of Finance. The Saudis effectively hired the US military as their mercenaries. Too bad Trump doesn’t read – as in Yergin’s The Prize. He would have discovered that the Iran deal wasn’t so bad after all. Iran was ‘red-lined’ by the oil majors so long they probably have far more of it left than the Saudis. As for China, to keep the peace (and the Lords of Finance happy – which amounts to the same thing) it could offer – much as Castro did in 1960 – to BUY the intellectual property with some of those trillions it has accumulated as reserves to defend itself from attacks by the likes of George Soros. China is trying to de-dollarize anyway so why not just pay for what they probably realized they were buying from the get go? They could stop sucking down the West’s garbage, start mining their rare earths in an environmentally sustainable way and just tell the West sayonara.

  6. never gonna happen

    Hehehe, even Ford China has a CPC committee, which MD is required to attend monthly. Non-tarrif trade barrier was invented by Chinese. Great Wall was as much about denial of grain, and thus suppressing nomadic population, as prevention of incursions.

  7. Tomonthebeach

    This story make sense economically, but it seems to ignore the diplomatic fish frying in the kitchen. China just played Trump like a one-string banjo. S. Korea makes nice-nice with N. Korea. China makes nice-nice with North Korea.

    What leverage exactly does the USA have in this situation anymore? China and S. Korea can ignore US Tariffs with virtual impunity. Japan has to be very nervous. They too have been snuggling up to China of late. Can Trump really protect Japan from China? Will Trump close all Japanese plants in the US to bring them into line? Close all the Toyota dealerships? Throw 10s of millions of US plant workers out of jobs? Not likely.

    Trump can still start a shooting war, and that is what an impetuous moron would be seriously considering – ask Tillerson. Not really, right? He would have to be assembling a war cabinet and pumping more cash into DOD’s budget. Oh, shit. He just did.

  8. bobbyp

    How is it “theft” when a Sovereign (nation state) does not recognize “intellectual property”? If one “sovereign” is negotiating with another “sovereign” then this should be a legitimate subject of give and take and not characterized as “theft”.

    If you want to speak in terms of “theft” then you have to acknowledge the West’s theft of 3rd world resources for about 400 years. Who is gonna’ pay for that?

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