Why Trump may have the upper hand in trade negotiations with China

We now know more about what prompted President Trump's latest threat to hike tariffs on China. According to the White House, the Chinese backpedaled on trade reforms the U.S thought the negotiations had already finalized. But it's not just that. Trump's pressing the advantage now because he thinks the U.S. has more leverage: Our economy's doing relatively well, but, more to the point, the Chinese rely a lot more on U.S. demand than vice versa. Which means U.S. tariffs hurt China more than Chinese tariffs hurt the U.S.

"They have more to lose. It's simple math. They cannot lose access to the U.S. consumer," as one White House official told Politico. Which isn't wrong. Chinese jobs certainly rely a lot more on purchases by Americans than American jobs rely on purchases by the Chinese. That's true by definition, given that America has a big trade deficit with China. (And thus China has a big trade surplus with us.) For decades now, the country has famously relied on an economic development model that prioritizes exports.

But there's still the deeper question of why does China rely so much on foreign consumption in the first place? China's dependence on exports is a choice, not a necessity. It could stop being dependent if it wanted to. And kicking the habit would actually strengthen the country's hand in dealing with Trump's trade war.

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The thing is, countries generally depend on exports for two reasons: First, when they have underdeveloped energy, food, and manufacturing sectors, and thus have to export a lot to afford those key imports. And second, when they have a small domestic population, and need to trade with other countries to gain a big enough consumer base to develop their economy.

China has neither problem. It may still be somewhat poor in per person terms, but it has plenty of domestic resources and its technological capacities are pretty advanced. More to the point, its domestic population is enormous: nearly 1.4 billion, several times the size of the United States. Simply put, there's no concrete reason for China to rely on exports at all. U.S. nationalists like to accuse China of ripping us off, while champions of liberalized trade respond that American protectionism would condemn the Chinese masses to permanent poverty. But the truth is China could be walled off from international trade more or less entirely, and it would still have the resources and the domestic consumer base it needs to build up an advanced economy with high living standards. Yet it relies on an export-driven economic model nonetheless. What gives?

The key problem seems to be that Chinese consumers don't spend enough on their own to power the economy’s development. The country has the people, but the people don't have enough money. As much as China gets sold as an alternative to America-style capitalism, it has many of the same problems. It's dealing with rampant inequality, which means it has a disproportionate share of citizens at the low end of the distribution without sufficient incomes. For the bottom fifth of earners in China, their savings rate is lower than that of their richer domestic peers, but it's still positive and actually pretty high compared to similar populations in other countries. As the International Monetary Fund put it, "This points to inadequate social transfers, a lack of progressivity in taxation, and a limited social safety net."

In the last few decades, China's taken steps to improve its social safety net, particularly with regard to health care and some other cash support programs. But it clearly has a lot of holes left to plug. Meanwhile, China actually ignores free market ideology more by using state-owned banks to extend endless credit to largely state-owned enterprises. This approach certainly keeps the economy humming. But it does so by financing businesses directly with debt rather than by providing more spending money to everyday Chinese consumers.

The whole approach is actually deeply weird, for several reasons.

First, China could easily take a different path if it wanted to. Like a lot of modern countries, China has its own fiat currency and a central bank to backstop it, so it could spend as much as it liked transferring more money down the income ladder. The only upper limit would be inflation, which is currently quite low, and wouldn't really kick in until China employs most of its work force and runs out of labor.

Officially, Chinese unemployment is already low. But labor force participation has dropped over the last decade, and there's evidence the official statistics significantly understate the true level of joblessness. Meanwhile, Chinese society is actually a hotbed of labor unrest and regular protests. It's not just that China's export-led model is unnecessary — there's good reason to believe its failing China's own citizens.

The second reason China's strategy is so weird is, as I mentioned, it actually leaves the country more vulnerable to rivals like the U.S. If China expanded its own social safety net and domestic transfer programs, it could rely more on the consumption of its own citizens to power its job growth — and rely less on the consumption of the U.S. and other foreign populations. In that case, tariffs levied against Chinese exports would hurt its economy less, giving it a freer hand to run the trade policies it wants whether the rest of the world likes it or not. (Furthermore, bulking up your citizens' spending money is less likely to fall afoul of international trade laws than direct subsidies to industry.)

Why doesn’t China do this? It’s hard to say. One reason may be that it's operating in the larger globalized trade order the U.S. itself did much to design. That trade order is more or less designed to trap countries in a zero-sum competition over limited global consumption, driving down wages and fattening the pockets of the global capital-owning class. Why wouldn't China try to claim as much of that consumption as possible?

The other reason may be that China remains an authoritarian one-party state, and a prosperous populace is an empowered populace. China's government may want enough growth in living standards to placate its citizens, but not so much that they can actually demand democratic reform.

But whatever its motivations, this is the course China chose. And its actually left the country with a weaker hand to play in Trump's trade war than it otherwise would have.