When Elephants Fight, It Is The Grass That Suffers

 

THE WHITE PAPER on China’s membership of the World Trade Organization (WTO) since it acceded to the world trade body in 2001 released by the State Council Information Office on June 26 implicitly acknowledges how much China has benefited from its membership.

This is all couched in terms of how China has lived up to its membership obligations and is now championing global free trade — an unabashed riding on the coattails of the global backlash against the United States’ protectionist turn.

The latest step in that come today with US tariffs of 25% on $34 billion worth of Chinese goods from ball bearings to lithium batteries coming into effect and China retaliating by imposing a similar 25% tariff on 545 US products, also worth a total of $34 billion, and likely to focus on agricultural products.

US President Donald Trump had previously threatened a 10% levy on an additional $200 billion of Chinese goods if Beijing’s trading practices remain unchanged, and raised the stakes on Thursday by saying that more than $500 billion of Chinese exports could be tariff targets.

Should that happen, Beijing may resort to non-tariff retaliation in forms such as more expensive and lengthy customs inspections and consumer boycotts of US products, as it did last year to South Korea’s Lotte Group.

That would be a display of patriotic citizen loyalty that the United States would be unable to match and may point to the Achilles’ heel of Trump’s belief that he can push hard on trade because the U.S. holds the strongest hand and thus the rest of the world will, ultimately, back down.

Two days before the imposition of these latest tariffs, the WTO reported that in the seven months to May, trade restrictions imposed by the G20 had doubled over the previous reporting period. These include tariff increases, stricter customs procedures and imposition of taxes and export duties.

In a nod to its purpose, the WTO noted that during the seven months reported on (so they do not include the latest tariffs), trade liberalisation measures taken by G20 members covered $82.7 billion of trade, versus the $74.1 billion affected by trade restrictions. But the gap is narrowing rapidly.

The WTO’s report is blunt in saying that further escalation of protectionism — measures and rhetoric — could carry potentially large risks for the global trading system itself:

At a juncture where the global economy is finally beginning to generate sustained economic momentum following the global financial crisis, the uncertainty created by a proliferation of trade restrictive actions could place economic recovery in jeopardy. The multilateral trading system was built to resolve such problems and it has the tools to do so again. However, further escalation could carry potentially large risks for the system itself. Its resilience and functionality in the face of these challenges will depend on each and every one of its Members. The G20 economies must use all means at their disposal to de-escalate the situation and promote further trade recovery.

Trump’s antipathy for the WTO — beyond a general belief that all multilateral organisations exist to do down the United States — is that it has provided China with a mechanism to create the vast trade surpluses with the United States on which he is now waging trade war.

Our man in Washington tells us that in private Trump repeatedly says that United States should get out of the WTO because it is anti-American and recalls the president on the campaign trail in 2016 calling the WTO a “disaster”.

Perversely, because the US-created the system and has lots of effective lawyers at the WTO, it does better than most when it comes to dispute resolution at the WTO. According to this year’s Economic Report for the President, the US has had an 85.7% success rate in cases it has initiated before the WTO since 1995, compared with a global average of 84.4% and China’s 66.7%. And it wins 25% of the cases brought against it, compared to the overall average successful defence rate of 16.6%.

Whether Trump would push the destruct button on the WTO remains an open question, though he is constrained to an extent in that the US Congress would have to pass legislation for the United States to leave the organisation.

Doing so would send both world trade and world financial markets into a tailspin. Stockmarket indices are scoreboards that get Trump’s attention. A deal to ‘fix’ the WTO might appeal more to him, especially if markets react badly to this latest round of tariffs.

For all the rightful concern, the US tariffs so far are tiny in the global scheme of things, affecting the equivalent of 0.6% of global trade and accounting for 0.1% of global GDP, according to Morgan Stanley.  The collapse of the WTO would be on an altogether greater scale.

Meanwhile, Beijing will continue to play its long game and to occupy the moral high ground over the WTO, its belief in its ability to outlast Trump as unshakeable as Trump’s belief that it cannot.

 

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Not-So-Easy Trade Wars

TRADE WARS MIGHT, as US President Donald Trump says, be easy to win (although this Bystander, for one, doubts it), but some of the terrain that has to be to yomped across is complicated and treacherous. Take the example of semiconductor equipment manufacturers.

The direct costs that result from the tariffs the United States is imposing on China and the ones that China is imposing on US firms in retaliation would be unwelcome but manageable for the three leading listed US semiconductor equipment manufacturers, Applied Materials, Lam Research and KLA-Tenco.

The trio’s China business earned them $5.4 billion in the year to end-March, 2018, according to calculations by the rating agency Moody’s. That was equivalent to 18% of their total revenue. Although that was 41% up on a year earlier, their business overall seems to have been growing at a similar rate.

These are good times to be making the equipment that makes chips, as it should be given global chip sales have increased by one-third since 2016, and are forecast to be a $460 billion market this year.

This is where things start to get complicated for trade hawks. Only about one-third of the three US firms’ China revenue comes from indigenous Chinese chipmakers, Moody’s reckons; the balance comes from multinationals that manufacture semiconductors in China, such as Intel and Samsung. (That is in line with the overall rule of thumb that holds that about two-thirds of world trade is accounted for by value and supply chains.)

US-based multinational chipmakers manufacturing in China could apply for US exemptions from US tariffs for the components they export back to the United States, though that would do nothing for reducing the headline trade deficit figure by which the US president sets so much score.

China could even ban such export sales. There is no indication Beijing is considering doing so should it come to it, but who knows what symbolic gestures will be made?

Absent a trade war, US semiconductor equipment manufacturers could expect steadily growing sales in China both to indigenous and multinational companies. Prospects would be particularly bright for the next several years among Chinese companies as Beijing is pushing the development of an indigenous chipmaking industry under Made in China 2025 to wean the country off its dependence on the United States for this critical technology. China will make its own chips first, then later the equipment to make them.

In the event of a trade war, Moody’s estimates, the three would lose $660 million of business from Chinese companies this year and $775 million in 2019.

At the end of this month, the Trump administration is set to announce new rules to curb Chinese access to critical US technology. While investments in the United States by any company with at least 25% Chinese ownership will be at the forefront, restrictions on exports of technology by US firms are also likely.

Limits to the three US firms’ freedom to sell their chipmaking equipment to Chinese companies would be a significantly more serious threat to them than tariffs. That might be appealing to the Trump administration as a way of delaying China’s drive to self-sufficiency in chip-making. There are no ready alternatives to the three US companies to which Chinese firms can turn.

But that, in turn, could force China to speed up the development of its own manufacture of semiconductor-making equipment.

So who wins? There is no uncomplicated answer.

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China’s Measured Sanctions Squeeze On North Korea

LATEST CUSTOM’S DATA for trade with North Korea in the first five months of this year provide a snapshot of how China has used sanctions to regulate its trade with North Korea and thus Beijing to calibrate the economic pressure it exerted on North Korean leader Kim Jong-un to dial down his nuclear and missile testing programmes. (The darker blue columns in the chart show the 2017 figures; the light blue ones the data for 2018.)

Chart of China-North Korea trade, Jan-May, 2017 v Jan-May, 2018. Source: Chinese Customs data, China Bystander.

Between January and May, total trade, at $887.4 million, was 56.8% lower than in the same period of 2017, indicating the application of sanctions, which China began to enforce serious last November. However, the impact on imports and exports shows a telling contrast. China’s purchases from North Korea were down 87% to $94.3 million but what China sold to North Korea, decreased by less than half that, by only 40% to $793.1 million.

Given that China is North Korea’s main supplier of energy and food, that suggests that while Beijing was comfortable with choking off North Korea’s export earnings, it was less so in imposing sanctions that might put social stability in North Korea at risk.

The Singapore summit between Kim and US President Donald Trump has prompted discussions, particularly among South Korean firms, about the prospects of restarting business operations in North Korea, especially improving transport and infrastructure links as political leaders have suggested. However, sanctions remain a high barrier.

North Korea remains littered with the remains of joint ventures that had hoped to prosper on the back of the 2006 round of promises by North Korea that would suspend its nuclear programme. The US intelligence agency, the CIA, has listed 350 joint ventures involving foreign companies (three-quarters Chinese) established in North Korea between 2004 and 2011 and notes that most had shut down even before last September when the U.N. Security Council banned joint ventures following Kim’s sixth nuclear test that month.

There is also the joint industrial park in Kaesong, North Korea’s third-largest city, just north of the border with South Korea, where 120 South Korean companies used to operate before it was closed by Seoul in 2016 after a long-range North Korean rocket launch.

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Powering Up Rebalancing

Bar chart of electric power consumption in China by sector, Jan-May, 2018, year-on-year % increase.

ELECTRIC POWER CONSUMPTION acts as a proxy for economic activity. These sectoral figures from the National Development and Reform Commission (NDRC) for the first five months of this year give a snapshot of where the growth is strongest, and points up how the economy is rebalancing.

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When Declaring Victory Is Not The Same As Wining A Trade War

Made in China label. Photo credit: Martin Abegglen, 2010. Licenced under Creative Commons.

CHINA HAS IMMEDIATELY retaliated against the first tranche of the 25% tariffs on $50 billion a year of Chinese exports to the United States announced by the Trump administration.

China will impose an matching tariff on 659 categories of US imports worth $50 billion a year, effective July 6. Vehicle and aircraft parts and vegetables account for the bulk of the targeted imports.

The Trump administration on Friday said its tariffs would come into effect on July 6 and cover more than 800 types of Chinese exports worth $34 billion a year. The largest category of goods affected are machinery, mechanical appliances and electrical equipment (full list). The White House says the remaining $16 billion of exports to be targeted will be announced later.

It is imposing the tariffs for what it deems unacceptable and unfair intellectual property and technology transfer practices by China that it has said cost the US economy $225 billion-600 billion a year.

There is, however, careful calibration on the United States part of these actions. It has reduced its original list of 1,300 targeted categories to focus on those sectors Beijing is promoting as part of its ‘Made In China 2025’ plan to develop advanced industries and to minimize the impact through international supply chains on domestic US industries. Some of the 500 categories removed from the list were done so following lobbying by US importers.

Beijing, for its part, has taken aim at the most politically sensitive US industries. where it believes it can have most impact on US President Donald Trump’s electoral support in rural areas and the Rustbelt.

US restrictions on Chinese firms’ investment in the United States are expected to be announced at the end of the month.

The president’s advisor on trade and manufacturing policy, Peter Navarro, says that the ‘era of American complacency’ on trade is over. But there is an old adage about how generals always fight the last war. The Trump administration’s tariffs seem to be doing the same thing.

International supply chains mean much of the value of the goods China exports is not added in China, so they hurt the non-Chinese part of the supply chain as much or more as the Chinese part.

Furthermore, policymakers may not care too much if the United States tries to choke off the sales of its cheap products; they want Chinese companies to export the higher value-added goods the US actions will push them towards making (and they have plenty of alternative markets in which to sell both cheap and more expensive products; the US accounts for only one-quarter of China’s exports).

Meanwhile, China’s industry has developed to the point that in sectors such as artificial intelligence and autonomous vehicles it is already internationally competitive. Intellectual property protection is now more important to its companies than intellectual property theft.

Trump may end up declaring victory in this particular trade war by being able to show he is being ‘tough on China’ and cutting the headline number of the bilateral goods trade deficit, but it will be China that actually wins the war.

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China Can Be Content With The Trump-Kim Singapore Summit

 

North Korea leader Kim Jong Un (left) and US President Donald shake hands in the summit room during the DPRK–USA Singapore Summit, June 12, 2018. Photo credit: By Dan Scavino Jr. [Public domain], via Wikimedia Commons.

THE SINGAPORE SUMMIT between US President Donald Trump and North Korea leader Kim Jong Un was a quick-fire and highly choreographed affair, genuinely historic in just happening, but long on symbolism and short on substance.

It may turn out to provide the basis for the eventual denuclearisation of the Korean peninsula, though an equally long-term success would be the integration of North Korea into the international order as a nuclear power that played by international rules and norms.

Alternatively, it may all fall apart in time, as history provides some precedent.

But potentially it is a ‘reset moment’, although this Bystander is not alone in having no idea what Kim’s long-term game is.

For now, China will be pretty happy with where things stand. Kim has given nothing away that would concern Beijing. Meanwhile, the US president has tacitly followed the ‘suspension for suspension’ approach Beijing suggested all along once it was clear that the dormant six-party talks framework was going to be replaced by bilateral talks between Washington and Pyongyang.

Trump’s statements at a post-meeting press conference that the US would suspend its joint military exercises with South Korea and that the president would like US troops to leave the peninsula eventually (neither of which proposal was in the statement the two leaders signed at their meeting) would have delighted China. Beijing has long wanted a scaled-down US military presence in the region.

So, too, would Trump’s promise of security guarantees for the North Korean regime — China wants no outcomes that lead to either the unification of the Koreas or the collapse of the Kim dynasty, either outcome of which risks putting US or US-allied troops on its Manchurian border.

It will, no doubt, take the occasion when it arises to remind Seoul that Trump considered the joint exercises, or ‘war games’ as he called them, too expensive. From there, it will not be too far a stretch to put the idea in Seoul’s mind that the US president could have been suggesting that South Korea would be too expensive to defend in general.

Senior US officials, alive to the broader security implications of that for Japan and in the South China Sea, were quick to row back on that.

Most importantly for Beijing, no detailed plan or process for managing North Korea’s nuclear and missile programmes was laid out at the summit. The only commitment was to hold follow-on summit implementation negotiations, led by U.S. Secretary of State, Mike Pompeo, and an unnamed ‘relevant high-level [North Korean] official’.

This opens the door for all the interested parties, especially China, to turn that into an international effort for what will necessarily be a detailed and painstaking process of inspection and verification if the US aim of ‘complete, verifiable and irreversible denuclearisation’ is to be achieved. The considerable volume of regional diplomacy that has been underway for some months is, in a sense, preparation for that.

“A good beginning is half done,” a foreign ministry spokesman, said of the summit, adding that China wished to “support the two sides to implement the consensus reached by their two leaders, promote follow-up consultations, further consolidate and expand the achievements, and make the political settlement of the peninsula issue a sustainable and irreversible process”.

In other words, it wants a seat at the table. China has a pivotal role to play in as much as it has the critical hand on dialling up or dialling down the enforcement of international sanctions on North Korea.

Pompeo will visit Beijing on Thursday when Beijing’s ‘support’ will immediately be made available.

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The US Resumes Its Trade War With China

WE SAID EARLIER this month after the United States put its trade war with China on hold that that would last only until US President Trump tweets that “it is back on, or was never off or is over”.

We have moved into the ‘back on’ phase.

The Trump administration says it plans to impose 25% tariffs on $50 billion worth of Chinese imports by the end of June. The list of goods to be subject to the tariff will be published on June 15. The announcement also promises specific investment restrictions and enhanced export controls on “industrially significant technology”.

In a rather resigned-sounding comment, the Commerce Ministry said it was both “surprised and unsurprised” by the announcement.

Wilbur Ross, secretary of its US opposite number, is due in Beijing later this week for a follow-up round of talks to those earlier in the month that led US Treasury Secretary Steve Mnuchin to say that the Trump administration would hold off imposing tariffs on up to $150 billion in Chinese imports for alleged violations of US American intellectual property and unfair trade practices as the two sides were making progress towards a ‘framework’ for cutting China’s $375 billion merchandise trade surplus with the United States.

So the latest White House announcement may be Trump indulging in his new favourite negotiating tactic of cutting up rough ahead of talks.

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