What Trump Should Do and His Positives in China Trade Dispute

Balding's World

In Part I of this blog post, I laid out the case, that independent of who is in the White House, there is both a strong case to take a distinctly more confrontational approach to Chinese economic policy and that whoever inhabits the White House will have a much smaller impact than is widely believed.  Today, I want to layout the strengths and weaknesses of the Trump approach, and I should say at the outset, there are many more weaknesses than strengths.

Trump has one unique characteristic that makes him well suited for this situation: he is almost alone in the past thirty years of modern history of democratic leaders in taking on a sustained conflict with Beijing.  Since 1990, almost no democratic leader from a developed country has made a sustained effort of challenging Beijing and virtually all, even the great moral signalers, have shrunk from even the most tepid of challenges.  What astounds me as a China resident of nearly a decade, is the sheer cravenness and hypocrisy of so many with regards to China.  Money laundering, IP theft, human rights, sex videos of CEO’s used to extract concessions, the ability of Beijing to force countries and firms to accept and even laud behavior they would never tolerate else where simply boggles the mind. If anyone, even many of his supporters, made up a list of who they would choose to take this fight to China, President Trump probably would not be in many people’s top one-thousand.

There are a couple of points about this characteristic that I think are important to note. First, I suspect that Trump’s gains significant support from his willingness to take on this fight.  No US President or even democratic leader of a developed country has taken on this fight and there is a willingness to support him.  It is notable, even among many Democratic constituencies, there is anywhere from tepid to vocal support for his willingness to take on Beijing. I think the DC/NYC ex-admin crowd misses the story by failing to understand how simply accepting the fight plays politically.

Second, outsiders fail to grasp how revolutionary it is simply to confront Beijing.  Especially under Chairman Xi, this is a government that simply does not tolerate dissent or challenges.  I mention this because not only is this revolutionary from the side of the challenger, President Trump, it is revolutionary from the side of the challenged.  This is also why I believe that the specific method of challenging is less important than the willingness to challenge.  Whether it is a flurry of WTO legal challenges or political decisions, you should fully expect Beijing to impose costs because they view the act of challenging as more consequential than the method chosen.

Third, I do not know this for a fact, but I think we have a lot of evidence that Trump administration views the conflict with China as much more consequential than your standard trade dispute.  As I mentioned in the previous post, I do not believe this represents the run of the mill trade dispute but as China representing a clear and present threat to the international liberal order. Though he and many of his advisors may not view it in exactly those terms, they view this as a profoundly important conflict. That probably makes him much more willing to take this conflict further.  That probably means, I suspect many are underestimating the degree to which he may be prepared to impose pain.

President Trump also has two other characteristics which I believe are important in helping him but are very much double-edged swords.  First, rapid escalation.  Beijing prefers dealing with politicians on the clock because their basic strategy is play for time, emphasize the relationship, then make sure they land a good consulting contract advising firms on how to deal with Beijing.  Trump cannot accept the Chinese preference to play for time and hope that everything goes away like they do with most conflicts. The double edged sword is that while rapid escalation and accelerated time lines are a good strategy, he needs to avoid escalating too fast as he did with the $100 billion and veering from strategy to strategy.  The rapid escalation can be a very real strength, it can also be a serious hinderance.

Second, his unpredictability.  Beijing has the scouting report on the US government, and other government, and firms. They expect the US to move forward in a specific way and they have well thought ways to counter that typically involve imposing pain, making no concessions, and waiting out the other.  Trump’s unpredictability can be a positive in keeping Beijing off guard and defensive, however, as with the previous point, it needs to be molded into strategic unpredictability rather than the scatter shot non-stop chaos that typically defines the Trump administration.  Beijing is frustrated with the Trump administration because they are not jumping at a deal and continue to push the issue something that has not happened before forcing Beijing to always play reactive defense.  Announcing research on $100 billion in new tariffs is a classic example of the scatter shot chaos that the Trump administration needs to avoid.  Don’t overdo the unpredictability.

That makes one positive and two double edged swords for the Trump administration. It goes downhill for Trump from here.  The problem here is that Trump is setting off on quite possibly a legacy defining quest with his trusty sidekick Sancho Navarro and a mule.  This is not how you engage a dispute of this type.  However, as I noted in my previous post, I do not believe that Trump is significantly different from zero if we had a Presidential Wins Against Replacement in this conflict.

Before I layout what I think Trump should be doing, allow me a brief tangent on one more reason why I believe the risks are relatively low and I’m willing to tolerate Trump. I believe the downside risks are relatively low and the upside potential much larger. Begin from the premise this is not a standard trade dispute but a fundamental conflict and that any nature of conflict will impose some costs with different measures distributing those costs differently.

Now let’s assume there are two downside risk scenarios: a) China returns to the status quo and nothing changes or b) China increases market protectionism on US/foreign firms after the trade dispute.  Compare that a potential upside where China makes material market opening concessions.  To simplify, is the probability multiplied by the downside loss greater than or less than the probability multiplied by the upside gain?  Even if we assign a relatively low probability, say 5%, to material market opening concessions by Beijing, given the multi-period economic gains to both parties with discounted cash flows (etc. etc. etc.) we would have to say that those probability weighted gains would far outweigh those probabilistic losses.  To put this differential in perspective, US losses from IP related primarily to China amount to $300 billion per year. President Trump wants to impose 25% tariffs on $50 billion of Chinese imports for a total tariff take of let’s assume $12.5 billion plus dead weight loss for economic activity foregone. If we assign even a small probability to recovering that lost $300 billion in IP every year for a decade, that will radically alter the expected payoff.

Now let’s move on to what President Trump needs to do.  Let me emphasize at the outset, I recognize, these are virtually impossible for the Trump administration but I can hope can’t I?

  1. Build coalitions. I believe this is biggest mistake but also most easily rectifiable error the Trump administration has made to date.  I cannot think of an issue in recent modern political history which garnered more broad-based support that a major political figure worked so hard to turn into opposition.  Democrats, Republicans, business, labor, nationalists, globalists, Australians, and Germans believe Chinese economic behavior is a fundamental threat.  Virtually any constituency you turn to would express profound concern about Chinese economic policy.  The Trump administration however has managed to turn virtually all of them against their poorly conceived Tweet led trade conflict strategy.  Get a political director and Capitol Hill liason who does nothing but shuttle between meetings to get Democrats and labor on board as well as GOP inclined business, bankers, and nationalists.  At the same time, hire people in State and Treasury and put them on a never-ending plane ride between capitals rounding up international support to confront China.  You are building a 21st century economic version of NATO for the new Cold War. You have to build a deep and coordinated economic alliance.
  2. Show your dedication to free tradeand alliance partners. If Trump wants to confront China, which he should, he needs to show his dedication to the principle of free trade.  From NAFTA to TPP, the Trump administration should make showing US commitment to those agreements and allies a priority.  Any disagreements you have with TPP wording or specific industries in NAFTA, are literally the definition of Jeff Bezos spending time chasing a $1 bill in the wind. This is important for three reasons. First, Beijing strategy is always to separate alliances.  US going all in on TPP and NAFTA will cause a mushroom cloud from Chairman Xi’s office.  Second, alliance partners are not going to challenge Beijing unless Washington is unconditionally providing cover.  One of the things that has happened is no one has challenged Beijing because they are so afraid of what Beijing will do. If other governments and firms do not believe this is a concerted and sustained effort where they feel they will be protected, you will struggle to build a coalition.  Third, President Trump cannot actively confront China over free trade and impose punitive measures restricting trade with China, when he is actively engaging in trade restriction with even long trusted allies.  If the target is China, target China. If the target is an industrial dispute with a ally like Canada, seek to resolve the dispute rather than turn them into larger conflicts between allies. You need to be consistent in your approach.
  3. Develop the argument and intellectual framework. I cannot think of a time when such an overwhelmingly strong intellectual and evidentiary argument was so poorly presented.  That means focusing on what really matters: Chinese protectionism from trade and investment.  Forget the obsession with bilateral trade deficits and arguing over whether China should be in the WTO. Whatever you think President Trump, those are irrelevant points that make you seem petty, vindictive and lacking understanding about what is happening.  The goal is not to subjugate or humiliate China, the objective is to get them to change their behavior to they behave like the rest of the world with regards to trade and investment openness, respecting contracts, and intellectual property acceptance.  This pushing for increased market access in trade and investment where evidence of rank protectionism and national discrimination is simply overwhelming.  Focus, focus, focus, and repeat, repeat, repeat the argument and present the evidence of how even by emerging market standards, China is a closed market.  We are not talking national security secrets here, China still maintains an effective state-owned monopoly on salt.  Focus on what matters, what you want, and where your strongest arguments and evidence are.
  4. Expand the board. While One Belt One Road program is little more than a PR campaign, perceptions matter. While China is touting this revolutionary plan that in financial terms from Beijing is effectively a rounding error, the Trump administration downsizing key organizations like the State Department and talking about closing of America from the world.  You cannot effectively challenge China’s creeping authoritarianism globally by retreating from investing in American influence internationally. George Bush remains very popular in Africa for his administrations efforts in development assistance specifically targeting anti-AIDS work.  Emerging Asia is practically crying out for US attention after the benign neglect of the Obama administration.  Much of emerging Asia have decidedly favorable views of the US and would welcome a balancing influence to China with India being decidedly concerned over Chinese influence.  This requires filling senior positions as well as rank and file State Department and related position.  Furthermore, the Trump administration should actively pursue a new development assistance plan designed to build up allies with improved market access, investment schemes, and public health and infrastructure development on a concessionary or grant assistance basis.
  5. Institutions matter. Whether it is the WTO, the ADB, the World Bank, the IMF, or ASEAN, liberal international interests and the United States are better served by investing in them how they serve a law based system that restrains power.  The United States is at cross purposes confronting China about a range of activities while simultaneously retreating from its role of international leadership.  There are lots of good people, both Republican and Democrat to career civil servants, that are well placed to lead efforts in this Herculean task that has been put off for so long.  It is in the US interest to invest in them.
  6. Messaging and perceptions matter. Even though you are fundamentally right about Chinese protectionism, Trump administration are losing the messaging and perceptions battle because of the complete lack of messaging discipline from the top down.  From the Twitter that veers from angry rants to conciliatory note passing to the constant stream of conflicting and back biting leaks, messaging is a complete and total mess.  What makes this so inexplicable is that the White House can stand on facts. As the saying goes in the legal profession, if your client is innocent you argue facts and if your client is guilty you argue the law. Somehow despite having the best and easiest argument that China is a protectionist country, the Trump White House has singularly failed in presenting straight forward fact based evidence and arguments. This means taking the argument and evidence to the American people. This means using language and messaging that brings in allies who feel protected about their firms complains in China.  Probably the biggest thing: GET OFF THE DAMN TWITTER ABOUT CHINA!

The basic advice I have provided about what Trump needs to do to really take on this fight are nothing new. There is nothing profoundly insightful here.  Furthermore, I have little hope that he can make these adjustments, but I can always hope can’t we?

Just a few wrap up thoughts before this goes on too long. First, not all of these disputes with China are WTO issues.  In fact, for many areas, these are not WTO issues.  President Trump needs to take as many issues as he can to the WTO and get allies to sign on to those pieces of litigation but do not think this can all be resolved by just filing some WTO complaints.

Second, the only way the actions we have seen, from rapid escalation to size of tariffed goods to rhetoric, make sense is if the Trump administration views this as a very consequential (closer to what I define as a fundamental) dispute than say a technical/marginal/industry specific dispute.  I suspect, though I have no inside evidence to support this, that the Trump administration views this trade dispute in that type of light.

Third, the natural conclusion from this belief is that the risk for escalation is higher than is being priced into the markets.  If this is only, for instance, about slowing Chinese steel exports, this is enormous overkill.  If this is about trying to fundamentally alter Chinese economic behavior with regards to international economics, it makes more sense.  Therefore, Trump will likely be looking for a lot more than a commitment on one or two industries.

Fourth, one of the fundamental problems in this conflict is China has zero credibility.  Trump has openly said they have no credibility on their promises.  The agreement they reached in the spring of 2017 basically meant nothing.  How the US and China craft any agreement is going to be interesting given the lack of credibility that pretty much every recognizes they have around their promises. China has a press conference once a week to tout its openness but when you ask about specifics, it falls apart.  The smoke and mirrors routine to make promises and hope people stop paying attention is part of what brought us to this point.

Fifth, look for an agreement that brings concreteness and observability.  At one point the Trump administration floated the idea of asking Beijing to import $100 billion more from the US.  This was widely dismissed by analysts for a few reasons, but I suspect the intent, again I have no inside information and maybe I’m giving the Trump administration too much credit, to demand an observable concrete outcome or target.  Part of the lack of credibility is that Beijing makes agreements that get lost in technocratic black holes that get blamed on everything under the sun while Chinese markets stay closed.  Look for an agreement that tries to bring concreteness and observability to the table.

Sixth, focus less on trade and more on investment.  All the talk is about the trade deficit and trade barriers, and the rampant protectionism should be addressed, but probably the bigger issue is the strident restrictions on international investment in China.  A major reason the trade deficit with China exists is firms chose to invest in China rather than manufacture in the US and export.  We aren’t talking national security industries we are literally talking about everything from salt to dance troupes as well as financial services to more advanced manufacturing.  Whether it is straight up prohibitions to requiring JVs, China has squeezed international investors. This matters because most US companies prefer to set up a China subsidiary rather than just export to China.  This directly impacts the IP issue and we see this in FDI inflows into China which are growing at only about 3.5% annually so far this decade.

Fundamentally, the view of this comes down to the size of the battle being waged.  If you believe this is simply a specific industrial dispute over say the aluminum and steel industry, then the risks being incurred are far in excess of the potential benefits. However, if you view this as a fundamental conflict about changing an entire systemic refusal to adapt to the international trading and investment system, the payoff risk calculation gets flipped on its head.

Finally, the speed and size of escalation is understandable given Beijing’s regular attempts to effectively run out the clock and try to intimidate others into not imposing retaliatory or punitive measures. As I covered in Part I, confrontation is a reasonable generalized strategy and costs are merely question of where to distribute them not whether they exist. Given the long term reticence to impose any costs on China’s behavior, this does run the risk of imposing above punitive or behavior correcting optimal levels. However, given Beijing’s refusal to tolerate any dissent, they will be livid at any level.

For all the talk I have seen about how much pain a specific Chinese tariff would impose, I have seen almost no quantification of the long term damage done to US interests by more forcefully pushing to resolve some of the issues and the larger market issues at play.  Then statements issued about how we should push China but not impose tariffs are worthless platitudes. You will not prompt new behavior by a Communist dictatorship by not imposing costs on unacceptable behavior.  The only question is which specific measures that impose costs do you want to impose?

This is not a standard trade dispute between two states that accept the rules of the game but by states in a fundamental dispute over the rules and purpose of the international trading system. While I have covered Trump here in more detail, I think the nature of the conflict is much more important than the specific personality that drives so much of the coverage. This is one reason I am more sanguine about the personality risks because I don’t see him making much different from any President having the same conflict with China.  I think the much larger payoff and risk is in not having the conflict at all.