September 10, 2019

The Next Stage of the U.S.-China Trade War Will Be Much Worse

U.S. Trade Representative Robert Lighthizer, left, and Chinese Vice Premier Liu He arrive for a group photo at the Diaoyutai State Guesthouse in Beijing, China February 15, 2019. Mark Schiefelbein/Reuters

The trade war between the United States and China has entered a new and dangerous phase.

By Edward Alden
Bernard L. Schwartz Senior Fellow
Council on Foreign Relations

The trade war between the United States and China has entered a new and dangerous phase. Both countries have moved from using tariffs and other trade sanctions in a reasonably strategic fashion in order to try and strengthen their negotiating position into a series of punitive measures designed to inflict significant economic harm on the other. As markets signaled last week, with stocks taking a roller coaster ride and bond yields plunging, the risks of an unconstrained economic conflict have risen substantially.

Like all wars, trade wars are easier to begin than they are to end. They can start with limited, rational objectives, but if these fail to be achieved, leaders almost invariably see escalation as preferable to humiliating retreat. The result is a costly and damaging conflict that no country intended nor wanted. 

This was a lesson the world’s leaders learned during the “beggar thy neighbor” economic conflicts of the 1930s, which is why they set up institutions after World War II to prevent trade wars. That vision culminated in the creation of the World Trade Organization in 1995 and the commitment by all its member countries to resolve their differences through binding dispute settlements.

It is not a vision that U.S. President Donald Trump agrees with. Previous American administrations had been frustrated by what they saw as predatory Chinese trade practices that were not curtailed by WTO rules, but Trump, fixated as well on chronic trade deficits, chose to throw off those shackles. After first targeting allies by restricting steel and aluminum imports, the Trump administration last year imposed tariffs on Chinese imports—against the rules of the WTO—to try to force changes in Chinese behavior. The sanctions succeeded in bringing China to the negotiating table, but the talks broke off in May after Beijing balked at some of the more sweeping U.S. demands. Instead of remaining at the table to see if the differences could be narrowed, Trump broke off the talks and imposed new tariffs that will soon cover most of China’s more than $500 billion in exports to the U.S.

Now, both sides are digging in for a prolonged conflict. On the day last week after U.S. stocks had their worst performance of 2019, Trump boasted that “the longer the trade war goes on, the weaker China gets and the stronger we get.” Beijing responded by announcing that it would impose new countermeasures against the U.S. next month. Chinese President Xi Jinping, facing protests in Hong Kong and other challenges to his authority, can’t afford a show of weakness. Hu Xijin, editor of the Chinese state-run Global Times, tweeted last week that “Chinese society has full confidence to fight a prolonged battle with the U.S.” Trump in turn warned that new Chinese sanctions would be met with a still harsher American response. “Just so you understand,” he told reporters, “I’ve been very mild about it—very, very mild. There’s a long way I can go.”

Unfortunately, there is a long way both sides can go. The tariffs imposed so far are relatively modest, from 10 to 25 percent. With WTO rules now thrown aside, there is nothing preventing each side from levying much steeper tariffs.

A currency war is also looming. China has allowed the renminbi to decline to lower the costs of Chinese exports and offset the damage from U.S. tariffs; earlier this month it permitted the currency to fall below the symbolic level of seven to the dollar. Trump responded by again pressuring the independent Federal Reserve to make more aggressive cuts to U.S. interest rates, arguing that a weaker dollar “will make it possible for our companies to win against any competition.” Other economies caught in the crossfire of such competitive devaluations, including the European Union and Japan, would have little choice but to respond in kind. 

If that weren’t ominous enough, a technology war is rumbling as well. The U.S. has already restricted exports to Huawei, China’s giant telecoms equipment manufacturer, but has stopped short of barring critical inputs like Qualcomm chips and Google’s Android operating system. If it did bar them, China could respond by restricting exports of rare earth minerals, which are vital inputs for consumer electronics, electric vehicle batteries and other high-technology products. 

Any of these actions would worsen the collateral damage that is already being done to other economies around the world, while the Trump administration still hasn’t abandoned its threats to increase tariffs against close allies. The U.S. will soon be in a position to impose new tariffs against the European Union that are legal under the WTO—unlike Trump’s other trade restrictions—since they stem from a long-running trade dispute over subsidies to aircraft maker Airbus. Trump also has until November to decide whether to slap tariffs on cars imported from Europe, Japan and elsewhere following a Commerce Department finding that such imports supposedly threaten U.S. national security. The EU has warned it will retaliate fully against any U.S. tariffs.

The only thing holding the U.S. and China back at this point is concern about harm to their own economies. Late last week, Trump decided to delay until the end of the year tariffs on consumer goods like toys and smart phones after complaints by American companies of damage during the Christmas shopping season. If the U.S. economy begins to slow significantly, he will likely be reluctant to escalate the trade war further, especially with the election coming in November 2020. China in turn is facing its weakest growth in decades and is seeing investment flee to Vietnam and other countries to escape the U.S. tariffs. Beijing may be loath to impose sanctions that increase uncertainty and accelerate that outflow.

But the thing about wars is that leaders often do things that hurt their countries terribly in order to maintain apparent “credibility” or save face. The British writer Norman Angell infamously wrote on the eve of World War I that economic interdependence in Europe had made war a thing of the past because the economic costs would be far too high. 

Economic self-interest alone has rarely been sufficient to constrain states. That’s why wise leaders built institutions like the WTO to encourage mutual restraint and find peaceful ways to resolve economic conflicts. Without those rules in place, the only constraint is the good sense of the current generation of political leaders. No wonder the markets are so fearful.

Originally published by the Council on Foreign Relations, 08.20.2019, under the terms a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International license.