Why China is Losing the Trade War

February 05, 2019

By Jeff Ferry, CPA Chief Economist

Three things happened last week that made me feel more confident than ever that US tariffs are working and China is losing the so-called “trade war,” which is not a war at all but simply a battle to enable the US economy to stand once again on its own two feet.

First of all, I was at the Brookings Institution last week for the launch of my friend Professor Kim Clausing’s thought-provoking new book on trade and taxation. One of the panelists was Soumaya Keynes, the US Editor of The Economist. Asked if she thought tariffs were legitimate policies in international trade, she replied that if a nation violated World Trade Organization (WTO) rules, punishment (as she termed it) was required, and the logical punishment is tariffs. She added that China had clearly violated WTO rules on issues such as forced technology transfer and so the tariffs make complete sense.

That’s surprising coming from an editor at The Economist, a British publication sold globally that bills itself as one of the world’s foremost defenders of free trade. The Economist was founded in 1843, in the midst of a raging political debate in Britain over trade, and the first of its 13 founding principles decreed that “free trade principles will be most rigidly applied” to every major political question. The fact that a senior editor in its US bureau is endorsing tariffs on China shows that support for strong action against China is now much broader than the Trump administration.

There is an emerging consensus in the US that China’s exploitative behavior towards other nations and its manipulation and outright theft of technology from western companies can simply no longer be tolerated. This will frustrate President Xi’s plan, which has always been to spin out talks with the Trump administration for as long as possible in the hope that Trump would be succeeded by a more emollient president. But that is looking increasingly unlikely. Whoever succeeds Donald Trump will find no letup in the pressure to make America safe from the national security and economic threats of China.

This was further confirmed by some new comments by Martin Feldstein, the respected Harvard economist and former advisor to presidents including Reagan, Bush, and Obama. For decades, Feldstein has been regarded as the epitome of the anti-tax, anti-deficit conservative Republican. Yet even he has joined the chorus criticizing China. In a Jan. 29tharticle, Feldstein says: “American firms regard China’s behavior as a form of extortion…The US government has no desire to stop China’s economic growth or the growth of its high-tech industries. But stealing technology is wrong. It has gone on for too long and should not be allowed to continue.” Feldstein goes on to say that the Chinese do not appear to be negotiating seriously, in which case tariffs on half of Chinese imports will rise next month to 25 percent, a move he supports.

Thirdly, let me call your attention to a fascinating video from Rad Power Bikes, a Seattle startup that makes an e-bike. E-bikes and e-bike motors from China have been subject to a 25% tariff since August. Rad is one of the pioneers in this young industry. Last summer, Rad raised its prices, which start at $1,499, by $200, because of the tariff.  Last week, they announced that their prices are now returning to the pre-tariff levels. Not only that, they are refunding the extra $200 to any customers who paid the extra charge in 2018.

How were they able to absorb that $200-per-bike tariff cost on their Chinese-made bikes? If you watch the video, aside from two good-looking young executives with stylish haircuts and broad smiles, you’ll see that they attribute the change to “enhanced relationship with our manufacturers.” That is corporate-speak for persuading their manufacturers to cost the price they charge Rad. This confirms an argument we have been making for months: that Chinese exporters will cut their prices rather than lose business in the US market. The US market is the world’s largest, it’s full of affluent consumers, and it’s also the most open large market in the world to Chinese manufacturers. (The European market has used tariffs to protect European manufacture of bikes. The US has not, with the result that over 90 percent of the bikes purchased here come from Asia, chiefly China and Taiwan.)

I suspect that Rad’s ability to cut $200 out of its costs so quickly suggests that Chinese producers were making huge profits on their American sales. That is what you would expect in an industry that uses $2 an hour labor and government-subsidized steel and aluminum to undercut pre-existing American prices. Knowing their costs are much cheaper, the Chinese producers were originally able to price their products high enough to earn fat profit margins. They saw the Americans coming. (And you wonder why there are so many Chinese millionaires today.) With the pressure of the tariffs, those margins are shrinking.

The net result of the steep e-bike tariff is that the US economy is better off. Consumers are paying the same for Rad’s bikes, Rad has the same profit margins as before (maybe even higher as those handsome young men may have learned how to put the squeeze on Chinese suppliers) and the US Treasury is earning a healthy few million dollars from tariff revenue.

Of course, there are still some folks who don’t get it. In a recent editorial entitled Steel Tariff Profiteers, the Wall Street Journal editorial board attacked the steel tariffs for delivering high prices and profits to major US steel companies. It was a piece of shamefully one-sided journalism. They pretend to be concerned that Ford employees had lost some $750 from their profit-sharing bonus due to Ford’s higher costs for steel and aluminum in 2018. Strangely, the Journal’s compassion was nowhere to be seen in all the years that steel and aluminum workers were getting laid off and steel and aluminum mills closing because of dumped, government-subsidized Chinese steel depressing world prices for those metals.

New Jobs—and No Price Increases

The tariffs on steel, aluminum, solar panels and washing machines are creating more than 11,000 new jobs, as we pointed out in a study last fall.  About half of those jobs are in steel, with new greenfield steel mills now being planned by Nucor and Steel Dynamics, among others. That job total, which does not include the short-term construction jobs involved in building new facilities, dwarfs the number of jobs lost from tariffs.  This week, Nucor said it’s now recruiting for the first 235 jobs scheduled to start work in June at the mill it’s building in Frostproof, Florida. Around a dozen companies have announced new solar panel manufacturing investments in regions from Florida to Maryland to Oregon. Mayors and governors in the affected regions have enthusiastically welcomed the new projects.

Furthermore, as we pointed out recently on GM, US car companies are actually doing very well in the US market. Ford’s North American profits are holding up well, with operating earnings averaging $2 billion a quarter in the last several quarters, while GM’s have been averaging some $2.5 billion. Major manufacturers and steel consumers like Caterpillar and United Technologies have also reported strong results for 2018.

The Journal’s claims that tariffs have led to price increases are equally spurious. The motor vehicle industry, a large steel buyer, is holding consumer prices for new cars at the same levels as a year ago. Beer in cans is also rising at less than the rate of inflation. A good illustration of the spurious nature of their claims is the fact that steel prices, after a short-term increase in the summer, have now fallen back to the levels of last January and February. Does this mean that Ford should expect an additional $750 million of profit in 2019? Well maybe. But in fact, the price of steel or any other raw material input is a relatively small factor in the complex price-and-cost equation of a global car company. The biggest problem both Ford and GM are suffering today is declining profitability in China. This problem is very much related to the way in which China makes it difficult for American companies to do business there.

If consumers are not suffering from the tariffs, neither are intermediate users of steel and aluminum. A look at the industrial production figures for December 2018 confirms that. In the year to December, according to the data published on Jan. 18th, manufacturing production was up a strong 3.2 percent. Some of the heaviest metal-using sectors showed the strongest increases: motor vehicle and parts manufacture was up 7.8 percent; aerospace 6.1 percent; computers and electronics 6.5 percent; and machinery up 4.9 percent.

Those very strong production figures for 2018 help to explain why manufacturing added 284,000 jobs in 2018, the sector’s best showing on the jobs front in 20 years.

Wall Street’s free traders are very worried that tariffs might slow down their lucrative mergers-and-acquisitions activity, which profit from the opportunities and dislocations created by globalization. The Financial Times tells us that the combination of Celgene and Bristol Myers Squibb is going to generate a whopping $1 billion in fees for the banks, lawyers and accountants involved. But that is small potatoes compared to the 2016 acquisition of SABMiller by Anheuser-Busch InBev, which generated $2 billion in fees. That is the globalization deal par excellence—a hugely expensive merger of companies serving nearly indistinguishable tasteless beers to a global consumer population whose choices are shrinking as an ever-shrinnking number of conglomerates try to dominate world markets.

The alternative?  Restore the strength of our domestic economy. Make no mistake. The tariffs are working.


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