Trade war is in neither the US nor China’s interests

In it together.

The current trade dispute between the US and China is part of an unfolding reality in international trade that has its origins in the early 1970s when relations first began to thaw between the two countries.

Past economic isolation has taught China’s leadership that the technology required for many high-tech sectors could not be developed indigenously. Subsequently, technological and supply chain advantages have allowed US firms to gain a strategic foothold in key sectors of the Chinese economy.

This indicates that threats to limit trade with each other is a red herring. US complaints (and those of the EU for that matter) about the business operating conditions in China are longstanding and hardly provide the basis for a trade war.

What the US seeks is a more dynamic economic recovery, while China is bent on modernisation. Technology and intellectual property concerns are real but will not provide the solution that each side needs. Rather, a long overdue rethink of the global trade system is required. Only this can produce the dynamism and growth that both the US and China seek.

Economic sanctions and technology

China US economic relations have long been characterised by economic sanctions. In 1950, following the outbreak of the Korean War, US firms were instructed to suspend oil sales to China. Shortly afterwards, China began the requisition of the properties of US-owned oil companies including the Standard Vacuum Oil Company and the Texas Company. Then, when China fell out with the Soviet Union in 1960, China increasingly turned towards Japanese and European companies for technology.

US president Richard Nixon’s visit to China in 1972 witnessed a turning point in China’s economic relationship with the US. A lack of access to advanced technology proved costly and expensive for China. For example, a lack of appropriate technology in advanced chemical refining meant that during the 1960s crude oil had to be transported from western China to Japan for refining and then reimported back into China. This proved an early and costly lesson in China’s bid for technological self-sufficiency.

US companies were quick to take advantage of China’s demand for technology. The engineering technology firm Lummus first supplied China with crucial ethylene technology in 1973 for its Beijing Yanshan oil refinery. Lummus’s critical role in supplying the complex technology is illustrated by the fact that approximately 60% of China’s ethylene and styrene production is based on its technology today.

Unsurprisingly, US firms continue to perform well in China. Although it is difficult to get an accurate picture of their performance, the table below shows that the returns of US majority firms operating in China has been impressive, especially compared to other regions.

China’s long game

China too has played a long game in terms of modernisation. When China started opening up its economy to the rest of the world in 1979, it welcomed foreign investment as part of a more substantial drive to transform the nation.

This had its origins in the “Four Modernisations” policy, which was a long-term programme designed to modernise China’s agriculture, industry, science and technology, and military. Although it was first announced by Zhou Enlai in 1954, its central tenets have appeared in China’s planning documents ever since.

The recent Made in China 2025 initiative and emphasis on domestic innovation, which appears to have become the target of president Trump’s trade sanctions, are a continuation of these policies. The government is committed to drastically improving the quality of its manufacturing output.

But this plan conceals weaknesses in China’s growth model. Since the global financial crisis, FDI’s role in financing growth has been declining. This is significant since FDI typically comes with technology and know-how.

China’s opening has also not delivered the type of progress that would allow it to compete on an equal footing with the US. Specifically, it lacks the large transnational firms through which trade, investment and innovation take place. In 2016, China had just two companies that ranked in the top 100 transnational corporations by foreign investment. The US had 22.

Even without trade sanctions, China may well find it difficult to meet the targets of Made in China 2025. The strategy assumed average labour productivity growth in the region of 7.5 to 6.5%. These targets will be difficult to achieve under slowing growth. Labour productivity growth in 2016 was around 6.5%.

Market access works both ways

Given the above, it is reassuring that China has continued to defend the idea of globalisation and unsurprising that is has demanded new trade governance structures. In the aftermath of the 2007-08 financial crisis, China went to great lengths to avoid the return of protectionism in its major export markets.

President Xi repeated this view at Davos in 2017 when he said that “China has no intention to boost its trade competitiveness by devaluing the RMB, still less will it launch a currency war”. He reiterated it again at the recent Boao Forum of Asian leaders. Xi’s plea for reforming the global economic governance system to reflect new dynamics in the international economic architecture, reflects the real challenges China faces in international trade.

Concealed in the broader trade dispute is that neither country’s growth model is sustainable in the long term. China, with its slowing productivity growth, and the US, with its urgent need to renew its economic dynamism, could find considerable common ground in building a new global trade system.