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More Than Trade at Stake in Clash Between China and the United States

Oct 23, 2018
Kip Beckman
Principal Economist
World Outlook

President Trump’s strategy on trade negotiations has been to impose tariffs and then threaten to raise them even higher if the countries incurring his wrath fail to make meaningful concessions at the bargaining table. His tactics appear to be working. Under the threat of a 25 per cent tariff on auto exports, Canada recently agreed to partially open its dairy market to American imports, while in the summer, Mexico reached a deal with the United States after making concessions on the North American content of vehicles manufactured in the three trading-partner nations and on wages for Mexican auto workers.

Far more is on the line in the negotiations with China, which involve the two largest economies in the world, and it is unclear whether the President’s strategy will work as effectively. The Trump administration has already implemented tariffs in excess of US$200 billion on Chinese imports, with more to come if China doesn’t change its ways. China’s US$350 billion-plus trade surplus with the United States is a major irritant for President Trump, who contends that the Chinese unfairly restrict U.S. exports and steal U.S. technology.

However, to date, China shows few signs of caving to the demands from the Trump administration and has ramped up tariffs on U.S. exports. Convincing the Chinese government to change its economic model, which, among other things, provides strong support for many money-losing state-owned enterprises, could prove to be much more challenging than revamping NAFTA. China’s reliance on access to the U.S. market is significantly lower than that of either Mexico or Canada. Less than 20 per cent of China’s GDP is dependent on exports, compared with a greater than 30 per cent share for both Canada and Mexico. This suggests that President Trump may have far less leverage with China than he did with either Canada or Mexico.  

There is little doubt that China’s economy has been hurt by the tariffs, as prices rise in some of its supply chains. But Beijing has already taken steps to mitigate the impact of U.S. tariffs by easing bank reserve requirements, and other stimulus measures can’t be ruled out if the trade dispute drags on into 2019.  China could hold out longer than the United States if, in the months ahead, American households react to higher prices for iPhones and flat-screen TVs, many of which are imported from China.

It is possible that the current spat over tariffs masks a far more important issue that has been simmering for years and won’t go away even if the United States and China reach an agreement on trade. The Wall Street Journal notes that the dispute between the two countries is part of a larger conflict over world technological, economic, and geopolitical dominance that has developed over the past few decades, as China moved from a poor agrarian economy to an economic powerhouse and legitimate rival to the United States. The growing confrontation between the United States and China in the South China Sea and American concerns about President Xi’s incredibly ambitious “Belt and Road” initiative—an attempt to construct a network of highways, railways, pipelines, and ports linking Asia, the Middle East, Europe, and Africa—are only two of several areas where the United States and China have butted heads and will continue to clash.

China’s economic rise began in 1978, when the government of the day abandoned socialism and implemented widespread reforms embracing certain aspects of the market economy. Its economy started to boom and went on to record double-digit growth for decades. Standards of living soared, and China quickly rose to become the second-largest economy in the world. Many in the West contended that, as the Chinese became wealthier, they would demand democratic reforms and, over time, the government would have to loosen its grip on the economy. Failure to do so would eventually cause the Chinese economy to stall and possibly even implode like that of the former Soviet Union.

That hasn’t happened. China’s political system has not turned into a Western-style democracy, and the state continues to be a powerful force in the global economy. In fact, rather than China experiencing an economic crisis, it was Western democracies that were on the verge of collapse in 2008. The sluggish growth following the end of the 2008–09 recession has led to serious questions about liberal democracy, as evidenced by the return to autocratic rule in former democracies like Turkey and Hungary. Many consider China’s model, which combines elements of the free market with strict government control, as a viable alternative to Western democracy. A view of the conflict between the United States and China from this perspective makes it even more unlikely that China will give into U.S. demands and abandon an industrial policy that has guided its economic development for decades.   

The United States still has several competitive advantages over China, including open financial markets, strong institutions, the rule of law, and the world’s strongest military. However, the U.S. has lost some of its advantages by becoming more isolationist. President Trump may come to rue the day that he abandoned the Trans Pacific Partnership trade agreement, as it provided the United States with an important counterweight to China’s growing influence in the Asia-Pacific region.   

Source: Greg Ip, “New Cold War Brews Over Trade,” The Wall Street Journal, September 27, 2018.

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