9 Things to Know About the Trade War with China

What’s happening?

In early 2018, the Trump administration began imposing tariffs on selective Chinese products coming into the US.  Over the next 18 months, the two countries have entered into a back-and-forth “trade war” imposing taxes on the import of goods from each other.

Why is the US raising tariffs on China?

The basic reason is two-fold:

1-      The administration believes that China is stealing intellectual property (IP) from the US. 

2-      President Trump wants to close the gap of the trade deficit.

What is intellectual property and how are they stealing it?

Intellectual property theft can be as simple as trademark infringement such as using brand names without permission; knockoff sunglasses and purses with brand names like Prada, Louis Vitton, and Oakley, but on a larger scale, IP theft includes corporate espionage and technology theft that involve using patents without permission.

Is this a big deal?

A report by the US Trade Representative published in April 2018, found that intellectual property theft in China accounts for roughly $50 billion in lost profits per year for US companies who lose sales to the counterfeited goods. More concerning is that a 2015 paper by the Federal Reserve Bank of Minneapolis found that “more than half of all technology owned by Chinese firms was obtained from foreign companies.”

Still, China is about average on the global scale of offenders, ranking 25th out of 50 on the U.S. Chamber of Commerce International IP Index; a ranking system that measures each country’s commitment to protecting intellectual property.

How will imposing tariffs solve this problem?

It’s somewhat unclear, but IP theft was the legal basis for the tariffs of last July and September. The tariffs are designed to put pressure on the Chinese government to impose more serious punitive sanctions on offenders of IP theft within the country. According to the South China Morning Post, under current Chinese law the maximum fine for violation is 5 million yuan (US$744,210), but the average award is only 190,000 yuan (US$28,000), likely not enough to deter violations.

President Trump tweeted that the US is losing “hundreds of billions of dollars” in trade with China.  What’s that about?

That brings us back to point #2 mentioned above. Trump is likely referring to closing the ongoing trade deficit with China.  Last year, the US purchased roughly $540 billion worth of goods from China, and sold roughly $120 billion of goods to China (according to data obtained from the US Census Bureau).  The resulting difference in trade came to roughly $420 billion.

However, this money obviously isn’t “lost” to China.  Rather, it went towards US consumers purchasing goods – arguably at a lower cost than comparable goods produced in the US.

So, why does the President say we “lose” money in trade? 

The President (and pretty much everyone else in politics) is obsessed with registering growth in the US economy by measuring something called GDP – Gross Domestic Product – a measure of economic activity in the country.  In the calculation of GDP, the trade deficit subtracts from domestic economic activity. In other words, our economy would have been $420 billion larger had we not traded with China at all last year, and manufactured and consumed all the same goods and services here in the US.

However, China has cheap labor. If the same goods were made in the US, the cost of everyday purchases would likely rise substantially, costing each family more money and increasing inflation. In general, global trade serves to increase choices and keep costs lower for consumers.

Will tariffs close the trade imbalance?

Increased taxes paid by consumers (yes – US consumers pay the higher cost – not China), certainly dis-incentivize trade with China, but the solution is likely a short-term fix.  Unless tariffs are kept in place forever, the trade balance will persist for two reasons:

1-      China has cheap labor that the US can’t (and shouldn’t) compete with.

2-      China doesn’t have a demand for more American goods.

The first point is obvious.  China has 1.38 billion people, most of whom make substantially less money than the average American worker.  China’s demographics and low cost of labor give the country a unique advantage in low-cost global trade – and serve as one of the main reasons that inflation in the US has remained so low. Put another way, Americans love inexpensive things… and China makes lots of inexpensive things.

With low wages comes reduced purchasing power.  Which brings us to point #2. The Chinese don’t have the demand for higher priced brand-named American goods because they can’t afford to consume much more.

The trade deficit can be closed temporarily by tariffs, but demographics and income levels won’t change for decades.  Which raises the final question:

What’s the end game of the trade wars?

Trump bragged in early 2018 that trade wars are “easy to win”.  I am afraid that history will prove him wrong.  In brief, the president is racing the clock to get a “victory” on stronger sanctions against intellectual property theft. If he gets that concession from China, he will likely celebrate with a victory lap and call off the tariffs, but he has a limited time to get those concessions.  China, on the other hand, has no sense of urgency to make a deal (other than the fact that the country relies heavily on exports). If the Chinese economy can hold itself together for the next 15 months, then it can likely outlast Trump’s trade demands.  Meanwhile, the stock market has made it clear that it doesn’t like tariff talk; a factor that will grow in importance as the election nears.

My hunch is that Trump realizes that he can’t solve the trade deficit over the long term with tariffs, and that his re-election hinges on the strength of the economy (and the stock market).  Therefore, I suspect that the conclusion will likely be a de-escalation of trade wars sometime leading up to the election.