Manufacturing has been in a downturn for most of the year. According to Federal Reserve data, in the fourth quarter of 2018 we finally saw real output surpass the pre-Great Recession peak--only to see it once again fall below that level in the first quarter of 2019. Manufacturing investment has also declined since the start of the year. Why? Uncertainty driven by the economic impact of our trade war with China.
That’s not to say that business leaders oppose the Trump administration drawing a line in the sand. Manufacturers have for years found themselves stuck between two polar concepts. On one hand, China’s massive population and growing middle class—expected to reach 550 million by 2022—plus its relatively low labor costs make it a highly alluring place to do business. On the other hand, American businesses have long expressed frustration over Chinese subsidies to domestic firms, the dumping of below-cost products into this country, lax intellectual property rights policies, the requiring of technology transfers for market access, and currency policies that ensure a competitive pricing advantage for Chinese exports at the expense of American exports.
As Snap-On CEO Nick Pinchuk explained recently, “People talk about tariffs. Currency is a much bigger factor for us.” (Between 1999 and 2005 China fixed the price of the dollar-yuan exchange rate at 8.25 yuan to the dollar, which in the opinion of many economists created an overvalued dollar. Between 2005 and 2014, China allowed the yuan to drop steadily to 6.05. Since then it has started to climb in value again, to its present rate of 7.08 yuan to the dollar.)
So the debate isn’t over on whether we should find a way to get China to play by the same rules other countries follow (we should). It’s over whether tariffs—a policy option that can boomerang—are the best approach.
Some analysts think the risks outweigh the benefits. Doing business in China, the third-largest U.S. export market, is important to American companies. Not only could the psychological impact of a long-term trade war propel us into a recession, but how do we “win”? After all, China’s leaders take a long view of history—when it comes to dealing with other nations, particularly those subject to democratic elections and political pressures, they see time on their side. They just have to sit and wait.
Yet, as China’s economy cools, a drawn-out trade war with the United States could backfire. The U.S. has long been China’s largest export market—in fact, since 2010, Americans have bought approximately $4.5 billion worth of goods and services from China, about 20% of the latter’s total exports in that period (and four times the amount that the U.S. exported to China). The country has developed a reliance on American consumers that borders on addiction.
Maybe supporters and opponents are both right. A trade war, after all, is akin to banging your head against the wall and hoping the wall gives out first. There are no short-term winners. Ever since the days of Smoot-Hawley, which disastrously levied import duties on top of tariffs that were already high, pundits have cautioned against such policies. As IHS Markit explained in a recent assessment of the potential macroeconomic impacts of a trade clash, “Countries facing new tariffs ... experience declines in real exports and GDP. Other countries are hit indirectly through weaker demand for their own exports... These effects outweigh any potential gains from trade diversion to avoid tariffs.”
That’s the economic perspective. The political perspective is more complicated. In supporting the Trump administration’s current approach, Senator Lindsey Graham (R-SC) encouraged Americans to accept the short-term pain of cost increases with the long-term gain of more balanced trade relations. “Listen, [we] got more bullets than they do. They sell us a lot more stuff than we sell them. ... The goal is to get them to change their behavior.”
American Enterprise Institute's Derek Scissors puts it this way: this particular trade conflict can be justified because “the dictatorship running the world’s 2nd largest economy wants permanent unbalanced market access and to take the innovations of others at will.”
Previous administrations have been wary of pulling the Chinese tiger’s tail. This administration has thrown caution to the wind. While they don’t have many tools at their disposal, the ones they have could escalate the conflict and the pain experienced in both countries. For example, the next steps beyond tariffs include limiting China’s access to American capital markets and imposing greater scrutiny on the national security risk of Chinese companies, Huawei-style.
The president would surely like a “win” in this international dispute before the 2020 elections. The Chinese leadership may prefer not to give him such a political victory. And we may all have to take the long view of negotiating balanced trade relations between the two largest economies in the world.
Stephen Gold is president and CEO of MAPI, the Manufacturers Alliance for Productivity and Innovation