In Trump vs China, everyone can win

For now, China’s leaders seem to be discounting US President-elect Donald Trump’s threats to punish them for allegedly unfair trade practices. The fact is that if they were to let their currency float freely, the yuan would probably decline, undercutting US exports. And if Trump did impose 45 per cent tariffs on Chinese imports as he’s vowed, China has plenty of ways to retaliate. The ensuing trade war could well hurt the US more than China. That doesn’t mean a Trump administration should simply accept the status quo in trade relations with China, though. A tougher stand could be good for both sides.

China remains one of the world’s most closed major economies. According to the World Bank, the US maintains an average tariff on goods from “most favoured” nations of only 3.4 per cent. China’s average is 9.9 per cent — higher than Russia, South Africa, Myanmar and Colombia. Even more important than outright tariffs are the barriers China maintains against foreign direct investment. Foreign companies are blocked from a wide range of seemingly innocuous industries — everything from cotton to tobacco to metal smelting. And as the US and European Union Chambers of Commerce have complained, those firms also face a growing number of other hassles, including difficulties enforcing contracts and accessing financing from Chinese banks. This has naturally prompted a backlash against Chinese companies, which have heeded the government’s urgings to seek out their own mergers and acquisitions abroad. In the last year, outward direct investment from China grew 53 per cent to $134 billion. Critics not just in the US but Australia, the UK and Germany have begun asking why Chinese companies should be allowed to invest in their farmland, nuclear power plants and technology companies when their own firms would have trouble doing the same in China. Even if China’s ventures into Hollywood don’t pose a national security threat, the fact that the country only allows 34 foreign films onto its screens every year betrays obvious hypocrisy.

China could easily end up paying a price for this widening asymmetry. A President Trump wouldn’t even need to levy devastating and possibly counter-productive tariffs on Chinese goods. He could simply work to ensure the US government scrutinises deals involving Chinese buyers much more closely — and slowly; acquisition targets would quickly look elsewhere for buyers. Chinese firms looking to graduate from low value-added, copycat manufacturing desperately need the kind of talent and technology global mergers can provide. Without it, they face a much steeper and more prolonged climb up the value chain.

Arguably, China would be wiser to head off international concerns now, before the US, UK and European nations start closing off their own markets. If lowering barriers to investment would entail some loss of control, it would also unquestionably further China’s own goals. As Chinese leaders from Deng Xiaoping on down have recognised, foreign companies provide not just badly needed capital but management and competitive pressures that result in greater efficiency all around. The sclerotic Chinese state sector in particular needs a boost in order to increase productivity; subjecting those bloated companies to true outside competition is the surest way to improve the way they do business. This may sound hopelessly idealistic. But there are historical parallels. During the Reagan administration, a similar backlash built up against Japan. The White House would’ve found plenty of political support for retaliating against what many Americans (including Donald Trump) saw as unfair Japanese trade and investment policies. 

Instead, President Reagan pushed Japan to accept a variety of “voluntary” export restraints. This in turn prompted Japanese firms, looking for ways evade the restrictions, to set up US subsidiaries, thus creating American jobs. Reagan made sure the Japanese understood he could always levy stronger protectionist measures if needed, so it was in their interest to make a deal. The parallels aren’t exact. Japan is a strong US ally that relies for its security on the US military umbrella; its leaders have more reason to compromise than China’s do. At the same time, Chinese reformers are well aware that their economy stands to benefit from opening up its markets. Consumers will enjoy cheaper foreign products like baby formula, which they’ll no longer have to smuggle in from abroad. Sectors in need of upgrading such as food processing and healthcare will gain expertise and technology. Letting in foreign retailers and service providers — everything from fast-food chains to financial firms — will help spur the transition to an economy driven more by consumption and services than investment and manufacturing.

These changes are politically difficult in China, which is why they haven’t taken place yet. In that sense, Trump could be doing the Chinese a favor by raising the specter of an outright trade war. As his counterpart, Chinese President Xi Jinping, likes to say, there’s a “win-win” solution here — if both sides are wise enough to see it.