29 06 2019

The US trade war against China will change history (2)

Major powers plan to cut up China for themselves. The US claiming its part. Major powers plan to cut up China for themselves. The US claiming its part. Punch Aug 23, 1899, by J. S. Pughe. Library of Congress statement : No known restrictions on publication.

The ongoing US trade war against China will have deep longer term repercussions, independently of whether a trade deal is reached to end it. Had it only been a question of erratic actions by a lunatic president, the effects could have been limited. But Trump is not alone. The general mood in the US establishment is that China should be contained, or even rolled back. So the key-word is now ‘disentangling’ of the US economy from China.

And why this ‘disentangling’? The globalisation implies that all the bigger economies have become ‘entangled’, as the supply chains for most products now cross borders. Components from different countries are used to make most products in the US, Europe, China etc. Trust is essential for these supply chains. A company needs to be able to trust that the components it is sourcing from country X will arrive at the agreed price and in time for it to be able to manufacture its products.

The sudden hiking of tariffs disrupts the supply chains. But the sudden cutting off of the access to components that a company relies on is immensely more disruptive than tariffs. It is not that the components become more expensive. They are simply not available any more. If there is no alternative sourcing possible, production will stall. This is what the US has done, first to one Chinese telecom giant, ZTE, in 2018, and now to the even bigger Chinese telecom company Huawei. The short term impact is severe. But the long term impact is much more profound, as it is signalling to China that it can no longer trust US providers. This will set in motion a long term process in China to substitute away from US technology. Even if a deal is reached between US and China in the near future, the damage has been done. Trust has been broken. And the message perceived in China is clear: they will have to rely on their own technology or technology from reliable allies, because otherwise the dependence will be used against them. That is the logic behind China establishing an unreliable entities’ list that will include companies and people who ‘block or cut supplies to Chinese firms with non-commercial purposes’. The list is still not published and will probably continue so if an agreement is reached with the US.

The US sees it differently. The Chinese could just give in, give up their strive for technological leadership, accept their role as underdog in the tech industry and their troubles would be over. Can it really be that difficult? Others have done that. Europe, Japan, South Korea. But they misread China. China undoubtedly needs a deal more than the US does, so they are willing to make substantial concessions to the US. But there are several red lines that they are unlikely to accept being crossed. The most important in the context of the trade war is that they will not give up their industrial policy intended to build their own high tech industry within key areas such as semi-conductors, artificial intelligence, electric vehicles, aviation and so on. In the political area, they will not negotiate the integrity of China (which for China includes Taiwan and Hong Kong) and they will not accept limiting their military capacity so to guarantee eternal US military supremacy in East Asia. If it is money the US wants, they will surely get it. Historically, China has during the last two millennia often bought peace on its borders paying huge sums (mainly in the form of silk) as protection money to barbarian tribes on their Northern and Western borders based on the simple calculation that it was cheaper than waging eternal war with them. They are probably willing to pay extortion money to the Americans too, obeying the same logic.

However, even with a deal there is a risk of the world being split up in essentially two competing high tech areas, with limited technological interaction or trade between them. This was what happened during the cold war and was no doubt an important reason for the collapse of the Soviet Union. It is of course economically inefficient as it means doubling of research and development, risk of incompatibility of tech systems and so on. If in this scenario some level of trade is maintained, it will on the other hand also bring benefits by breaking down monopolies and providing more choice. In the specific case of Huawei and the mobile phone industry, at stake are the Qualcomm and Arm dominance of the mobile processors, and the Google/Android-Apple dominance of the operating systems. But this goes much beyond the mobile phone industry and 5G.

Would China be able to survive and prosper in case of technological isolation? They may or may not. The pessimists point as an example to the Chinese failure up to now to gain market share for their own computerchips and operating systems. The optimists point to the success of the Chinese space programme and the development of super-computers, despite that China has been cut completely off from Western technology in these areas due to US sanctions. They will explain that the reason the Chinese still use Windows, Android, Intel chips etc. despite Government efforts to develop indigenous software and components, is that private Chinese companies haven’t – up to now – seen any urgency in changing, so there has been no market for these substitutes. Even the Huawei founder, Ren Zhengfei, has until recently argued against switching to domestic components, as international supply chains in many cases are more efficient. The trade-war has changed that. However, the ‘disentanglement’ will be costly for the Chinese, perhaps prohibitively so. Much depends on whether the Europeans and Japan follow the US in completely isolating China technologically.

Some consider a trade rupture as inconceivable taking into account how dependent China is on the trade with the US. However, this may not be the case. The US accounted in 2017 for 19% of China’s exports. As total exports constituted around 18.5% of China’s GDP, it means that the exports to the US constituted around 3.5% of the Chinese GDP. As it is estimated that the import component of Chinese exports is around 50%, the impact on China should all export to the US stop would be around 1.75% of GDP. Important, but for an economy growing with 6-6.5% annually not devastating. Furthermore, the final assembly of part of the Chinese export production would probably be moved to neighbouring countries, not affected by the US tariffs, thus circumventing the US measures. So all in all, the impact from the tariffs imposed on Chinese exports should not be overestimated. The main impact on the Chinese economy will, as mentioned rather result from denying Chinese companies access to necessary high tech components and machinery.

What is the likely outcome of the trade war? Difficult to say. My guess is still that there will be some sort of agreement, but that the technological trade war will continue, even if at lower intensity. A total rupture is of course also a possibility. As mentioned, the China bashing competition will intensify during the upcoming US electoral campaign, so it is important for all the candidates not to be seen as soft on China. The liberals will say this is because of Chinese human rights violations (Uighurs, Tibetans, internet censorship, the surveillance state, etc.) and the need to defend the free world, while the nationalists will add the need to contain China and prevent it from becoming a geopolitical competitor.

Where does this leave poor, old Europe? The EU countries have the option to disregard their own interests and continue backing the US in whatever it is doing, if not for other reasons then because of their heavy technological dependence on the US and hence their vulnerability to US extraterritorial measures. The country with most at stake is Germany, which has a prosperous, well-balanced trade with China. Germany is arguing for the need for Europe to unite and stand up to China, Russia and the US. However, it will be difficult to get Europe to unite if it implies standing up to the US. EU is heavily divided over a lot of issues, loaded with high levels of public debt, and embroiled in the Brexit fall-out and the interminable strive for EU enlargement (Ukraine, Belarus, Georgia, Armenia, Turkey etc.). Furthermore, the US has several unconditional supporters within the EU (Poland, the Baltic Countries, Denmark), which willingly would undermine any common policy perceived as being contrary to the US (just take the Danish policy of obstructing the ‘Nord Stream 2’ gas pipeline from Russia to Germany, toeing the US line and ignoring with disdain the Germans for whom the project is high priority to be able to phase out both coal and nuclear power and switch to renewables in the longer term). At the same time, traditional European positions are eroding within its traditional areas of strengths.

Still, the most likely scenario is an increasingly divided technology world, with US, Japan and a reluctant EU on one side, and with China, Central Asia and Russia on the other. The emerging and developing economies will be hard pressured by the US to choose side also, but particularly the East Asian countries will try hard not to do so, as the trade with China for them is more important that their trade with US and its allies. The final outcome is not easy to predict.

 To read the first article, click here.

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Note: The Trump administration’s China policy was supposed to be defined in a speech by vice-president Pence in October 2018. In this he makes the most incredible and ridiculous, historically incorrect, statements. Some examples: (i) ‘America refused to join in China’s Century of Humiliation’. This is simply untrue. In 1844, with China already on its knees from the British assault on China (the first opium war), the US signed the ominous Treaty of Wanghia with China. It is true that the US didn’t participate in the horrendous second opium war, culminating in the occupation of Beijing and the looting and burning down of the Summer Palace in 1860, but the US participated together with Britain and other European powers (incl. Russia) in the suppression of the Boxer uprising (1899-1901). (ii) ‘We rebuilt China over the last 25 years’ (is he joking?), (iii) ‘American missionaries (…) not only (…) spread their faith, but (…) founded some of China’s first and finest universities’ (!?), (iv) ‘America ensured that China became a charter member of the United Nations’. They did? They insisted on Chiang Kai-shek’s Taiwan, then with 6 million inhabitants, representing China in the UN, until Nixon-Kissinger in 1971 struck a deal with China, which included admitting it into the UN. And so on…...

Below some photos from the Boxer War 1898-1901 (called "boxer" war because of the rituals carried out by the insurrect Chinese) to help understanding the Chinese sentiments related to foreign democratic, civilized and free nations telling them what to do :

Troops of the Eight nations alliance of 1900 in China. Left to right: Britain, United States, Australia (British Empire colony at this time), India (British Empire colony at this time), Germany (German Empire at this time), France, Austria-Hungary, Italy, Japan. By Anonymous - Historica, Yamagawa shuppan, Public Domain, https://commons.wikimedia.org/w/index.php?curid=12208599

 

"Boxer" rebels taken prisoners by US troops 2001. By ralph repo - Boxer Prisoners Captured By 6th US Cavalry, Tientsin, China [1901] Underwood & Co [RESTORED], CC BY 2.0, https://commons.wikimedia.org/w/index.php?curid=33422352

 

 A Chinese prisoner, possibly a Boxer, being beheaded in front of a crowd of Chinese. European officials watch over the procedure. https://wellcomeimages.org/indexplus/obf_images/aa/14/cbcbadc77d1feb7511ea15af72b3.jpg Gallery: https://wellcomeimages.org/indexplus/image/V0031250.html

 

 Execution of Boxers after the rebellion, to appease foreign powers. https://en.wikipedia.org/wiki/Boxer_Rebellion#/media/File:Execution_of_Boxers_after_the_rebellion.png. File created by Jeff Lea. Author unknown - Postcard

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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