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Economists debate: Should we worry about the trade war?

Asia / 12-09-18 / by
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trade war

At the GTR Asia Trade and Treasury Week in Singapore, the US-China trade war – naturally – hogged the limelight. Kicking the event off was a debate between two economists noted for their contrasting views on international trade. Deborah Elms, executive director of lobby group the Asian Trade Centre, is decidedly opposed to tariffs in any way, shape or form, while Tony Nash, CEO and founder of Complete Intelligence, views the current situation as almost a natural evolution for a global trade system which has failed.

Moderated by Alex Capri, senior fellow at the National University of Singapore Business School, the highlights of this stimulating conversation are below.

Note: this conversation took place on September 4, 2018.

 

Capri: We’re at US$50bn of US tariffs, with talk of another US$200bn possibly this week. China is talking about retaliating with US$60bn. What is the actual collateral damage right now and in the future to global supply chains, particularly in Asia?

Elms: I think we should look beyond saying: ‘If the trade war happens,’ or: ‘Is this a trade dispute?’ This is a trade war. We are now at US$100bn in tariff levels between just the US and China. The US now has lined up an additional US$200bn in additional products – expect those in the next two weeks, my guess is they will land at US$180bn. The Chinese will retaliate again, US$60bn, but then they’re out of room to do dollar-for-dollar matching of tariffs. The Chinese don’t import as much in goods from the US, so they’ll have to retaliate on the rest in some other non-goods fashion. It’ll have to come in services against US companies based in China, but it won’t be on goods.

The implications for Asia and supply chains are starting to bite. It took a while for this to trickle down, as much of it is slow moving. The last bit of the US$50bn from the US and Chinese didn’t hit until August 23. Supply chains, which are slow to shift, haven’t been moving particularly fast up until now. But as people begin to realise this isn’t an ‘if’ but a ‘now’, and that it’s not short-term, but long-term, those supply chains will shift. Many will relocate to the rest of Asia, especially the Southeast, from China.

Singapore is a classic example. Many of the semiconductors produced in Singapore are exported to China to be re-exported to the US. That’s going to hit hard in many places in the region. Those supply chains will shift over time: 25% tariffs are hard to absorb. It’s going to be a difficult transition and it will take time. The short-term implications will be painful for an awful lot of Asia – there is much more of a connection between US-China supply chains than people expect.

Nash: We have to define the question first. We’re dealing with institutions in the global trade environment formed immediately after the Cold War: the WTO, Nafta (North American Free Trade Agreement), the EU. It represented a trade arbitrage: Nafta in North America, the EU in the eurozone – taking advantage of low cost sites within those trade blocs.

When China came into the WTO it created a global trade arbitrage. Since then, Chinese wages are now loosely equivalent to Malaysian wages. China finds it hard to compete without heavy subsidies and restrictions. All of this talk about tariffs and trade war, it’s really about the generational change from those institutions established post-Cold War until now.

We’re in a cycle of world history where people are evaluating those institutions. The average tariff under the General Agreement on Tariffs and Trade (GATT) was 35%. Under the WTO it’s 2%. Tariffs really aren’t a big deal in world trade anymore. The bigger issue is subsidies, non-tariff barriers (NTBs) and regulatory issues. Since the 1980s, there has been  a lot of talk about the regionalisation of supply chains. What we have with these different arbitrage opportunities, especially with China coming into play, is an impediment to the regionalisation of supply chains. Now with green movements, carbon taxes, because we have these regional blocs, we’re starting to have a realisation that the regionalisation of supply chains is better for everyone – better in terms of the environment, jobs and wages.

In these trade disputes, Trump is the catalyst – there’s no way to dress that up. You have to look at his campaign, every single statement he made had to do with jobs and wages. Everything. He’s trying to establish the landed cost of goods exported from China or Mexico or elsewhere and understand how US or regional manufacturing could be competitive. That’s really all it is, dressed up in belligerent tweets and statements.

But this is all about understanding the true landing cost, if you strip out subsidies and trade barriers, and how competitive those markets are.

 

Capri: We’re seeing the Regional Comprehensive Economic Partnership (RCEP) being negotiated and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) being embraced minus the US. Those are rules-based multilateral trading frameworks. Is that the solution? And what’s China’s role in all this?

Elms: Most countries right now are grappling with these very difficult questions. Governments around the region are asking us about this at the top level. What are we going to do when the world’s largest player figures out that the system doesn’t work to benefit the world’s largest player anymore?

In Asia we have these regional agreements which can help stabilise things. Last week in Singapore we had senior ministers discussing RCEP, 16 countries here in Asia, all 10 members of Asean, plus China, Australia, Japan, Korea, India, New Zealand, meeting in intensive conversations about how Asia can link itself together as a bulwark against disruption elsewhere. The plan to have a substantial agreement this year will be difficult. They’re close, and are in great urgency because of the disruption.

But the problem with regional trade agreements is they don’t cover everyone. If you happen to be sitting in an uncovered country there’s a challenge. It would be better for firms to have global agreements, but it is very difficult when the two largest players in the system are throwing arrows at each other. How quickly can we create rules in the global system that will benefit both parties and get them both back to the negotiating table?

Nash: We have to understand what we mean by free trade. What is free trade? In my mind, it is removing protections that domestic companies have so foreign firms can compete on an equal basis. It’s not about tariffs or regulations. If you think in that way, the current tariff war is just one early element of that. Talking about abiding by the rules, in January 2017 the National Development and Reform Commission called me to Beijing to give a briefing on Trump’s policies: what would a Trump presidency look like? This was a closed door meeting and it also had the biggest think tank in China in the room, the China Centre for International Economic Exchanges.

I told them Trump’s policies were clearly outlined on his website and speeches. When we got to talking about his trade policies, I said: ‘This will be difficult, we will have a trade dispute and it will come down to subsidies and NTBs. You’re going to have to give on these.’ What was their response? The central planning agency of the Chinese government said: ‘The Japanese and the Germans do it too!’ Their response wasn’t: ’We don’t do that!’

At that moment it became painfully evident to me that there’s a mass circumvention of the rules of global trade. The Chinese, you can see in their negotiations, they’re embarrassed that they’ve been found out. It’s not that they don’t recognise the problem, they’re embarrassed that Trump is taking them to task very publicly.

Elms: One of the problems that the Trump administration has been facing is producing the evidence. Many people ask: ‘has China played fairly’? That’s a difficult question to answer. But the Chinese response would be: ‘show us where we’ve violated WTO rules’. One of the things that’s been lacking thus far has been clear evidence by the US side of specific rules that have been violated.

The spirit may have been a bit of an issue, but the letter of the law appears to largely have been followed. The US produced a 200-page report on IP and tech transfer in which it mostly says that China over a long period of time has violated the following of these kinds of things. But is very thin on specific evidence.  If the Trump administration wants to ram the evidence home, it needs to say: ‘Here are specific cases of specific incidents of IP theft and tech transfer today, not 10 or 12 years ago, but today.’ That would go a long way towards solidifying the case. That’s why this entire argument has been hard for other countries to get around.

 

Capri: Everyone is familiar with the situation with ZTE and Huawei, which have just been blocked from Australia’s 5G network development. How should companies in the tech sector, with global supply chains, start planning their future value chains, in light of this?

Elms: Part of what the Trump administration is hoping to achieve with the tariff regime is that firms will start to reshore production back to the US. For some products that’s likely to happen.

But I also think it is missing something: there are 4 billion consumers here in Asia, versus 380 million in the US. For many products, firms will decide their futures are in Asia rather than the US. They will probably outsource their production to China or Asia generally. You’ll probably see a split in supply chains. Rather than having one supply chain hub in China, producing materials and sending some to the US and some to Asia, you may see firms splitting to have some in the US and some in Asia. Companies don’t often realise where their supply chain footprint lies. You may know where your first tier suppliers are, but don’t have a clue where your third and fourth tier suppliers sit, until they get cut off. So now firms have a chance to look at their sourcing locations, warehousing distribution networks, and say: ‘Does this still make sense, at a time of 25% tariffs into the US?’

Nash: If you remember before the financial crisis, almost every manufacturing company was looking at a China plus one, two or three strategy. In China in 2012, we saw real retribution towards Japanese companies over the Senkaku Islands dispute. Two years ago, we saw retribution in China against Korean companies around these defensive missiles put on Korean territory.

Two weeks ago, there was an announcement in Japan that a number of Japanese companies were rotating large portions of their manufacturing out of China. We’ve also seen the same with Korean companies, they were some of the first production line experts in China, 30 years ago. For them to rotate out of China, it’s a big statement.

I would say the earlier analogy would be from 2007, when there was a minimum wage imposed in the Pearl River Delta and a bunch of Korean, Japanese and Taiwanese companies backed up their trucks to the factory, shipped everything out to Vietnam and started operations there . There’s something similar underway, but it’s a much broader trend. The China-plus strategy from pre-financial crisis is underway again now.

Not just because of the cost of production, but also things like industrial espionage. One example would be Operation Shady Rat, and all of these subsequent industrial espionage efforts that have taken place out of a building in Tianjin, where the Chinese government is looking into foreign companies’ IP.

We are seeing a regional rotation out of China for a number of reasons, including cost and IP. We’re seeing regionalisation in North America, and that has quite a lot to do with environmental considerations as well as cost and job considerations. There’s a number of things moving towards an inevitable regionalisation.

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