A Possible U.S.-China Trade War

Washington, October 26, 2017 –  The media is paying little attention to the possibility of a U.S.-China trade war in the near future, despite the fact that President Donald Trump has set in motion proceedings that will empower him to initiate one. During the presidential campaign, Trump railed against China in virtually every speech. He accused China of “raping America” by “stealing American jobs.” He lauded China’s leaders as clever and powerful and America’s as inept and clueless about the Chinese threat. With such a dramatic windup, it might have been expected that Trump would immediately move toward strong trade actions against China following his inauguration. Yet, at some risk of disillusioning voters excited by his campaign diatribes, he has done very little so far to respond to the supposedly overwhelming China threat.

Despite his inaction, it is clear that Trump has not laid aside his concerns about China. The principal U.S. government agency assigned responsibility for the detailed management of international trade relations is the Office of the U.S. Trade Representative. On Aug. 19 the USTR announced it was initiating an investigation of Chinese efforts to steal intellectual property of U.S. firms. This might seem like a detailed and technical bureaucratic procedure of little interest to the general public. Indeed, the press has largely treated it that way. Yet this investigation may portend far more than what appears superficially.

In order to understand why, it helps to know a bit of the history of trade regulation in America. The U.S. Constitution explicitly grants Congress the power to regulate trade. Throughout most of American history, among the most hotly debated and consequential acts of Congress were the occasional tariff bills setting tax rates on a wide range of imported goods. Tariffs affected which industries would thrive and which would succumb to foreign competition. They also raised the prices consumers and manufacturers would have to pay for importable goods. Tariffs influenced the general price level, causing inflation when increased and deflation when reduced. Furthermore, for the first century and a half of U.S. history, tariffs were the main source of federal government revenue. Until late in the 20th century, the Republican Party and its predecessors (the Whig and Federalist Parties) generally supported higher tariffs while the Democratic Party typically supported lower tariffs—in other words, freer trade. In fact, one of the principal reasons the Democratic Party first introduced an income tax in 1913 was to provide a revenue alternative to tariffs so Democrats could cut them and still fund the government.

The Great Depression of the 1930s began a sea change in U.S. trade policy. For the first time, Congress began to cede power over tariff setting to the executive branch, beginning with the Reciprocal Trade Agreements Act (RTAA) of 1934, which delegated to the president authority to lower (but not raise) tariffs to facilitate trade agreements with foreign countries. The Great Depression had had a devastating effect on world trade. The Democratic Congress and President Franklin Roosevelt were determined to restore it. The RTAA and subsequent modifications allowed the executive to commit the U.S. not just to bilateral tariff cuts, but also to the multilateral process that emerged after World War II, the General Agreement on Tariffs and Trade (GATT). The Republican Party remained fairly skeptical of trade, but during the postwar prosperity increasingly began to embrace it as more and more successful U.S. businesses became global.

By the 1970s domestic U.S. manufacturing came under increasing pressure from newly industrializing countries and the postwar economic revival of Europe and Japan. Congress became concerned that some countries were cheating on GATT rules. The GATT process itself had weak enforcement mechanisms. Thus when Congress passed the Trade Act of 1974, it included Section 301, which once again delegated power to the executive, but this time to raise tariffs on countries that violate agreed trade rules.

In recent decades Section 301 has been dormant because GATT was superseded in 1995 by the World Trade Organization, which provides stronger enforcement mechanisms than its precursor. Under WTO rules, countries are empowered to sanction other countries for flouting trade rules. The dispute is then adjudicated through the WTO, often taking many years to resolve. During the presidential campaign, Trump often criticized multilateral trade agreements—such as the WTO—in favor of dealing separately with each country. Economic nationalists like Trump and his former chief strategist, Steve Bannon, argue that U.S. national power is more potent if exercised bilaterally.

When Trump directed the USTR to conduct a Section 301 investigation of China, he was reviving an old law designed for bilateral enforcement prior to the creation of the WTO. The law mandates an investigation first, involving a public hearing, which I attended in Washington, D.C., on Oct. 12. During that hearing, several U.S. business leaders, lawyers, and academic researchers testified about specific cases of alleged Chinese theft of U.S. intellectual property. Intellectual property includes patents, copyrights, and trade secrets involving sophisticated technology as well as privileged internal communications, often obtained by hacking or other means of spying. Chinese business leaders also testified at the hearing. Staff from the USTR as well as the Departments of State, Treasury, Commerce, and Justice listened to the testimony and questioned the witnesses. Considering the Chinese reaction, the dispute is likely to expand beyond these hearings.

The Chinese participants pointed out that China has been making large strides on better enforcement of intellectual property rights. Because these cases are often very technical and concern secrets, China established special courts for intellectual property issues in 2014. These courts mainly adjudicate disputes between rival Chinese companies, but many foreign companies have successfully sued Chinese companies as well. Chinese participants in the D.C. hearing testified about these courts and emphasized that any U.S. concerns about Chinese state violations of intellectual property should be addressed through the appropriate WTO procedures, since both the U.S. and China are WTO members.

On the other hand, the American complainants and Trump administration officials present seemed skeptical of the power of such intellectual property courts to enforce judgments when the source of the violation is the Chinese state itself. Some of the testimony involved alleged intellectual property theft by Chinese state-owned enterprises, firms controlled by friends or family of top Chinese leaders, or hackers working for China’s army. Some of the participants noted that in a one-party state like China, lacking the checks and balances of the U.S. constitutional system, intellectual property courts may be powerless to act against top party officials and state organs.

It is very unlikely that Trump initiated the Section 301 process just to trumpet complaints without the intent to follow through with action. The outcome of this process is that Trump will be able to sanction China in ways designed to force compliance with intellectual property trade rules. This will give Trump considerable leverage. But if he uses that power to sanction China and interests close to its leaders, they are likely to retaliate in ways consistent with WTO rules. Both sides have considerable scope to escalate a trade war with few external constraints. Next week I will consider what the dynamics of a U.S.-China trade war could be, given the domestic political interests and powers of the respective countries.