A U.S. and China trade war has been put on hold, but maybe not for long. For a few weeks this spring, President Trump’s Make America Great Again and President Xi Jinping’s Made in China 2025 seemed ready to collide. Then came word that China would buy more U.S. goods and the U.S. won’t impose harsh new China tariffs.
“Be cool, it will all work out!” Trump tweeted about talks en route to a recent trade deal that China’s state-run People’s Daily hailed as a “win-win” for both countries.
Trump’s throwback vision — stressing steel, agriculture, autos and oil — may coexist for a while with Xi’s prescription for China’s centrally planned high-tech, high-income future. But the harmony can’t last long in the world’s most important economic relationship.
Already, Trump, under fire over the China trade truce, said Tuesday it’s just a “start” and then Wednesday said talks would likely need a “different structure.” More broadly, the largely status quo deal won’t alter China’s grand plan to overtake America’s technological leadership by nearly any means necessary. Ultimately, China and the U.S. could erect barriers in strategic sectors, creating an economic cold war that severs closely integrated global supply chains.
Blue-chip giants Boeing (BA), Apple (AAPL) and Intel (INTC) all climbed Monday as Wall Street celebrated Trump’s deal with China, though Boeing gave up most of those gains Tuesday. While their near-term future in China may be more secure, the longer-term remains as uncertain as ever.
Made In China Aims To Belt Foreign Rivals
Made in China 2025, the 10-year plan set out three years ago, looks like anything but a win-win for the U.S. or any of Beijing’s other major trading partners. Through state subsidies, acquisitions, market access rules and sometimes outright cybertheft, Xi is bent on closing the technological gap, dominating domestic markets and establishing global leadership in advanced sectors such as semiconductors, robotics and artificial intelligence.
The official aim is to steadily displace foreign components, achieving 40% self-sufficiency by 2020 and 70% by 2025.
Concerns over China’s techno-military ambitions are only heightened by its One Belt, One Road trillion-dollar vision to command global trade by financing infrastructure across Asia and into the Middle East, Europe and Africa. China also created the Asian Infrastructure Investment Bank to rival the World Bank and the D.C. consensus on the global economy.
Yet it’s unclear if the U.S. has the appetite or strategy to thwart Beijing’s ambitions. Just 10 weeks ago Trump tweeted that “trade wars are good, and easy to win” and then demanded a $200 billion cut in the China trade gap. Yet rather than move beyond tariff skirmishes to a full-blown U.S. and China trade war, Trump gladly took Beijing’s pledge to boost American energy and agricultural purchases somewhat. And that modest concession came after Trump pledged leniency for Chinese telecom equipment giant ZTE, which violated sanctions on Iran and North Korea. ZTE had ceased operations after the U.S. banned American companies from working with it.
Why Trump Backed Off U.S. And China Trade War
Why was Trump so quick to relent? He may have favored a unified approach to North Korean diplomacy. Beijing also called his bluff, judging that Trump would have no stomach for a U.S. and China trade war with American farmers in the cross hairs ahead of key midterm elections.
Trump also may have realized he had a much weaker hand than he had imagined.
His initial threat was a 25% tariff on $50 billion worth of high-tech Chinese imports. But Trump tariffs largely would have hit Chinese ventures of U.S. and other foreign multinationals, the Peterson Institute for International Economics found. The tariffs on mostly intermediate goods would have raised U.S. production costs, hurting competitiveness.
“That the tariffs fail to hurt Chinese firms directly should not be a surprise,” wrote Peterson Institute researchers Mary Lovely and Yang Liang. Made in China 2025 is an aspiration, but current Chinese tech prowess still lags that of the U.S. and others, they noted. “It is impossible to hit tomorrow’s exports with today’s tariffs.”
Trump said something similar about his desire to go easy on ZTE, tweeting that it “buys a big percentage of individual parts from U.S. companies.”
Still, the U.S.-China trade relationship remains uneasy. By midweek, Trump signaled that ZTE’s fate was still in play as the U.S. seeks more certainty that the deal with Beijing will actually curb the trade deficit.
U.S. And China Trade War: National Security Issues
The Trump administration’s sudden shift from wielding a big stick to selling more carrots, so to speak, reflected a long-running split between businesses’ short-term financial interests and national security concerns about long-term strategic goals, says American Enterprise Institute resident scholar Derek Scissors.
Despite a consensus that America must confront China on trade, both sides “keep fighting over how tough we should be,” he told IBD.
Likewise, Scissors says, a growing consensus holds that the U.S. must act multilaterally to hold China to account. Even Trump had a change of heart about the Trans-Pacific Partnership trade deal cobbled together by President Obama to help counter China’s influence in East Asia. Trump relentlessly criticized the 12-nation deal in the campaign. He dropped TPP, never ratified by the Senate, on his fourth day in office. But he recently told top economic advisor Larry Kudlow to explore getting back in.
Yet saying we should act multilaterally is easier than doing it, says Scissors. He sees no realistic chance for a TPP revival. Instead, Trump is targeting allies with steel and aluminum tariffs and a new probe into auto imports.
For now, America’s strategic drift and Trump’s status-quo trade deal are playing into China’s hands. But Scissors says a cold U.S. and China trade war is coming.
A Cold Trade War With ‘Chinese Characteristics’
“We’re heading into a cold war with Chinese characteristics,” Scissors said. “They aren’t the Soviets.”
Unlike the USSR, China is a rival but not an enemy. And it’s fully integrated with the global economy. “I don’t think it gets as bad,” Scissors said.
Other nations have sought to climb the income ladder via unfair trade policies to build up national champions. Yet “China now has the wealth, commercial sophistication and technical expertise to make its pursuit of technological leadership work,” warned James Lewis of the Center for Strategic and International Studies, in a submission to the Trump administration’s probe of China’s technology and intellectual property practices.
It boasts the world’s fastest supercomputer, half as many tech unicorns as the U.S. (private companies sporting a $1 billion market cap) and wildly successful public companies such as Baidu(BIDU), Alibaba (BABA), Tencent (TCEHY) that can give U.S. FANG stocks a run for their money.
“The fundamental issue for the U.S. and other Western nations, and the IT sector, is how to respond to a managed economy with a well-financed strategy to create a domestic industry intended to displace foreign suppliers.”
Yet there’s also a clear military dimension to China’s ambitions to become the leader in areas including artificial intelligence, robotics and aerospace.
China Economy Takes A Different Road
The premise behind allowing China to join the World Trade Organization in 2001 was that trade would force its state-run system to gradually converge with market economies. That opened the door for U.S. multinationals to outsource their assembly lines, capitalizing on China’s huge pool of low-wage labor. More recently, Chinese companies have been moving up the value chain, aided by strategic deals but also by technology from foreign joint-venture partners as a price of market access.
Many have questioned whether the liberal technology policies of the U.S. and other rich nations ever made sense. Yet now that Beijing is directing a $300 billion national “self-sufficiency” campaign to minimize reliance on technology from the U.S., Germany, South Korea and others, its bid to buy technology has been met by a chill, if not paranoia.
U.S. Blocks China Technology Takeovers
In 2015, when Beijing spelled out Made in China 2025, Chinese investments in U.S. tech startups surged to $9.9 billion from $2.3 billion a year earlier. The tide began to turn at the end of 2016 when President Obama, on the advice of the Committee on Foreign Investment in the U.S. (CFIUS), blocked the sale of a German chipmaker’s U.S. unit to Grand Chip Investment GMBH, owned by a Chinese company.
Last year, President Trump nixed a bid by Chinese investors to buy Lattice Semiconductor. In March, Trump blocked a $117 billion Broadcom (AVGO) offer for Qualcomm (QCOM) on national security grounds. The apparent fear was that Broadcom, ready to move its headquarters to the U.S. from Singapore, would sandbag Qualcomm’s 5G wireless R&D and give a leg up to China’s Huawei. Facing pressure from U.S. lawmakers, AT&T (T) and Verizon (VZ) this year dropped plans to sell Huawei’s new phone in America.
Qualcomm has long been in Beijing’s sights. China has threatened to derail Qualcomm’s mergerwith Dutch chip firm NXP Semiconductors (NXPI). In 2015, Qualcomm ponied up $1 billion to get out from under a Chinese antitrust probe. Qualcomm seemed to have bought regulatory tolerance, in part by lending its technology to a joint venture with Guizhou Province to produce server chips.
China has used such strong-arm tactics to gain proprietary technology, costing U.S. firms upward of $200 billion a year, according to some estimates.
But if Beijing won’t give up its tacit encouragement of technology transfer as a cost of doing business in China, the U.S. Congress could step into the breach.
Congress is weighing legislation to beef up the CFIUS to let it oversee more transactions, including technology transfer agreements, bankruptcy sales and early-stage venture capital deals. The VC industry warns that banning Chinese funds from U.S. investments will push startups to migrate elsewhere.
The Trump administration reportedly has mulled curbing Chinese citizens’ participation in advanced research at U.S. universities. A Duke University researcher is believed to have transferred knowledge to develop China’s new stealth fighter jet.
If China continues to resist competitive market dynamics, “Western nations will naturally turn from managed integration to something more self-protective,” Daniel Rosen, founding partner of the Rhodium Group research firm, wrote in Foreign Affairs.
Trade War Costs: ‘Trillions Of Dollars’
While products such as toys, furniture and apparel could avoid national security scrutiny, Rosen sees a real risk of disengagement in strategic areas.
Countries don’t follow Econ 101 textbook examples with trade only in finished goods. Modern supply chains and investment links often involve a myriad of countries for a single product, especially for tech goods.
The breakup could happen in stages, as China marches toward Xi’s 2025 goals. Or the impact on technology supply chains could be more violent, like a major slow-moving earthquake.
Consider the chip industry in which U.S. and China trade frictions are highest. China consumes about 60% of the $412 billion semiconductor market, but three-fourths of those chips are imported (even factoring in foreign multinational output in China). No Chinese firms rank in the top 20 producers. Those chips are then assembled into finished electronics like the Apple iPhone, the bulk of which are shipped overseas. High-tech exports in the first quarter totaled $138 billion.
“The cost of disengagement will be severe for China, the United States, and third parties,” Rosen wrote. “It is possible that when China and the United States stare these hard realities in the eye, with adjustment costs likely to run into the trillions of dollars over the next decade, they will seek an alternative.”
But with Beijing working to “hardwire its system not to converge,” a long-term U.S. and China trade war becomes increasingly likely, he said.
China’s leaders aren’t willing to trust their country’s future to the free market. Wages in China have leapt above those in Brazil and Mexico and can’t compete with Vietnam or India. The working-age population is shrinking and will keep doing so for decades. To a large extent, if China is going to remain the world’s manufacturing giant and join the ranks of rich nations, it will have to depend on robots and other technology, such as artificial intelligence.
China’s ascendancy is hardly a sure thing. “Like many grandiose ambitions of central planning, the more spectacular elements will likely fall by the wayside,” Council on Foreign Relations research associate Lorand Laskai wrote of Beijing’s AI roadmap. “However, the plan might still succeed if only because China is committing resources to a societywide AI push” and reorienting the education system to train Chinese students to work with AI.