Trade war drives CPC rifts

Reports are surfacing that the escalating trade conflict with the US is driving a wedge between elements of the Chinese leadership:

BEIJING (Reuters) – A growing trade war with the United States is causing rifts within China’s Communist Party, with some critics saying that an overly nationalistic Chinese stance may have hardened the U.S. position, according to four sources close to the government.

President Xi Jinping still has a firm grip on power, but an unusual surge of criticism about economic policy and how the government has handled the trade war has revealed rare cracks in the ruling Communist Party.

A backlash is being felt at the highest levels of the government, possibly hitting a close aide to Xi, his ideology chief and strategist Wang Huning, according to two sources familiar with discussions in leadership circles.

A prominent and influential academic whose views have found favor in some party quarters has also come under attack for his strident views on Chinese power.

There are hints — which, given the totally opaque nature of elite Chinese politics, we should take with a dollop of salt — that the factional tensions could even be weakening the “core leader’s” grip on power:

China, for all its problems, seems set on an inexorable rise to superpower status to rival the US. On multiple benchmarks – economic, technological, military and diplomatic – Beijing is making rapid advances.

We are a long way, in other words, from peak China. But that begs another question which has been sweeping Beijing over the northern summer – whether we are now witnessing peak Xi Jinping.

In recent weeks, the signs of a nascent pushback against Xi’s absolute power have started to emerge. Some are cryptic, given the nature of Chinese politics, contained in coyly worded postings on social media. Some are the stuff of rumour, or back alley news, as the Chinese call such information, which flourishes in the absence of a free press.

More background on CPC factional disputes.

Daily links: Fentanyl and state failure

China is the main source of the insanely potent synthetic opioid fentanyl in the US, which killed more than 27,000 people in the 12 months through November 2017. “The biggest difficulty China faces in opioid control is that such drugs are in enormous demand in the US,” an official of China’s equivalent of the DEA is quoted as saying. The Opium Wars in reverse?

The trade deficit has sliced $457.2 billion off the US economy’s cumulative inflation-adjusted growth, or 14.33%, from the start of the recovery in mid-2009 through the first quarter of 2018, according to last week’s revised GDP figures. But we are told that trade deficits don’t matter.

Britain is probably not going to run out of food in the event of a “no deal” Brexit. Nevertheless, it’s interesting to note that the British government cannot guarantee food security for its people, and seemingly expects the food industry to take all the responsibility for stockpiling goods. Meanwhile, the food industry has absolutely no plans to do this.

A simulation models the release and spread of a moderately lethal and moderately contagious virus. It kills off 150 million people over the course of 20 months, including 15 to 20 million people in the US.

Over 100,000 Russians marched last month in the city of Yekaterinburg to mark the centennial of the slaughter of the Romanov imperial family by rabid Communists.

Duterte publicly destroys more than A$8 million worth of contraband luxury cars in the Philippines:

Book review: Free Trade Doesn’t Work

Years before the problematic aspects of US trade policy had erupted into the national political conversation, economist Ian Fletcher laid out a powerful intellectual case against free trade in a 2011 book, which I read and reviewed in April of that year. Given the extreme timeliness of the topic and the very superficial level of most punditry on the trade question, I thought it might be useful to republish my review (lightly edited) below.

Few things are more fervently and universally extolled than free trade. Economists, editorial boards, and politicians join in singing its praises. That free trade benefits all nations is an article of faith for America’s ruling elite. Protectionism is regarded as self-evidently stupid and evil; it is sufficient to call something “protectionist” to discredit it.

The belief in free trade is, in short, a sacred cow. It is unchallengeable in the realm of American politics and punditry because the economic case for it is considered airtight. Facts about industrial decline, job losses, and mounting debt are irrelevant. Common sense is irrelevant. Economic theory tells us that free trade benefits the US overall; therefore, no matter how high the costs of free trade, we can be sure that our economy is somehow reaping benefits that exceed the costs, and that any form of protectionism will necessarily do us more harm than good.

Ian Fletcher, Senior Economist of the Coalition for a Prosperous America, explains why this isn’t so. His book Free Trade Doesn’t Work: What Should Replace It and Why is a methodical dismantling of the assumptions, arguments, and popular beliefs that undergird free trade. In lucid prose that even an economic ignoramus (like me) can understand, Fletcher lays out the arguments against free trade and in favor of a flat tariff. It’s a fact-filled, rigorously argued, and highly readable book.

Dissecting Ricardo

The intellectual core of the case for free trade is, of course, David Ricardo’s 200-year-old theory of comparative advantage, which holds that (in Fletcher’s words): “If we could produce something more valuable with the resources we currently use to produce some product, then we should import that product, free up those resources, and produce that more valuable thing instead.” All well and good — but the theory depends on a host of dubious assumptions which simply do not hold true in the real world. Those assumptions are that:

  1. Trade is sustainable
  2. There are no externalities
  3. Factors of production move easily between industries
  4. Trade does not raise income inequality
  5. Capital is not internationally mobile
  6. Short-term efficiency causes long-term growth
  7. Trade does not induce adverse productivity growth abroad
  8. There are no scale economies

All of these assumptions are false at least some of the time. Assumption (2), for example, ignores both the negative externality of environmental damage and the positive externality of technological spillover (i.e. free trade wipes out industries that could have spawned new technologies and new industries). Assumption (5) is necessary for free trade to be a guaranteed win-win, rather than a potentially win-lose, proposition; the theory of comparative advantage says that market forces drive all factors of production to their best uses in the economy, but assumes that these factors cannot be driven right out of the economy to other countries. Of course, they can be. Capital is highly internationally mobile, and while this benefits the world economy as a whole, it certainly can hurt individual countries.

Assumption (1) falls apart when a “decadent” nation, which prefers short-term consumption, trades freely with a “miser” nation, which prefers long-term consumption. The decadent nation buys all the imports it can get, paying for them with a combination of exports, debt, and the sale of assets. The decadent nation is happy because it gets to consume more right now; the miser nation is happy because it gets to invest more and accumulate wealth. In the short run, both nations are “better off”; in economic terms, they have “maximized their utility.” Eventually, however, the decadent nation will exhaust its ability to assume debt and sell assets, leaving it poorer than it would have been without free trade. Trade restraints for this nation would be like restrictions on an heir’s squandering his inheritance.

And so on. Comparative advantage is, in short, a deeply flawed and inadequate picture of reality. Insofar as its assumptions hold true, it’s useful. “Fairly open trade, most of the time, is a good thing,” Fletcher concludes. But what about when it’s not?

Are tariffs the answer?

Neither the Ricardian view that free trade is always good, nor the pessimistic view that international trade is a zero-sum game, war by other means, is correct. The truth lies in some synthesis of these two extremes. The work of economists Ralph Gomory and William Baumol, set forth in their 2000 book Global Trade and Conflicting National Interests, tries to provide that synthesis. Gomory and Baumol observe that, contrary to Ricardo’s model, countries that get a head start in certain industries can lock other, potentially more-efficient, countries out of those industries due to the effects of economies of scale. Therefore, competition is imperfect and free trade outcomes are not always optimum.

Gomory and Baumol’s analysis suggests that international trade is sometimes win-win, and sometimes win-lose. Fletcher explains the policy implications of their work thusly: “Basically…a wise nation will willingly let other nations have their share of the world’s industrial base, but will try to grab the best industries for itself. Then it will sit back (here’s where laissez faire plays its legitimate role) and let the rest of the world compete…to produce for it the things it doesn’t want to produce at home.”

Fletcher’s preferred policy is the Natural Strategic Tariff — a flat tariff of around 30% on all US imports. It is “strategic” because, due to the different sensitives and responses of industries to import competition, it tends to cause the relocation of “good” industries like high-tech manufacturing to the US, but not “bad” industries like textiles. It works — for the US, not for other countries — because it interacts with the existing competitive strengths of the US economy. It is relatively politics-proof because it does not single out any industries for protection. It is, overall, an elegant and pragmatic response to the problem of America’s free-trade-induced industrial decline.

An avoidable disaster

If you have any doubts as to the existence of the problem, consider:

  • US imports are 17% of GDP while the entire US manufacturing sector is only 11.5% — meaning the US could export its entire manufacturing sector and still not balance its trade.
  • The US has run a deficit in high technology since 2002.
  • Every few years there emerges an entire new industry which has no strong American players (e.g. hybrid cars).
  • The US invented photovoltaic cells, but is now fifth behind Japan, China, Germany, and Taiwan in their production.
  • In 2007, the US was a net importer of spacecraft.
  • American companies had 90% of the world market in semiconductors in 1980, but have less than 10% today.
  • The printed circuit board industry is on its last legs in the US. (From Manufacturing and Technology News: “There isn’t one single vertically-integrated North American shop that could independently supply a circuit board.”)

Says Fletcher: “Losing positions in key technologies means that whatever brilliant innovations Americans may dream up in small start-up companies in future, large-scale commercialization of those innovations will increasingly take place abroad.”

The more one looks at the actual history of trade, the more unnecessary and avoidable this outcome seems. Contrary to popular belief, American policy was basically protectionist from Independence until after World War II. All four presidents on Mount Rushmore were protectionists, as Fletcher points out. So was Alexander Hamilton, who worried that Britain’s lead in manufacturing would remain entrenched, relegating America to banana republic status, and proposed tariffs, import and export bans, and subsidies for exports and key innovations. From 1812 until 1846, America had high tariffs (up to 40%). A brief episode of free trade from 1846 to 1861 was followed by more tariffs. From 1865 to 1932 — when America’s economic performance surpassed the rest of the world by the greatest margin — tariffs remained high. The overwhelming consensus in favor of protectionism did not end until free trader Woodrow Wilson reduced tariffs in 1913. Then Congress pushed them back up, making the Roaring Twenties a tariff era. Under FDR in 1930s, tariffs came down again — and stayed down. JFK’s Trade Expansion Act of 1962 marked America’s decisive turn against protectionism; America has not run a trade surplus since 1975.

Tariffs, then, apparently worked for most of America’s history. But didn’t the Smoot-Hawley tariff of 1930 cause the Great Depression (and even World War II)? Nonsense, according to Fletcher. Smoot-Hawley applied to about one-third of America’s trade — a mere 1.3% of GDP. It increased duties, on average, from 44.6% to 53.2%. (“Tariffs as a percentage of imports were higher in almost every year from 1821 to 1914.”) And as for the myth of a death spiral of retaliation by foreign nations, the State Department reported in 1931 that “With the exception of discriminations in France, the extent of discrimination against American commerce is very slight.” Says Fletcher: “Smoot was a moderate and routine adjustment to America’s trade regime, not a major shock to the world trading system.”

Free trade doesn’t exist

So much for America. Is free trade good, at least, for the rest of the world? Not really, argues Fletcher. Opulent Japan and South Korea are highly protectionist. If industrial policy and neo-mercantilism are somehow crippling them, it’s hard to imagine what these countries would look like with free trade (the Jetsons, perhaps?). The developing world is not well-served by free trade either. Rapidly-growing China, whose government owns 30% of the country’s industry and systematically manipulates foreign trade to increase economic growth, arguably would not be better off embracing laissez-faire. Trade liberalization has either hurt or not helped most other developing nations.

Free trade tends to mean that the industrial sectors of developing nations either “make it to the big time” and become globally competitive, or else get killed off entirely by imports, leaving nothing but agriculture and raw materials extraction, dead-end sectors which tend not to grow very fast. Free trade eliminates the protected middle ground for economies, like Mongolia or Peru, which don’t have globally competitive industrial sectors but were still better off having such sectors, albeit inefficient ones, than not having them at all.

For all the scorn we heap upon it, protectionism works, a fact grasped by our more clear-sighted trading partners. That is why embracing free trade is not even an option for America. International trade is a rigged game, and if America refuses to protect its economic interests, US trade policy will simply be dictated by the governments of Beijing, Tokyo, Brussels, and so forth. Fortunately, the American public is starting to wake up to this reality and vote accordingly, and Fletcher predicts that the free trade consensus will fall apart over the next few years.

I’ve barely scratched the surface of Ian Fletcher’s important and hugely informative book. Anyone interested in trade policy, even (or especially) supporters of free trade, should check it out. Since I do not wish to be an example of the saying that a little knowledge is a dangerous thing, I welcome correction on any of the points made above.

Daily links: Musk, Mission Impossible, US military

An amusing takedown of Elon Musk. For some reason, Musk is a deeply polarizing figure, viewed as either a visionary genius or a total charlatan. His increasingly bizarre and out-of-control behavior of late certainly raises doubts about his qualities as a business leader. The outlook for Tesla does not look good either.

New Yorker review of Mission: Impossible — Fallout. Very entertaining movie, although the crazily violent fight scenes and endless car/bike chases through Paris get numbing after a while.

All your base are belong to us: More than 300,000 American military personnel are deployed or forward stationed in 177 countries.

More US embassy weirdness: Bomb detonated near the embassy in Beijing.

Some salient questions about the US-EU announcement on trade relations.

North Korea returns remains of (allegedly) US soldiers in goodwill gesture.

What happens when a total stranger decides to destroy your life by posting false information about you on a sleazy grudge-settling website?

ZTE gets a stay of execution

They chose wisely:

Congress will not push to reinstate a Trump administration ban against Chinese phone maker ZTE, which President Xi Jinping successfully lobbied President Trump to lift, reports Bloomberg, citing sources familiar with the matter.

Why it matters: Lawmakers’ initial effort to block Trump’s ZTE deal was the last obstacle the Chinese company — a repeat violator of U.S. sanctions and considered a national security threat by the Pentagon — faced before returning to business as usual.

The ban would have destroyed ZTE, a partly state-owned company that employs tens of thousands of Chinese, creating a huge political problem for Xi Jinping. The carefully constructed deal to save ZTE, a “personal favor” from Trump to Xi, was linked to China’s assistance in setting up the North Korea summit.

As David Goldman argued in June, the push to reinstate the ZTE ban was in effect a neo-conservative Senate coup against Trump’s foreign policy:

If the Senate passes the defense appropriation bill with the ZTE bomb, and Trump is unable to excise it by presidential veto or other means, Beijing will draw the conclusion that the president no longer is in control of US foreign policy. Instead, it will confront an adversary that does not want to achieve this or that particular policy objective, but rather wants to undermine the regime. Its first response will be to mobilize national resources to achieve independence in semiconductor production as quickly as possible, replacing its $220 billion a year in chip imports with domestic substitutes.

Goldman adds that “this will go down as the dumbest thing America ever did.” That may be a bit hyperbolic, but I agree that the prospect of the Senate blowing up the ZTE deal is unacceptable and I’m glad that cooler heads appear to have prevailed. Killing ZTE would be perceived as a direct attack on China, and I don’t think the US is remotely prepared for the consequences that would ensue.

Stepping back from the brink?

The economic dispute between the US and China is heating up:

Chinese officials are warning that they are prepared not only for trade war, but for financial, diplomatic and limited military confrontation with the United States, in response to American demands for fundamental changes in Chinese economic policy.

The dispute between the world’s two largest economies has moved beyond narrow issues of trade or specific areas of prospective conflict: Washington now views China’s technologically-focused economic strategy as a challenge to America’s world position, and China views Washington’s demands on China as the equivalent of a “new Opium War,” as a senior Chinese official told Asia Times last week.

Helped along by the US Senate’s torpedoing of a carefully crafted agreement with telecom giant ZTE:

A critical turning point was the Commerce Department’s ban on sales of American chips to power ZTE’s mobile handsets, sourced mainly from the American semiconductor giant Qualcomm. ZTE had violated sanctions on sales of high technology to Iran and North Korea. China’s President Xi Jinping intervened personally with President Trump to rescind the decision. Trump’s Commerce Department negotiated an unprecedented $1.9 billion fine as well as direct American controls over ZTE management, only to have the US Senate vote to reinstate the crippling ban on chip purchases. Trump’s Republican opponents united with Senate Democrats to embarrass the US President. The Chinese official commented, “That is Trump’s problem, not our problem.”

Thanks guys!

The US needs to address any Chinese trade abuses. But no amount of punitive trade actions will save the US economy from corkscrewing into irrelevance, if America does not launch its own “technologically-focused economic strategy,” rather than trying to somehow shut down China’s.

Goldman has some suggestions:

First, do what the Eisenhower administration did in 1957 – shift federal resources toward science and technology and starve the universities of all other forms of aid, including student loans.

Second, restore federal R&D spending to the levels of the Reagan years (when we spent 1.3% of GDP on basic R&D vs. about 0.7% now).

Third, begin Manhattan Project-style programs under the aegis of the Defense Department to force breakthroughs in critical technologies: quantum computing, semiconductor manufacturing, drone technology, artificial intelligence, missile defense (including space-based systems), and anti-submarine warfare to start.

Fourth, as I noted above. organize a brain drain out of China: Identify and recruit their most inventive and creative tech people.

Fifth, get together with the Japanese and organize an alternative to China’s One Belt, One Road program. The fulcrum of this program is the 600 million people of Southeast Asia, most of whom would welcome an alternative to Chinese dominance.

Breaking free of Chinese suppliers could take “months”

Nobody said a breakup would be painless, but it may be a lot easier for the US to cut its dependency on Chinese suppliers than is generally assumed. From the blog of trade expert Alan Tonelson (emphasis mine):

Throwaway lines are among my favorite aspects of opinion writing, largely because in a simple, usually brief, and almost by definition understated sentence or two they can thoroughly debunk or at least gravely weaken shibboleths that have reigned virtually unchallenged for decades. And Financial Times columnist Rana Foroohar had a doozy yesterday.

As is well known by anyone who’s been closely following the development of President Trump’s trade policies and the uproar they’ve triggered, some of the biggest fears surrounding the prospect of the “trade wars” they’re deemed all too likely to ignite concern the impact on global supply chains. As explained this morning by Nobel Prize-winning economist and New York Times columnist Paul Krugman;

“[C]orporations have invested trillions based on the assumption that an open world trading system, permitting value-added chains that sprawl across national borders, was going to be a permanent fixture of the environment. A trade war would disrupt all these investments, stranding a lot of capital.” […]

Just how fast they took place, and can still take place, is where Foroohar’s column comes in. In yesterday’s column, she echoed my point about supply chain movements that are either already underway or being contemplated:

“Over the long term, China and the US are headed towards regional supply chains for high-growth technologies of the future.” She continued – consistent with the conventional wisdom, “But in the short term, the interdependencies will be difficult to untangle.”

Then, however, came the kicker – which received no special emphasis from the author at all:

“Several executives who supply Fortune 500 companies have told me it would take months if not years for the biggest US companies to break completely free of Chinese components.”

To repeat: Months – and at the outside years – for many companies to marginalize China’s role in particular in global supply chains. And then remember the reward: Greatly diminishing China’s still-burgeoning influence over the American economy and over the broader global economy, and in the process blunting the growing threat it poses to U.S. security interests both in the Asia-Pacific region and around the world.

Buckle up

US Trade Representative Robert Lighthizer

The tariffs cometh:

U.S. Trade Representative Robert Lighthizer said Wednesday the administration would likely be unveiling tariffs against China soon, but cautioned that the precise details are still subject to change.

“The president is going to make a decision in the very near future,” Lighthizer told the House Ways and Means Committee. “Our view is that we have a very serious problem of losing our intellectual property, which is really the single biggest advantage of the American economy. … We are losing that to China in ways that is not reflective of the underlying economics.” […]

He said that the existing world trade system, including the World Trade Organization, was “wholly inadequate” to deal with China because it is “state-dominated economy that rejects market principles.”

Better dig a bomb shelter and stock up on canned beans and shotguns shells, as we are reliably informed that tariffs will lead to a “trade war.”

Protectionist China

Reuters provides a handy rundown of China’s restrictions on US imports. They are… significant:

TECHNOLOGY

China keeps close control over the use of tech within its borders, including full or partial blocks against many popular U.S. firms including Google, Facebook Inc, Twitter Inc and others.

The Chinese government has adopted a raft of strict new cybersecurity regulations, which foreign business groups complain either put China off limits or require them to provide sensitive intellectual property for government checks. […]

AUTOS

Global carmakers can only operate in China, the world’s largest auto market, via joint ventures (JVs) with local partners, with their stake limited to 50 percent, part of a government drive to protect home-grown auto firms.

Tesla Inc chief executive Elon Musk said on Twitter earlier this month that China trade barriers created an unfair playing field and that it was “like competing in an Olympic race wearing lead shoes.” […]

China also imposes a 25 percent duty on imported vehicles, versus a 2.5 percent import tax in the United States.

BANKING AND FINANCE

Foreign financial firms face long-standing equity caps to participate in some services in China, including a 50 percent limit on life insurance and a 49 percent cap on foreign-invested securities broker-dealers. […]

ENTERTAINMENT

China has a strict quota system for imported movies, limiting the number allowed to be shown on domestic cinema screens through the scheme to 34 each year. Hollywood producers also get around 25 percent of the box office, compared to nearer 40 percent they received in other overseas markets.

FOOD AND AGRICULTURE

China bans imports of poultry, poultry products and eggs due to avian flu. It conditionally lifted an import ban on U.S. boneless beef and beef on the bone in June last year. […]

RAILWAYS

China requires rail equipment suppliers to its domestic train networks, which are among the world’s longest, to prove that at least 70 percent of their supply chain is in China.

Embracing “free trade” when your trading partners are severely protectionist is a bit like leaving all your doors unlocked when your neighbors are thieves.

Tariff talking points

Some thoughts from trade expert Alan Tonelson on the impending metals tariffs:

>Many countries have declared their intention to retaliate against the American tariffs with higher barriers to U.S. exports. Curiously, they are overlooking the Chinese government-subsidized overcapacity at the root of the long-time distortions in world steel and aluminum markets.

>Many of these countries want the problem tackled multilaterally. But the World Trade Organization (WTO) has failed to stem this overcapacity (or deal effectively with many other forms of Chinese trade and broader economic predation), and a G20 forum specifically addressing the steel issue has produced nothing since its founding in December, 2016.

>Although major steel-producing powers like the European Union have imposed their own steep tariffs on shipments from China, the global glut has continued. One reason may be that, since the global economic recovery took hold in 2010, according to World Steel Association data. the United States has been the major steel producer that has suffered by far the greatest loss of global production share by volume. (See this post of mine for the 2010 figures and the Steel Association’s latest report for the most recent – January, 2018 – figures.) And as of the most current World Steel Association data (2016), the United States is also the steel producer with the highest steel trade deficit by volume (21.7 million tons).

As a result, charges that American steel tariffs in particular will jeopardize the rules-based global trade system seem to be arguing that this system requires the United States to remain as the world’s dumping ground for government-subsidized steel.

Also don’t miss the follow-up post.