Taking an enemy position
Throughout military history, there are two basic ways to take control of an enemy stronghold. First, you can raise an overwhelming force and attack head-on; the attackers can expect to suffer heavy casualties pushing against fortified defenses, but if you need to take the position quickly, it’s the fastest way to go. Alternatively, if the attacking force can be patient, a siege – wherein the attackers surround the stronghold, limit trade, and starve the defenders into submission – might be the better option.
There are often parallels between military conflict and economic disputes. The ongoing trade dispute between China and the United States – the core of which is literally the limitation on trade - contains many echoes of a siege. Both China and the US are powerful forces, with no possibility for a dominant, overwhelming force from either nation. (In comparison, the US-coordinated trade embargo against Cuba had devastating effects on the island’s economy while Americans were essentially untouched for decades.) This slow-motion conflict utilizing negotiations, posturing, and (ultimately) attrition is reminiscent of a siege conflict.
We acknowledge the analogy is excessive. Last Monday’s threat of an additional 15% tariff (moving from 10%-25%) on $325 billion of Chinese imports, but that doesn’t compare to the damage caused by an actual armed conflict. On the other hand, the administration does not hesitate to label many of our trading partners – in Asia, Europe, and the Americas - as enemies. Moreover, the rhetoric is intentionally provocative, if not outright hostile.
Mechanics of a trade dispute
The administration has made their reasons for engaging in this trade dispute clear (e.g. intellectual property theft, market access for US exporters), but it’s worth pointing out that the costs of reduced trade are borne by both nations. In economic terms, there is a deadweight loss in both consumer surplus and producer surplus as increased prices prevent mutually beneficial trades from occurring.
We’ll forgo creating a supply-and-demand chart detailing the scale of loss for both parties, and instead consider the primary resource in this dispute: patience. The administration believes it has leverage here, because the daily losses (due to a lack of a trade deal) are higher for China than for the US. A greater proportion of China’s GDP is generated through exports to us, while US GDP depends less on trade with China. Specifically, the Chinese import about 20% of what the US imports from China. Americans appreciate the benefits of trade including inexpensive Chinese consumer products like footwear and electronics, but the Chinese equally appreciate rapid GDP growth, which might fall 1.2% due to the tariff-hike, according to Moody’s Analytics. Over the past week, the Chinese stock market fell 6.6% during mid-day trading as a result of escalating trade war threats.
So, does the US have the upper hand? Not entirely. China has several asymmetric advantages and can, in many ways, afford to be more patient than the US.
First, their political decisions are made by an oligarchy which can afford, in the short-through-medium term, to be unresponsive to its citizens. Democracies have shorter timelines to demonstrate improvement. Until now, criticizing China’s trade practices has been popular in middle-America’s industrial and farm states – the core of the administrations political capital. However, if the additional tariffs materially harm the national economy, voters may quickly assign blame and may even change direction.
Second, the Chinese people and American people are at different trajectories on the world stage. China has seen the transformative ascent of their living standards and global stature in a few short decades, so their government may have earned some patience from their citizens. Americans, while still a dominant player on the global stage, generally acknowledge a decline of their economic supremacy which (unconsciously or not) they had been accustomed to. Moreover, nationalist sentiment in China could give the Communist Party additional latitude dealing with foreign threats, since any changes imposed by outsiders are likely to goad the populace into a mindset of resistance.
Third, the Chinese government can use monetary and fiscal stimulus to offset the short-term damage to the trade revenues. The US has already accrued record breaking long-term debt for our recent economic pop, but China has not fully spent the additional deficit spending ($78B) they’ve allocated through 2019 and, of course, they can go off-budget in times of crisis. China’s government has greater authority to directly intervene in the markets. During the recent stock-price tumble, China bought oil and financial stocks to prop up the market. The Chinese central bank (PBOC) has recently cut bank reserve requirement ratios and reversed rate-tightening, both accommodative monetary policies designed to keep money flowing through the system.
Finally, if the President does unilaterally impose tariffs, it will likely result in a legal challenge given our commitments at the World Trade Organization. The President has shown willingness to engage in legal challenges, but our disregard towards international enforcement bodies suggest we will receive only limited support from our nominal allies. The administration’s nationalist tendencies have not won us many fans on the international stage, which creates a disadvantage.
An incomplete siege
In a proper siege, the defenders must be fully isolated in order for the strategy to work. If the defenders can move food and supplies through the blockade, then they aren’t being damaged and the siege is demonstrably ineffective. Military history includes many examples of failed sieges (e.g. the Berlin Airlifts of the Cold War) due to porous borders and insufficient perimeter security.
In regards to our current standoff between China and the US, the same principle applies. China may bear the brunt of tariffs today, but over time they could find ways to ameliorate the potential damage. The current targeted tariffs are difficult to implement successfully because of the interconnected nature of global supply chains and the fact that this fight does not include our trading partners and allies.
For a simplified example, imagine China wants to sell a car for $10,000 in the US, but faces a 25% tariff, so the car costs $12,500 in the US. To circumvent the tariff, China exports the car to a neighbor, like Malaysia. The car undergoes a few minimal changes to alter the product’s country-of-origin. Malaysia sells the car to the US for $10,500 – avoiding the brunt of the tariff while Malaysia and China both get revenue. China can use multi-national shell companies, flexible supply chains, and procure raw materials or components from other countries (generating diversified voting blocs with a vested interest) to sidestep the taxes.
Complex products, like cars, might not be resistant to tariffs, but what about simple commodities, which have fewer methods for manipulation? Again, in the long term, we live in a world with more than one supplier and buyer for most products. Let’s consider another example, this time focusing on a US producer. Chinese retaliatory tariffs are targeting US grown soybeans. Thus, US farmers can ship soybeans to other countries with demand (say Germany). Other countries that also produce soybeans, like Brazil, may simply start supplying China instead of Germany. The tariff impact may increase combined transactional costs (i.e. it makes the world less efficient), but mutually advantageous trading is hard to stop. The supply and demand curve for most products is defined at a global level. Over the long term, it’s not too hard to compensate for a price imbalance of one link within a grand interconnected web of global trade. These tariffs might have limited impact over the long term as trade relationships reorient on a global scale.
Beyond May 2019
At the time of writing this article (May 9th), the current tariff threat is unresolved, but that could change quickly. Meanwhile, China has its own problems – weak credit demand, slow consumer demand, an aging population, deleveraging local government debt, weak demand from other trading partners (Japan and the EU), and other structural reforms. The trade conflict with the US is just another issue to deal with. The Chinese national press is already announcing expectations for a prolonged trade war (with great optimism, as you’d expect from state-sponsored media), but it’s unlikely, over the long term, this dispute will change very much.