Asia’s Stake in a US Trade War

US President Donald Trump’s would-be trade war presents affected Asian countries with multiple dilemmas, whether threat or promise.

The first starts from the fact that Trump has no coherent agenda that might address the causes rather than the crude evidence of the US’s gaping trade imbalance. Hence his first salvos on steel and aluminium were not only marginal in trade terms fired not at China, identified as the main culprit, but at a mix of allied countries headed by Canada, Japan, Germany and South Korea. In the case of Canada, its merchandise trade surplus with the US is tiny relative to the total volume of trade and is eclipsed when services are included. Tweets and populist gestures are not policy.

The one thing steel and aluminium did do was to spur these and other countries to show solidarity in the face of the US and hence effectively align themselves with China in a general pushback against Trump. All this has raised the stakes for what is promised to be the next and bigger salvo aimed specifically at China, which are due out on March 23 and are expected to include US$60 million in annual tariffs against as many as 100 products that the President argues were developed by using trade secrets the Chinese stole from US companies or forced them to hand over in exchange for market access.

No one doubts that China still erects far more barriers against trade and investment than the above major trade partners. Even the Germans, by far the most successful of western exporters, are frustrated both by barriers and theft or forced transfer of intellectual property. South Korea is still smarting from China’s use of tourist restrictions and attacks on Lotte group over its acceptance of the US missile defense system.

But cutting back a US trade deficit with China (including Hong Kong) which is now around US$375 billion thanks to China’s exports being double its imports from the US, faces huge obstacles if its main impact is not to be on US consumers.

The first point to realize is that a very significant percentage of those exports is the direct result either of US (and other western) investment in China or of US producers’ and retailers’ transfer to China of so much manufacturing over the past two decades, particularly since China became a member of the WTO in 2001.The initiative mostly came from US, not Chinese companies. The latter are now making their own inroads into the US market, but remain small compared with other foreign brands.

Secondly, although local value-added has been increasing, China remains primarily an assembler of parts made by companies in other countries – Japan, South Korea, Taiwan etc. Apple is the most prominent case in point, sourcing more than 200 manufacturers of components across the world for assembly in China. Unless any tariffs aimed specifically at China actually lead to falls in US consumption of, say, iPhones, the short-term trade balance impact will be tiny. Transfer of assembly to the US may follow in time, but that is measured in years, not the Trumpian attention span.

Apple also provides an example of how a significant slice of the US trade imbalance has a counterpart in the profits of US companies. The value of an iPhone is mostly in the intellectual property and brand name, most of which belongs to Apple. The profits from this are almost entirely held offshore to escape US tax. In the case of Apple they are about US$350 billion and for the US tech giants as a whole about US$1.6 trillion. Of course, only a part of this relates to earnings from manufacturing in China or sale of services in China, but in the case of Apple it would be a large part given that it sources so much of its global sales from China.

Recent changes in US tax law are expected to bring much of this cash hoard back onshore, and in time will, together with a lower domestic corporate tax rate, make manufacturing in the US itself more attractive. But that will take more time than Trump has got.

Return of the cash hoard might in theory help address the fundamental weakness of the US economy, which underlies the trade deficit – excessive consumption and inadequate investment, whether in new factories or repairing old infrastructure. But that seems more pious hope than probability given tax cuts which will increase the government’s own deficit and the inability of the tech giants to find sufficient investment outlets for most of their cash so will spend it on dividends and share buybacks. Corporate profitability in the US has been rising steadily and is now at its highest in decades. But investment has not followed.

The best that can be hoped for in the more immediate future is that Trump can satisfy himself and his constituency with some showy gestures, a Potemkin village of a trade war, which sparks protests from trade partners and a few gestures of retaliation without fundamentally affecting trade. Some dangers are anyway probably exaggerated. For example if China responds with measures against US soybeans and buys from Brazil, other countries will have to buy from the US. Commodity markets are mostly global.

For sure the US feels threatened by China’s technological progress, much of which has come about through links with the US. But plugging trade loopholes and intellectual property ones are not the same.

As for Asia, how should it respond? Perhaps the first thing to note is that it is not just China that enjoys a large current account surplus. So do Japan, Taiwan, South Korea and Singapore. So they need to stop fighting against appreciation of their currencies against the US dollar. The dollar’s strength despite the trade imbalance and low interest rates has certainly contributed to blowout in the deficit. The two-decade failure of Japan’s domestic stimulus efforts suggests there is no easy cure for the surpluses of these advanced, efficient but aging economics. Germany is similar. It could withstand a significant rise in in the value of the euro, but its Eurozone partners could not.

Where stimulus is both justified and is more easily effective is in Southeast and South Asia. Yet here too surpluses remain common. Thailand and Malaysia run large ones thanks to weak private investment. The Philippines’ years of current surplus have come to an end but the country and Indonesia and Vietnam should be able to support annual current-account deficits of 3 percent of GDP. Private and public capital is still in abundance to fill the gaps – it is the projects and their implementation which lag.

For Southeast Asia, the answer to Trump is to be more open, to attract more capital from surplus northeast Asia and western Europe into manufacturing in particular. But the political and legal conditions have to be better. For the northeast it means more encouragement of investment elsewhere in Asia rather than in US treasury bonds or Sydney real estate.

There is a real danger that the “me too” idea will catch on in places such as Manila and Jakarta as local interests use Trumpism as nationalist cover for their protectionist interests. After all, if the US can betray the system it had promoted for 60 years, why should others not do the same? Cutting off your nose to spite your face has become a fashion.

The lead in opposing Trump’s trade threats must however come from the developed world. Korea and Japan must stick together, difficult though that may be. The EU must remain in concert with them as well as Canada which in turn must keep close to Mexico in protecting the benefits of NAFTA. With his bullying attitudes and simplistic mind-set, solidarity is more important than reprisal threats. But they must also not forget that the sheer size of the US trade imbalance is a genuine issue and that they have their own part to play by reducing reliance on exports and accepting a weaker dollar.

The current US economic expansion is now old and probably nearing its end. In which case other markets become more important and US import demand should stagnate for a while at the same time as demand from China and the developing world continues to grow and Europe’s recovery continues. This can happen naturally, given time and interest rate policy in the US and currency alignment generally. But whether Trump has the patience is another matter.