Trump trade policy will turn the US into Brazil
Shielding raw materials exporters while ignoring the decline of America's high-tech capacity, defensive trade action stands no chance of rejuvenating the US industrial base
The broad US stock market gave up an early rally and fell over 5% after President Trump’s announcement of punitive tariffs of 25% on steel and 10% on aluminum, the highest in US history. US Steel, the country’s largest producer of the metal, rose 6.4% on the news and aluminum producer Nucor gained 2.4%, while the S&P 500 average lost 1%. General Motors fell almost 4%, Ford fell 3%, United Technologies fell 2.8% and Boeing fell 3.4%.
Raw materials prices have little to do with the erosion of America’s industrial base. Chronic underinvestment in capital-intensive manufacturing is the underlying problem, and American manufacturers avoid big capital commitments because they can’t compete with Asian subsidies for industrial plant and equipment. Asian economies view a $10 billion semiconductor fabrication plant the way Americans view a bridge, stadium or airport, as a public good that merits taxpayer support. China’s economy is so big that its subsidies distort capital investment around the world.
By protecting raw materials exporters while ignoring the decline of American high-tech capacity, the Trump trade policy nudges the US economy towards the economic profile of a Brazil: a producer and exporter of agricultural goods and raw or semi-finished materials with an atrophied industrial base.
Trump announced the tariffs in offhand remarks to reporters at the White House, after a day of conflicting signals. The White House had planned an announcement as of Wednesday night, but postponed it until this morning. Trump tweeted early Thursday, “Our Steel and Aluminum industries (and many others) have been decimated by decades of unfair trade and bad policies from around the world. We must not let our country, companies and workers be taken advantage of any longer. We want free, fair and SMART TRADE!”
As the equity market plunge suggests, Trump’s announcement is anything but smart. America’s greatest commercial challenge comes from China, which dominates many categories of high-tech manufacturing and has committed tens of billions of dollars to a campaign for supremacy in semiconductors. But China’s steel and aluminum exports to the US amount to less than 1% of the total; America’s main suppliers are Canada, Brazil, South Korea, Mexico, Russia, Turkey and Japan, in order of importance. China has been accused of depressing world prices of industrial metals, although aluminum prices have risen by 60% and steel prices have doubled since the Nov. 2015 low. US Steel’s stock price has jumped from $7 a share in early 2016 to $43 before Trump’s announcement.
US Steel’s 29,000 employees won’t determine the outcome of any major election, but the White House evidently believes that it needs to show the flag on trade to maintain credibility with its working-class supporters. If Trump’s trade announcement was a cynical political gesture with domestic politics in mind, the damage will be limited. But earlier this week, the president promoted trade warrior Peter Navarro to a rank equal to that of Economic Policy Council head Gary Cohn, which suggests that other shoes are likely to drop.
In two recent essays for the Journal of American Affairs, I examined the
The reason has to do with return on capital. In the United States, return on equity is negatively correlated with capital intensity. In China, it is positively correlated, and strongly so. That is the result of government subsidies for capital investment.
The charts below show the capital intensity (total assets per unit of earnings before interest and taxes) vs. return on equity of each company in the China MSCI Index and the S&P 500 respectively.
As I wrote in the Journal of Economic Affairs, China dominates the key digital technologies:
On several occasions the US Department of Defense has had to abandon high-tech research projects that require sophisticated micro-manufacturing because it could not find an American manufacturer capable of executing the task. Defense Department rules exclude the use of foreign manufacturers, and in some fields the only technical capacity is located in South Korea, Taiwan, or other countries.
- Liquid crystal displays, which are employed in a wide variety of products, with $100 billion in annual sales. South Korea controls 35% of the market, Taiwan 25%, and China 20%.
- Light-emitting diodes (LEDs) are produced mainly in China and Taiwan.
- China and Taiwan dominate the production of semiconductor lasers, the energy source for fiber optic communications.
- Solid state sensors, which generate images in digital cameras and related devices, are produced mainly in Taiwan and Japan.
- Flash memory is produced mainly in South Korea, Japan and China, with only 10% of world output coming from the United States.
- Integrated circuits are a $270 billion global industry. Most are produced in Taiwan and South Korea, and China has undertaken an aggressive investment program in the industry. Less than a quarter of world output is produced in the United States.
- Solar energy panels, a $30 billion industry, are dominated by China.
Restoring the US industrial base would require a radical departure from past policies. Requiring domestic content for high-tech defense goods, for example, would compel US manufacturers to create onshore capacity, but the taxpayer would have to support the effort. The government would have to persuade US companies to restore the R&D capacity they abandoned during the 1990s, when Bell Labs, RCA Labs, GE Labs, IBM Labs and other major industrial facilities still functioned. The Federal R&D budget stands at half of its Reagan-era level in terms of GDP. Even if the government were to restore funding, it lacks the corporate and national laboratories who know how to spend it effectively.
The US share of global high-tech exports has fallen from just below 20% in 1999 to barely over 5% in 2014, while China’s share has risen from 3% to 26% during the same period.
The United States has never encountered a competitor like China. Old-fashioned remedies like tariffs are not effective. I wrote in
Solar panels are a case in point. China decided to address its urgent pollution problem by shifting to solar power during the early 2000s. It also sought to exploit growing global demand for clean energy. The technology to manufacture solar panels was developed in the United States and Germany, and German production equipment was available on the open market. China meanwhile directed investment into the components of solar panels such as polysilicon and glass frames, dominating the supply chain for solar panel production. As a result the U.S. share of solar panel production fell from 50 percent in 2007 to 6 percent in 2011. The largest Chinese solar panel producers are unlisted and do not publish their financial data, so it is impossible to gauge their profitability. The United States responded by imposing stiff tariffs on Chinese solar panel imports, up to 239 percent in the case of some companies. The European Union, Australia, Canada, India, and Turkey also imposed tariffs against Chinese exporters. The Chinese responded either by absorbing the tariffs, or by shifting production to other countries.
There is no indication, though, that Trump will attempt to protect high-tech manufacturing, for the simple reason that it has already left, and there are few jobs left to defend. Instead, the president will concentrate on labor-intensive, low-tech industries. That’s the way to give America the economic profile of a Brazil.
It was standing, leaning, and crouching room only for most reporters in the Great Hall of the People on Sunday as Zhang Yesui, spokesman for the first session of the 13th National People’s Congress (NPC), warned Beijing “will not sit idle” if the US implements policies harmful to China.
Zhang briefly laid out what lies ahead in the NPC session－10 items on agenda; eight plenary meetings; 14 press conferences; fifteen-and-a-half days, starting on Monday – before easing back in his chair and opening the floor to reporters crammed wall-to-wall.
China’s former ambassador to Washington, taking questions from domestic outlets as well as international organizations, including CNN and Reuters, addressed topics from the US threat to impose trade tariffs to China’s defense budget.
Zhang's top five answers
Could there be a trade war with the US? China and the US have more common interests than differences, but it is “natural there are some frictions.” Opening up markets is the best route to progress, but “policies based on misjudgment or wrong assumptions will bring consequences neither side wants to see.” China does not want a trade war, “but if the US takes actions to hurt China’s interests, China will not sit idle and will take necessary measures.”
Why change the Constitution? The current Constitution has proved to be a good law, but must adapt to changing situations and draw on new experiences. Amendments must follow due process, and be based on broad consensus. There are no term limits in the Party's or the country's Constitutions for the role of chairman of the Central Military Commission, and no term limit in the Party's Constitution for the general secretary of the CPC Central Committee.
Why is China spending more on defense? China has made modest increases in defense spending in recent years, largely to make up for shortfalls. But the level as a proportion of GDP and per capita is lower than major countries. The spending is targeted at updating the armed forces and improving conditions for military personnel. China’s defense policy is defensive, it does not pose a threat to other countries.
Is BRI a ‘geo-strategic tool?’ This is a “misinterpretation” of the Belt and Road Initiative (BRI). The initiative is a proposal for economic prosperity, to pool strengths for shared prosperity for all countries. Consultation is key, all participants are equal, and the BRI is open to all who want to be a part of it. The vision is becoming a reality, but it is still in the early stages – it is natural that there are challenges. China is happy to share, it will not impose anything on others.
Next steps on the Korean Peninsula? The situation on the Korean Peninsula is “easing.” The US and the DPRK are the major players, and China hopes the two countries will begin dialogue soon. China’s position is “consistent and clear-cut” – denuclearization, peace and stability, dialogue.
Zhang, at ease and quick to smile – particularly in response to questions from overseas reporters – answered succinctly and clearly. There was no grandstanding or bombast, instead calmly laying foundations for a long NPC session ahead.
After a final thank you, a swarm of reporters pursued the spokesman to the exit. As the masses moved left, one light-fingered veteran reached onto the desk behind which Zhang had been sitting and pocketed three brightly-colored pencils.
Mementos, perhaps, but also a reminder that there are many more notes to be taken during this year’s Two Sessions – starting with Premier Li Keqiang’s government work report on Monday.
The spectacle of Western leaders attempting to out-stupid each other plays into China’s hands and may explain why its officials have stayed relatively quiet. Liu He, a high-level emissary of President Xi Jinping, kept a low profile on a visit to Washington, calling for cooperation. As Napoleon is supposed to have said: Never interrupt an opponent who is making a wrong decision.