US the likely loser of trade war with China

As indicated in a previous article, an all-out trade war between China and the US over North Korea’s nuclear program would trigger a global economic and geopolitical tsunami, possibly sending the US economy into a repeat of the 1930s-era Great Depression while at the same time  raising geopolitical tensions.

In spite of President Donald Trump’s boast that the US economy has never been better, its growth rate is expected to fall during the next two years largely because of insufficient domestic demand. This week at the United Nations General Assembly, Trump also threatened North Korea with total annihilation if it does not give up its nuclear-weapons program.

North Korean leader Kim Jong-un is equally belligerent, threatening to test more missiles in the future. China has responded by saying the two sides’ threats and rhetoric will not solve the nuclear issue on the Korean Peninsula.

So why is Trump, through his Treasury Secretary Steven Mnuchin, threatening to stop trading with nations (that is, China) that do business with North Korea? One major reason may be that some in the US believe that China can be coerced into supporting the US hardline policy against Pyongyang because a trade war could topple the Communist regime in Beijing.

Reviewing the argument for a trade war

Proponents of a trade war would argue that because China sends 18% of its exports to the US, the former would suffer the most harm. Their conclusion is probably based on the assumption that since exports account for 20% of its gross domestic product, China’s economy would  shrink by 4 percentage points (18% times 20%) in a trade war. According to these analysts, a US embargo of Chinese exports would reduce China’s annual GDP growth rate to 2.7% or less.

According to this crowd, the Communist Party’s sole legitimacy in governing China is its ability to facilitate and promote economic growth. So they reason that if the economy is stagnating or collapsing, the people will turn against the ruling party.

While it is true that the party’s overwhelming support (85% according to a Pew Poll) is derived from its good economic management, that is true for all governments or political parties. Bill Clinton defeated George H W Bush in the 1992 US presidential election because of the tanking economy. In 2016, Trump gained support from displaced workers because he promised them employment.

But for such a collapse to happen, all Chinese factories that do business with US enterprises would have to be shut, the laid-off workers have no alternative means of earning a living, and the government fail to help them. These are highly unlikely scenarios in view of China’s history of addressing economic headwinds.

During the global financial crisis that began in 2007, the vast majority of the estimated 23 million laid-off Chinese workers returned to their homes in the countryside. During this “home sojourn” period, many  went on to establish small businesses, tended farms or found employment near home, fostering a mini economic rejuvenation in some rural areas.

The Chinese government also stepped in quickly with a huge stimulus package of US$580 billion, or 14% of the country’s GDP at the time. The money was largely spent on employment-creation programs such as rebuilding in the earthquake region in Sichuan province, environmental upgrades, and helping workers establish their own businesses. The economy reversed its downward trajectory and recorded an average annual growth rate of almost 10% between 2009 and 2014.

What’s more, not all factories catering to the US market shut down, though some downsized. Most of them successfully scrambled to find other markets, domestic and foreign.

China’s huge domestic market

China has a population of more than 1.35 billion, and according to US-based consultancies, its urban middle class (those earning between $8,000 and $34,000 per year with net assets of $36,000) will surge past 550 million by 2020, thanks to urbanization.

In addition, there are hundreds of millions more living in the countryside who could be categorized as middle class. They have little debt compared with their counterparts in the US.

Last but not least, Chinese consumers save 26% of their disposable income compared with the US savings rate of around 5%.

Urbanization has transformed China’s consumption stance. Moving hundreds of millions of people from villages to cities will increase the consumption-to-GDP ratio. In fact it already has, rising from 34% in the early 2010s to above 60% in 2016. The new urban dwellers must buy food, appliances, furniture and other household goods and services. In the villages, they grew food, made their own clothing, and bought a minimal amount of household goods.

Given the enormous consumption power and a government with a proven record of stepping in to reverse economic plights, the Chinese economy should be able to withstand a trade war with its biggest trading partner.

Plan B: the Road and Belt Initiative

Chinese President Xi Jinping’s announcements of rejuvenating the ancient Silk Road trade route with what became the Belt and Road Initiative (BRI), the formation of the Asian Infrastructure Investment Bank and the Silk Road Fund in 2013 might have been more than just means to sustain economic growth or establish an outlet for industrial overcapacity. He might have foreseen that trade relations with the West and Japan could become confrontational.

To protect their own domestic markets, the US, the European Union and Japan have refused to grant China market-economy status as required by World Trade Organization rules. What’s more, China is at the receiving end of most of the developed economies’ anti-dumping measures, as they accuse it of selling products such as steel at below cost or applying unfair subsidies.

Instead of taking ownership of the consequences created by the US-originated 2007 financial crisis and undertaking structural-change decisions, some US politicians and officials blamed China. Ben Bernanke, then chairman of the US Federal Reserve, blamed “cheap Chinese money” for the financial crisis instead of reckless US financial management and unsustainable fiscal and monetary policies.

It was US businesses’ decision to abandon or minimize manufacturing to earn higher returns on capital and reduce pollution that hollowed the sector. Spending money on automation or innovation is the major culprit responsible for increasing unemployment in the US.

Meanwhile the BRI went on to promote trade between China and more than 60 countries straddling the massive Eurasian landmass, Southeast Asia, the Middle East, Africa and Europe. Last year, more than 130 nations and organizations including the US and its closest allies attended the BRI Forum held in Beijing.

Two-way trade between China and the countries participating in the BRI was valued at nearly $1 trillion in 2016. Should that trend continue, the figure could grow to between $4 trillion and $8 trillion over the next 10 years. A major factor supporting such a prediction is that China is making good on its pledge to invest $1 trillion in the countries that participate in the BRI, building infrastructures and businesses and increasing connectivity.

Most likely scenario

In view of the above analysis, China would likely emerge from a US-initiated trade war stronger than it is today. Its huge domestic market (larger than the West and Japan combined) could consume most if not all of the products made by its factories. As well, its trade relations and volumes with countries in Latin America, Africa, Southeast Asia and other regions are on the rise.

China has also shown resilience in withstanding US opposition postures. The US disallowing Chinese participation in the international space program backfired, culminating in China building its own. Barring Chinese enterprises from buying US technology firms has prompted China to increase spending on research and development, resulting in closing the innovation gap sooner rather than later.

For reasons indicated in the previous article, a trade war could push the US and the world into a recession or depression. This might be the reason Trump struck a more conciliatory tone toward China in his UN General Assembly speech and may not follow through with the trade-war threat.