US-China trade tensions

A US delegation including Treasury Secretary Steve Mnuchin and US Trade Representative (USTR) Robert Lighthizer will hold talks in Beijing tomorrow with Chinese counterparts including Vice Premier Liu He – President Xi Jinping’s top economic official. This follows two months of escalating trade tensions which threaten a scenario finally worthy of the name “trade war.” Yet Beijing does not see these talks as an end-game and seems set to offer few new concessions. The visit may shed some light on prospects for containing the situation but is unlikely to prevent weeks or months more uncertainty, a persistent risk of further escalation, and swings in market sentiment as the saga drags on.

For Chinese leaders, US President Donald Trump’s first year in office largely reaffirmed their assessment that he is essentially a pragmatist, for whom dramatic, aggressive rhetoric is part of the deal-making process, not a reflection of ideological commitment. This assessment and the resulting Chinese Trump-management strategy have been increasingly questioned after a turbulent two months.

The initial escalation in March was quantitative: steel and aluminium tariffs were followed by plans for wider duties targeting around $50 billion worth of Chinese imports, and the threat of another $100 billion-worth. However, it was April’s more qualitative escalation that makes a compromise look more challenging.

Tech-tonic shift

The Trump administration’s emphasis seems to have shifted in recent weeks, from trade deficit targets and demands for specific market access concessions, to more systemic concerns about some of China’s highest-priority policies and practices: aggressive support for its domestic industries, particularly in advanced technology, including via subsidies and preferential treatment linked to a “Made in China 2025” strategy which many countries consider unfair.

These issues were a focus of the previous administration but their return to centre-stage is more troubling to Beijing than tariffs, given the additional tactics Washington is now considering:

• The USTR investigation that prompted the latest tariffs also called for restrictions on Chinese investment in the US, with proposals expected in the coming weeks. It is not clear what form these will take, or if and when they might be introduced, but they will be designed to target sectors covered by the Made in China policy. They will also reflect restrictions on US companies in China, in line with the administration’s focus on the principle of reciprocity. Other steps may include restrictions on US firms’ activities in China – which could be an important long-term trend – and on Chinese nationals studying or researching in sensitive fields at US institutions.
• Most provocative for China were April moves against telecoms equipment giants Huawei and ZTE: the Department of Commerce on April 16 banned US firms from selling products to ZTE, and media reports claim the Department of Justice may be investigating Huawei (both cases involve sanctions against Iran and North Korea but no official allegations or charges have been made against Huawei). The moves raise the threat of very severe damage and disruption to China’s top two telecoms equipment companies, who also account for about one-third of the global market. ZTE’s production could be impacted within weeks and Huawei recently scrapped a EUR 500 million bond issue.

With the exception of the ZTE case, most of the US measures appear designed to give the administration leeway to move slowly and reverse some steps if it so chooses, and it is not clear what exactly the White House is demanding. China has so far remained reactive - restraining its responses until further US measures are actually implemented rather than threatened, in hopes that it can handle the situation via negotiations. This certainly leaves room to de-escalate and this remains the preferred option for both sides, but April’s shifts have raised the stakes and the ZTE move has hardened attitudes in China.

Ich bin ein ZTEer

In its view, China has a right to “catch up” economically like other industrialising nations before it, and it must develop advanced technology and industries – both to avoid the “middle income trap” of getting stuck as a low-end manufacturer and to avoid reliance on foreign technology. The ZTE case greatly increased the popular awareness and nationalist tenor of these arguments, and amplified Xi’s longstanding exhortations to develop domestic capacity in key technologies (notably semiconductors).

The ZTE move triggered a widespread reaction, from official media editorials to popular blog posts, with a narrative roughly along the following lines: the US is a hegemon and determined to remain one; that means thwarting China’s rise, including by constraining its economic and technological development. In this view, trade complaints are a pretext for hobbling companies like ZTE and Huawei that could become global industry and future technology leaders.

Tougher US tactics have certainly made Chinese leaders take the threat of escalation more seriously, but for now have reinforced rather than weakened Beijing’s commitment to plans like Made in China 2025. It immediately doubled down on plans to raise additional financing for related projects, and is increasingly confident that most Chinese will blame the fallout of a trade fight on US rather than Chinese leaders. The stronger patriotic tone of debate in China was summed up in a social media post by the editor of a major tabloid which ended with (to paraphrase in translation) “we are all ZTE people”.

Meanwhile, there is growing bipartisan consensus in the US that after years of failing to change China’s behaviour through diplomacy and engagement, the time has come for a tougher approach. Even many who oppose tariffs support other forms of stronger pressure, and view things increasingly through the lens of strategic national competition. The perception, fuelled partly by Xi’s more overt ambition and unabashed brand of authoritarianism, is that Beijing is now simply too strong a competitor to be treated like a developing country and allowed to exploit US commitment to free trade and investment.

Summer of struggle

The main determinant of how this plays out – and the main source of uncertainty – is thus whether President Trump, who has ultimate discretion over most of these escalation options, acts as the blustering deal-maker Beijing expects, or is bent on brinkmanship to force more fundamental change. China sees the ball in Washington’s court and is in no hurry to make a deal, anticipating pressure on Trump from consumers, business and interest groups, and a crucial juncture in Korean Peninsula diplomacy. Beijing hopes this will encourage Trump to take what concessions he can get from China this summer (which are not yet clear but will certainly fall short of what Washington is seeking) and spin them as a good deal. This may well prove the case, but the risk is that each side is underestimating the other’s resolve.

Chinese officials are not just posturing when they say they are ready to live with a trade war rather than be “bullied”, and are confident they can take the pain longer than Washington. But they may not grasp the similarly determined mood that might impact US decision making – the sense that this is about a long-term strategic threat not just trade numbers, and that the short-term pain of trade confrontation is a necessary cost of challenging China’s behaviour.

There are now two basic scenarios, roughly along the following lines:

1. Deal-art and de-escalation: there is certainly no lasting or comprehensive resolution of differences, but some form of compromise sees Trump sufficiently satisfied with China’s offers, and sufficiently concerned about the costs of escalation, to moderate, drop or postpone some threatened actions. This would temporarily contain the situation as Trump proclaims a win for his tough tactics, though the threat of implementation and re-escalation could persist for months or even years.

2. Escalation stations: after talks fail the US implements tariffs to the full extent threatened, introduces investment restrictions, retains the ZTE ban and pursues the Huawei investigation. China de-emphasizes its efforts to avoid escalation and be seen as rule-abiding, and retaliates with a wide range of measures including regulatory actions targeting US companies in China.

Since Trump himself may not yet be decided on a course, companies must recognise this uncertainty, take the risk of substantial escalation very seriously and plan accordingly, as many already are. This is particularly important because the recent shifts in popular and political narratives in both countries will not be reversed. Even if some accommodation is reached to contain the current situation, underlying causes of friction are not just about Trump but about structural factors that are very likely to persist for years to come. Periodic trade disruption, and an increase in restrictions on and scrutiny of multinational companies by both governments are thus likely to be long-term trends and go far beyond tariffs.