The Battle for Control of the World Trading Order: Cold War On

The trade skirmish is over. The Chinese-American cold war is on. Even if a deal is confected, it will not resolve the confrontation between America, the current world hegemon, and China, the wannabe.

China’s president, Xi Jinping, insists the Communist Party must retain control of China, and be free to use subsidies, trade discrimination against American firms, and whatever weapons, legal and otherwise, are necessary to implement his “Made in China 2025” plan to have China dominate the industries of the future. That program cannot be accommodated by the world order established after WWII by US-led Western, largely open-market countries that rely on free markets to determine the allocation of their resources, and on (more or less) free trade.

By largely ignoring those rules, Xi and his predecessors have flooded American markets with their goods, while preventing US firms from selling a significant amount of stuff in China. Chinese firms have operated freely in America, while requiring US firms to take on and transfer their technology to Chinese partners. And by subsidizing key industries they have dominated many of the industries of the 20th Century and plan to do just that with industries of this and future centuries. While America and other nations slept.

Enter Donald Trump. The American President never did believe in free trade and, revealing either his ignorance or infidelity to the truth, says that bilateral trade balances matter and that exporting nations pay any tariffs imposed on them. Even free-traders concede that previous Presidents’ acquiescence in China’s trade practices have allowed it to gut American industries and devastate communities, immiserating blue-collar workers. And that Trump’s tariffs are necessary weapons in a trade war that, if successful, would “Make America Great Again”, to use Trump’s not entirely accurate formulation, and not incidentally make him “a winner”, a term with deep, preternatural meaning for, the President.

Problem: Xi Jinping cannot concede what Trump must have, a verifiable promise that China will play by what are Western/American rules, which would require the Communist Party elite to cede control of the allocation of his nation’s resources to market forces. Xi has something quite different in mind: replacing decades-old American rules with a new set – one that accommodates nations in which an autocratic leadership, not markets, control which industries grow, with the goal of dominating world markets. In short, Xi cannot concede what Trump is demanding without abandoning his entire vision of China’s future, and Trump cannot accept what Xi can concede without forfeiting America’s ability to retain its current leadership position.

Which is why the real war, a Cold war, will rumble on after any settlement of the current trade dispute. China won round one, the territorial round, by claiming territory in the South China Sea and by inventing its “Belt and Road” program. The UN estimates that one-third of the world’s shipping passes through the South China Sea. So far, China has met occasional challenges to its control by a few American gunboats by shouting warnings. But it has the power to become less accommodating whenever it chooses. China also has won de facto control of territory from Africa to South America to Europe by using the cash built up by its trade practices to fund its “Belt and Road” programme to gain control of ports and other infrastructure around the world.

The battle over resources is another matter. China supplies 80% of US imports of about $160 million in so-called rare earths, needed by manufacturers of everything from smart phones to weapons systems, and could ban exports, but only if it were willing to bear the costs.[1] Also, pharmaceutical products are among those to receive state support under Xi’s “Made in China 2025” program, scary since we are already dependent on China for the ingredients of thousands of medicines and supplies of penicillin, antibiotics, antidepressants, cancer drugs and other medicines according to a study by Rosemary Gibson and Janardan Prasad Singh. On the other side, America can make it difficult for China to buy oil on world markets and to have access to the international financial network on which many of its companies depend.

In the battle for technological leadership, US has the heavier artillery. It is cracking down on the export of key technologies to China, on visas for Chinese students who learn what we have to teach and return home to make it available to the state, and on doing business with commercial-enterprises-in-name-only such as Huawei.

Finally, there is the not small matter of financial weapons. China holds over $1trillion of American IOUs, and about $200 billion in shares in American companies. They could dump those, but only at a high cost to itself. The Trump administration’s weapon is more lethal. It is considering confronting Chinese companies, which have raised tens of billions of dollars through American markets, with “No Trespass” signs on Wall Street, on the not-implausible ground that Chinese companies lack the degree of transparency required of listed enterprises. This would be an important step towards decoupling the world’s two largest economies, a process already well under way. The Lindsey Group reports that 41% of American firms operating in China have already moved their production facilities outside of China or are actively planning to do so.

The effects of the new Cold War are likely to be permanent. Many companies are transferring operations from China to avoid tariffs, existing and threatened. This movement of links in supply chains is unlikely to be reversed. And American policymakers, having seen the power of tariffs, are unlikely ever to unwind them fully, and instead will take the country in a more mercantilist direction, supported by military and other authorities determined to reduce reliance on China for every strategic product from medicines to rare earths. Trump may have over-reached when he claimed that steel imports from Canada represent a threat to our national security, but there are indeed significant threats from other imports, especially from China. In such cases, tariffs on imports or subsidies to retain domestic capacity are not inappropriate. As Adam Smith put it:

If any particular manufacture was necessary, indeed, for the defence of the society, it might not always be prudent to depend upon our neighbours for the supply; and if such manufacture could not otherwise be supported at home, it might not be unreasonable that all the other branches of industry should be taxed in order to support it.

Like the first Cold War, this new battle will be a test of two very different systems, an America in which individual choices, constrained only by reasonable regulations, guide the direction of an economy, and China, in which that direction is subject to decisions by party leaders as to what is in the best interests of their party and the state. History suggests that central direction of large economies leads to corruption, inefficiency and collapse, but also that America cannot be counted on to suffer short-term pain for long-term gain.

Harvard’s Graham Allison has reminded us of the Thucydides Trap, a war into which rising and incumbent powers have often fallen. The great Athenian historian and general pointed out, “War is an evil thing; but to submit to the dictation of other states is worse.” Both Xi, the challenger, and Trump, the current champ, believe that. Cold might not be the temperature at which their current war remains.

“We have to accept that the US cannot forever be the supreme nation…”, Malaysia’s Prime Minister Mahathir Mohamed told a Tokyo audience. But “We” need not include America. As the late, much-missed columnist Charles Krauthammer pointed out, “Decline is a choice. More than a choice, a temptation.” This is one temptation, one choice, that for all his many failings, Trump has not made.