An Outlook for the US-China Trade War ―What makes the two economically interdependent superpowers confront each other?―

proposal

(Project of the Kajima Institute of International Peace)

An Outlook for the US-China Trade War
―What makes the two economically interdependent superpowers confront each other?―

Takashi Sekiyama
Associate professor, Toyo University

Introduction

It was March 23, 2018 that a US-China trade war became apparent. On this day, the United States implemented, in accordance with Section 232 of Trade Expansion Act, additional tariff measures for the imports of steel and aluminum products from many countries including China. As a retaliation for this, the Ministry of Commerce of China announced a plan to impose additional tariffs worth approximately USD 3 billion for 128 items of US products. On July 6, 2018, the United States imposed punitive duties of 34 billion US dollars on 818 items of imports from China under the pretext of countermeasures against Chinese infringement of US intellectual property rights. China lost no time in leving commensurate retaliatory tariffs. The exchange of retaliations were followed by the second and third raising of tariffs by both sides on August 23 and on September 24, respectively. Thus, the bilateral confrontation has now heated up.

As of 2017 China is the United States' largest trading partner --- Canada is the second largest, while Mexico and Japan rank as the third and the fourth. Moreover, the ratio of trade with China has recently been increasing in annual US total trade, accounting for 16.3% of the US total trade for 2017 (See Figure 1). For China, too, the United States is the largest trading partner. However, the US-China trade is asymmetrical or imbalanced, and the US trade deficit with China continues expanding, registering USD 375.7 billion in 2017. This amount accounts for 46.3% of the total US trade deficit.

Fig. 1 US Total Trade with China

Source: US Census Bureau

Why are the United States and China intensifying confrontation, while deepening economic mutual interdependence? The relation between economic interdependence and an inter-sate dispute or confrontation is one of the major issues in the discipline of international politics. One interpretation is, as Montesquieu stated, "Expanding economic interdependence is to foster a political cooperative relationship." (Viner 1951 and many others). Meanwhile, there exist critical views against the cooperation-inducing effect of interdependence. Some proponents argue that an increasing economic interdependence is likely to create a political confrontation rather than promote cooperation. (Gilpin 1981 et al.)

The purpose of this paper is to discuss the causal relationship between economic interdependence and diplomatic confrontation between the United States and China, and to provide a prospect of the bilateral trade friction. Regarding the causal relationship where confrontation intensifies under economic interdependence, the hypotheses in the table below are available from preceding researches and the present author's own analysis. This paper is intended to examine these hypotheses.

Table 1 Five Hypotheses on Confrontation under Economic Interdependence

Hypothesis 1: The Thucydides Trap

The first hypothesis is that an existing superpower and a rising superpower inevitably fight for supremacy, and that even economic interdependence cannot deter their struggle for supremacy. A well-known example of this is the years-long Peloponnesian War in ancient Greece that took place between the hegemon Sparta and the emerging power of Athens, as narrated by the famous Greek historian,Thucydides. While an existing superpower desires to maintain the current state of international regimes, an emerging superpower attempts to change the existing regime to be more advantageous to itself; as a result, a friction takes place over their respective positions and can ultimately develop into a total conflict. According to Graham Allison's "Destined For War," actually 12 out of the 16 struggles for supremacy over the past 500 years developed into a war, except four including UK-US relations in the early 20th century and the Cold War.

If this hypothesis is correct, the current US-China trade war may be just a prelude to a prolonged struggle for supremacy.

In fact, the new national security strategy publicized by the Trump administration on December 18, 2017 looks on China as a revisionist power aiming at promulgating a state-led economic model of its own, taking the place of the United States. The said strategy evinces a US posture of facing China squarely. Furthermore, on October 4, 2018, Vice President Mike Pence gave a speech, "Administration's Policy Toward China," in which he severely criticized China over not only the bilateral economic friction, but also over a wide range of issues including human rights, diplomacy and military. Thus, the Vice President's speech insinuated the Trump administration's preparedness not to avoid an all-out confrontation with China. Professor Allison, the author of "Destined for War," commented on the Trump administration's punitive duties against China as a de facto declaration of a cold war. (Allison, 2018).

We, however, should not forget the fact that the United States and China are nuclear powers and member states belonging inseparably to the same international economic system. The present author surmises that the possibility of an all-out conflict between them may be low, because such a conflict would require of them unbearable sacrifices, military and economic.

Hypothesis 2: Democratic regime vs. Non-democratic regime

The second hypothesis is that economic interdependence is effective in deterring confrontation only under democratic regimes. This idea is closely related with the so-called democratic peace theory that a war is less likely to occur between democratic countries than between a democratic country and a country with a political regime other than democracy. This idea has its ideological origin in Immanuel Kant's "Permanent Peace" and Thomas Pain's "Common Sense" in the 18th century. Michael Doyle (Doyle, 1983), Bruce Russet (Russet, 1993) and others have verified it empirically. According to them, (1) among democracies, norms that favor peaceful resolution are shared; (2) since high transparency of policy decision process in the parliament makes it easy for other countries to understand the process, mutual distrust is unlikely to grow between democracies, and (3) it is hard to create a cause for attack among democratic countries sharing the same values. They conclude that there is little likelihood of a full-scale conflict like a war between democracies.

But a reverse view of the above will lead one to a contrary judgement. (1) The United States does not share with undemocratic China any norms favoring peaceful resolution; (2) the United States has scarcely any trust in China's non-transparent policy decision process, and (3) it is easy for the United States to find a cause for attack such as human rights problems. That China is an undemocratic country cannot be a direct factor to bring about confrontation between the United States and China; yet it is a factor at least for encouraging confrontation.

Hypothesis 3: Asymmetric interdependence

Thirdly, between two interdependent countries, it is considered that the country with a lesser degree of dependence is apt to become high-handed against the other country with a greater degree of dependence. If country A relies heavily on trade with country B, and country B has a relatively low dependence on trade with country A, damages each of them is to suffer, when their bilateral trade is suspended, will be widely different between them. In such relations of asymmetric interdependence, country B could be moved by an incentive to coerce country A to yield to its own demand, capitalizing on the weaker position of country B.

China's confrontation with Vietnam and the Philippines in the South China Sea can be seen against the background of asymmetric interdependence between China and these Southeast Asian countries. Since the beginning of the 2000s, economic interdependence between Japan and China made another asymmetric development --- China's dependence on Japan decreased, while Japan's dependence on China increased. This fact may arguably account for China's strong stance toward Japan in recent years. (Sekiyama, 2013)

When it comes to the US-China relations, China is more dependent on the United States than the United States is on China. As of 2017, China's ratio of dependence on trade (total trade value / nominal GDP) is 34.2%, while that of the United States is 20.3%. Furthermore, US ratio of dependence on partner countries' markets (exports to partner countries / nominal GDP) is only 0.7%, while that of China is 4.2%. If trade between the United States and China becomes stagnant, the Chinese economy will be likely to suffer more seriously than the US economy will.

The trade friction this time is considered to have been triggered by the United States capitalizing on the asymmetry of the bilateral interdependence.

Hypothesis 4: The effect of interdependence to escalate a diplomatic confrontation

Fourth, there is a popular opinion that among countries interdependent on one another, a diplomatic confrontation tends to mount all the more because policy makers predict that confrontation will not develop into a military clash. The present author believes that this hypothesis can explain the background of the recent US-China confrontation much better than the foregoing three hypotheses. Interstate confrontation connotes a broad spectrum of affairs from a diplomatic exchange of accusations to a full-scale war.

Even countries economically interdependent may exchange oral or written accusations with each other, and sometimes such accusations lead to a military show-off of maneuvering warships or to economic sanctions such as partial restriction on economic activities. However, if that kind of confrontation accelerates to a military clash, its outcome is bound to not only endanger the lives of citizens, but also cause irreversible economic sacrifices. Consequently, the greater the degree of interdependence, the more chance of compromise not to escalate confrontation to a military clash or worse. And if the countries concerned do not expect that a low-order confrontation will escalate to a high-order confrontation, their incentives will diminish to avoid a low-order confrontation including a diplomatic exchange of accusations and intimidations or economic sanctions. Confrontation has more conspicuous than ever between Japan and China since around 2010. This may serve as an example of the effect of interdependence to escalate a diplomatic confrontation. (Sekiyama, 2017)

To return to the US-China relations, both countries are now each other's largest trading partners and are tied with close economic interdependence. If they fall into the Thucydides trap as mentioned in reference to the first hypothesis and escalate confrontation to a full-scale conflict, it will demand intolerable sacrifices of them not only military but also economic. Therefore, both Washington and Beijing are highly likely to anticipate some compromise before the bilateral confrontation develops into a military clash or worse. Then, relatively low-level confrontation will be all the less likely to be avoided, such as blaming each other through official speeches and policy documents, or through the mutual implementation of additional tariff measures.

Hypothesis 5: Pressure from comparatively disadvantaged industries

Between two countries that are heavily economically interdependent on each other, comparatively disadvantaged industries in one of these countries that have lost competition with imports from the other country, may attempt through, among other things, elections to ask their government to take a hard-line attitude to the other country. According to standard trade theories in the discipline of international economics propounded since the time of David Ricardo, it is a prevailing view that if each country pursues free trade only in the area of its comparative advantage industry, it will be able to gain profits along with other countries adopting a similar strategy. This theory is based on the premise that production factors including labor force and capital may move swiftly from comparatively disadvantaged industries to comparatively advantaged industries.

In reality, however, labor mobility is not so easy. As a result of free trade, many comparatively disadvantaged industries will suffer from income reductions, unemployment, and the closure of businesses. Politically, the existence of workers of those industries victimized by free trade is important. Being losers in competition with imports from the partner country, they will request their government to take a hard-line posture against the partner country through, among others, elections.

According to a study by David Autor et al. (Autor, Dorn & Hanson, 2013), in the places in the United States facing competition with imported goods from China, such implications have been confirmed as rising unemployment rate; decreasing labor force participation rate; dropping wages, and rising take-up rate of disability benefits. According to those experts' estimates, during the period from 1990 to 2007, trade competition with China gave rise to a loss of jobs of more than 1.5 million people --- college graduates and non-college graduates --- in US manufacturing industries. Declines in US employment rate due to increasing imports from China are found in a wide range of age groups. Increasing imports from China are estimated to account for 84% of unemployed senior workers (aged 50-64); 71% of unemployed middle-aged workers (aged 35-49), and 68% of unemployed young workers (aged 16-34).

The idea that workers of comparatively disadvantaged industries that lost competition with imported goods from a partner country ask their own government to take a hard-line posture against the said partner country has not been pointed out clearly in the conventional interdependence research in the discipline of international politics. Yet it is a cogent theory to explain the background of the current US-China trade war.

Conclusion

Why is the United States now launching punitive duties against China tied to itself with a close economic interdependence? What is the reason for the United States' harsh confrontation with China? In the light of objective circumstantial evidences, each of the five hypotheses discussed above has a certain cogency. The present author opines that all these causal relationships have acted in some way or other to urge the Trump administration to initiate a trade war with China.

If these five causal relationships are correct, how will the US-China trade war develop from now on? The fifth hypothesis may be helpful to think about the development over a one to two-year period. If the Trump Republican administration has resorted to punitive duties against China for the purpose of gaining support for its election campaigns, there may be no reason that the administration should continue escalating retaliatory measures after completion of the midterm election on November 6. Especially, if, as a public opinion poll shows, the current policy fails to gain broad public support, the Trump administration will behave more cautiously. However, since, as stated in reference to the third hypothesis, it will take time for the negative implications of the trade war to unfold. Time allowance thus gained would enable the administration to adopt policies such as tax cuts and infrastructure investment financed by additional tariff income. The administration, therefore, will not have to immediately lower the imposed punitive duties. The raised tariffs will be maintained by both countries for a while unless China, which depends more heavily on the bilateral trade, comes up with some compromise.

Over the next five years, US incentive to wage a trade war with China will be maintained. Yet with the passage of ten to twenty years, the asymmetry of the US-China economic interdependence (US trade deficit with China), referred to in connection with the third hypothesis, will gradually be resolved. With the economic growth of China itself and other emerging countries, the dependence of Chinese exports on the US market will decrease; and more than anything else, China will hand over its position of the world's manufacturing center to other countries due to soaring labor costs at home. Should the United States exert diplomatic pressure against China by leverage from the asymmetry of their economic interdependence, now is the best opportunity. In this sense, over next few years, the incentive for the United States to wage a trade war against China may be maintained.

It is difficult to make a prediction for ten to twenty years ahead. Yet, as the first hypothesis suggests, the United States (an existing superpower) desires to maintain the status quo of the international regimes that it has built for its own interests. Meanwhile, China (an emerging superpower) will attempt to transform the present state in a manner advantageous to it. Such a challenge from China will inevitably cause bilateral friction between the United States and China over their respective positions. If, as pointed out in connection with the second hypothesis, China continues to limit freedom of speech and religion under the CCP's dictatorship, such behavior by China will add to confrontation.

However, as stated in reference to the hypothesis 4, the United States and China are now each other's largest trading partner, and are tied by a close economic interdependence under various international regimes for trade, investment and finance. Moreover, they are nuclear powers interdependent on each other in terms of security as well. If both countries fell into "the Thucydides Trap" and escalated the current confrontation to a full-scale conflict, they would suffer unbearable sacrifices. Washington and Beijing, therefore, anticipate that they will be able to make some compromises before the current confrontation will escalate beyond a military clash. They will allow themselves, under the circumstance, to indulge in verbal or written accusations, or to cause trade frictions --- such a level of confrontation will frequently occur from now on. Nonetheless, the present author does not believe that the United States and China will engage in an all-out conflict capable of splitting the world.

An Outlook for the US-China Trade War as Predicted Based on the Five Hypotheses

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