Speak Softly and Carry a Big Stick: China’s Approach to the Trade War?

When the Trump administration first instituted tariffs on China in May of 2018, China’s President Xi Jinping saw no reasons to worry. Mainstream economic theory has held that tariffs are equally detrimental to the country imposing them and to the country they are being imposed on. In response, Xi slapped retaliatory tariffs of an equal value on American goods and began a game of brinksmanship. Now, less than a year later, both sides sit at the negotiating table, keen to negotiate a successful agreement. For Trump, this opportunity will give him the big win he promised blue collar supporters, and for Xi, will make things relatively normal again for Chinese exporters. But questions abound regarding the current negotiations. Will they succeed? Are they even being undertaken in good faith? China’s past approach of mitigation and diplomacy over the latter half of 2018 indicates a likelihood that the country is simply playing a patient waiting game until 2020, when Trump can be defeated and hopefully a more trade-friendly administration will take office.  

 

After the Trump administration instituted a 25 percent tariff on steel, another import jumped significantly: turbine parts, according to The Wall Street Journal. By labeling steel plates as turbine parts, Chinese exporters were trying to avoid the steel tariff. Soon, such a dodge was being instituted on everything from plywood to diamond saw blades. This product misclassification was not the least among the tactics exporters used. Some turned to transshipment or moved their final stage of production to other countries like neighboring Vietnam so that their final product wouldn’t be classified as Chinese. The rising popularity of these practices can be seen in the recent rise of foreign direct investment in Vietnam and increasing land prices of industrial parks around Ho Chih Minh City, according to The South China Morning Post. These practices may be starting to lose their effectiveness as the U.S. catches on. In December, the U.S. Commerce Department announced tariffs on steel from Vietnam due to suspicions over such tariff evasion.  

 

The Chinese government has also tried to shield its exporters from the impacts of Trump’s tariffs. The South China Morning Post reported that the government instructed banks to lend more to firms that were struggling due to the decrease in American demand for their products. According to CNBC, multiple Chinese provinces have offered tax cuts and other exemptions to help struggling businesses.  

 

So far, Chinese public and private sector responses to the trade war have mostly focused on mitigating its impacts. While these tactics may have worked for some time, The Wall Street Journal reported in October of 2018 that Chinese export growth had accelerated to 14.5 percent for the year, from just 10 percent in August. However, this approach has been weakening as China has begun to feel some longer-term impacts in 2019. Forbes reported in January that Chinese exports to the U.S. have fallen 3.7 percent and the Shanghai Composite Index has fallen 30 percent. Pressured by the slowing economy, Beijing may be engaging in negotiations as simply another mitigation tactic as fundamental ideological differences between the two countries make a comprehensive agreement unlikely.  

 

Michael Schumann notes in The Atlantic that the U.S. and China approach the global economy in fundamentally different ways. Whereas the U.S. has traditionally been an advocate for free open markets, China believes that a large degree of government control and guidance is needed for stability and growth. The U.S. is convinced that such government intervention is creating an un-level playing field where Chinese firms are favored and international competitors are shut out. Ironically, it appears that Trump is using protectionist tariffs to achieve a freer market. Besides these fundamental economic differences, the U.S. and China are also engaged in intense cyber and intellectual property warfare. Human rights violations in Xinjiang and gradual political repression in Hong Kong are damaging American perceptions of China. It appears that a majority of the American people agree that a harder line should be taken with China. Polling from the Pew Research Center indicates that a consistent majority of Americans, regardless of political affiliation, have viewed China negatively since 2012. Democrats are also largely attuned to Trump’s hard stance on China, particularly because of the popularity of protectionism among the labor unions that once constituted the base of the party but defected in large parts in 2016 due to Trump’s trade promises. Thus, the trade war seems to have evolved from a dispute over the U.S.-China trade deficit to a more general vessel for a variety of grievances between the two countries. Untangling and compromising on all these issues seems like an insurmountable task for the negotiators of both countries in the mere 90 days given. White House economic advisor Larry Kudlow stated on Fox Business in early February that there was still a long way to go before any agreement would be reached.

 

China’s initial concessions have been modest, primarily consisting of vague promises to buy “significantly more” American goods. In an illustrative example, Trump recently touted a vague promise by Xi Jinping to purchase an additional five million tons of soybeans as an act of goodwill. “That’s a lot of soybeans,” Trump said, according to The New York Times. Yet for reference, the U.S. exports more than 35 million tons of soybeans to China a year, clearly dwarfing this amount. Trump’s tendency to fixate on large numbers may be an advantage that China will take advantage of in negotiations. Xi may be calculating that modest concessions combined with gamesmanship will temporarily alleviate the trade headache or prevent it from worsening. 

 

It appears that many in the market agree. Alec Phillips of Goldman Sachs assesses that over the next three months, there is a 20 percent probability that the negotiations will lead to a comprehensive deal rolling back tariffs. An Ernst & Young poll of top executives found that a majority believed that the tariffs would remain into 2020.  

 

Yet, there is a chance that modest progress can be made on some issues.  Beijing has shown more economic flexibility than once thought possible. For example, for its first factory in Shanghai in 2018, Tesla recently received a government exemption from the requirement of finding a traditional joint venture partner.

 

Overall, it appears that Beijing is aware that a prolonged trade war is not in the interests of either country. However, there are limited actions Xi is willing to take without radically restructuring the Chinese economy. Like Theodore Roosevelt’s infamous diplomatic approach, China may be relying on “speaking softly” to the American president first before wielding their more adversarial “big stick” options.