US-China trade war: Beijing likely to be more affected, must negotiate

The outbreak of trade war between America and China is popularly attributed to the present US President Donald Trump. But its origin can be traced back to 1995, when China was denied entry to World Trade Organisation (WTO).

A traditionally communist China can be termed as a copy book example of closed economy till the 1970s. When WTO came into existence in 1995 with the objective of promoting free trade among nations by dismantling tariff barriers, its door was closed before China despite Beijing’s willingness to join. The reason was high tariff for imported goods, restricted entry of foreign goods and the artificially fixed low price of Yuan, the Chinese currency. Briefly, the reason behind Trump’s decision to impose counter tariff on Chinese goods is the same conservative attitude in the communist economy, that has persisted for decades.

It will be an utter simplification to black paint Trump and his decision to be erratic and seat him in the same bench as Mohammad bin Tughlaq. Actually, Trump is not the sole person, who should be made responsible for the outbreak of trade war. It was inevitable due to the situation hatched by China itself for decades. So Trump is not the architect, but the situation prompted him to act in this direction. He must not be labeled as the culprit, but can be a facilitator for creating a new world order in international trade. Experts know the hide and seek game played by China regarding trade.

History will no doubt take its own course, but we can analyse the situation that has emerged as a gun-less war in the world. China’s claim was that it was opening up the economy, which was not accepted by the United States, European countries and Japan. So despite China’s ambition to be a member of WTO from the outset, it was not allowed by the developed countries. However, China wanted to be a big economic power and was adamant to be a part of WTO. Ultimately, China was allowed entry in December 2001. Certainly, communist China had to bow down to certain harsh pre-conditions for it. The United States and Europe were also keen to allow entry into the WTO for China because that would expand their export market to a great extent.

US was mainly an importer of Chinese consumer goods at that time also, i.e. between 1996 and 2001. So getting access to the huge Chinese market for its goods and services was important for the US. In order to rectify the trade imbalance ultimately China was allowed admission to WTO. The reform measures taken by China included among others:

Allowing foreign investment in the service sector; opening up of banking, financial services, insurance and telecommunication for foreign investment; opening up of the retail sector; introduction of transparency rules; accepting of intellectual property laws of WTO.

However, such policy changes were only cosmetic. China remains a pure ‘Command Economy’ without bothering for international norms, run by the communist regime at the hands of the military, even to this date. There is practically no free market, freedom of press, speech, expression and writing. All economic parameters/variables like interest rate, rate of exchange are controlled artificially and not determined by the market forces. This is against WTO rules. On the other hand, China is exposed to world market economies, which do not have any artificial control on such parameters. Trump has initiated a great challenge to the autocratic regime of China, which according to economists will lead to another restructuring of the world economy.

The US imposed import duties on Chinese products worth $50 billion in April for violating US intellectual property loss. China retaliated by imposing steep duties on various American products, including soya beans. China is the most important purchasers of US soya beans. The volume of US-China trade is around $650 billion worth of goods.

Apparently, the Chinese economy is gradually opening up, its growth is high and it claims that financially the economy is stable. However, that is only the tip of the iceberg. There are certain features of the Chinese economy which makes it internally vulnerable. Honestly speaking, outsiders do not know anything for real about China. In the 21st century, this is unbelievable.

Firstly, China’s massive debt is almost 300 times its GDP, which is not sustainable in the long run. Secondly, one indication of flowing down of the economy is already visible. One important parameter, namely volume of property transactions, is falling fast. Recently it fell by 33.6% on an annual basis. The fall is most pronounced in tier two cities, 44%. Thirdly, reformation of the economy is yet to gather momentum. Steel and many other sectors are suffering from over capacity for years. Fourthly, cost control is not always possible at the regional level, despite directives from the central party. For example, vehicle financing and shutting down unviable factories are not always politically feasible for the local governments. The country is vast and total authoritarian control of the central government is a utopia.

Herein lies the danger for China from Donald Trump’s tariff policy. If such policies are also emulated by other countries, for which there is every possibility, domestic consumption alone will not be able to sustain the Chinese economy. However, the most advantageous aspect of a Command Economy is that political leaders can impose their directives easily with very little fall-out. They also control the media and give a rosy picture of the economy, and claim it to be a market determined one. Interestingly enough, the people at large are slaves, though all vices of capitalism are there to keep them silent as drug addicts.

Many countries who are dependent on it have recognised China as a market economy. However, such is not the case with America or Europe as they know that this recognition will prevent them from imposing anti-dumping duty. This duty is levied in case of China flooding the markets with low grade and unhealthy products at a cheap price.

Europe and America have three serious allegations against China as it has not kept promises regarding opening its market for American or European exports. China demands investment from US or Europe through joint venture route, mostly with government enterprises. It lays emphasis upon technology transfer from US or European companies, which very often leads to violation of intellectual property loss.

Thus Chinese President, Xi Jinping may claim that his country is a market economy, the actual situation is not so. China has not moved much from the situation where it was denied entry to WTO. US Trade representative Robert Lighthizer recently echoed a similar view. It is in this context that the impact of trade war has to be understood.

China is already retaliating Trump’s decision by imposing 25% import duty on a wide range of US exports like oil and steel products, automobiles and so on. It is in protest of 25% tariff on Chinese exports to the US.

If this kind of retaliation continues, Beijing with its Command Economy model will be more adversely affected than America. China has no doubt entered global manufacturing supply chain and gained a dominating position. This trade mainly comprises importing intermediate goods (accessories, raw materials etc.) and assembling them in China. This is about 43% of Chinese merchandise trade, according to Chinese Ministry of Commerce data for 2017. It amounts to $4.3 trillion. Thus China can utilize its cheap labour force and technical know-how. The worst impact of prolonged trade war is that China may have to lose this processing trade. Other countries like Taiwan and South-East Asian nations manufacturing in China may shift their businesses elsewhere. Actually, even a small increase in US tariff will make their businesses unviable, because in these cases, the profit margin is not at all high.

In order to avoid closing of factory doors, large scale unemployment, falling demand and large scale unrest among people, China must refrain from the path of retaliation and take to negotiation. America and other European countries can source their raw materials from nations other than China. But it will be difficult for China to shift its manufacturing base overnight and maintain its high rate of growth. Another major hurdle is that the country's capital output ratio has already reached sky high, which no text book can justify. Under this new era Cold War, India should rapidly ploy her trade policies in order to reap the void in line with Europe and America.