The real culprit on trade: China, not Trump, broke trading system

American President Donald Trump’s tariff rampage appears to have fatally wounded the global trading system. The United States’ (US’) mercurial President declared during his campaign last year that “tariffs” were his favourite word, and his actions in office seem to indicate that, on this occasion at least, he was telling the unvarnished truth. India, in spite of hopes that recently announced trade negotiations would delay the inevitable, is not going to be spared: Mr Trump told a right-wing news outlet in the US that India, too, would be hit by tariffs on April 2. 

Such trade measures are an escalation, but also a culmination of actions taken by the US since Mr Trump was first elected in 2016 and took the country out of the Trans-Pacific Partnership. The interregnum of a Democratic administration under President Joe Biden did little to reverse Mr Trump’s original actions destabilising the global trading order. Indeed, in some ways Mr Biden intensified the US’ war on trade. It was he who added the wide use of sanctions, technology restrictions, and protections, as well as a subsidy and spending war, to the tariff measures of his predecessor.

  It would be easy therefore to blame the US entirely for the destruction of the global trading system. But that is only part of the story. Unless the rest of the story is properly understood, we will not be able to repair the damage that has been done.

The fundamental flaw at the heart of how international trade in the era of the World Trade Organization (WTO) functions is the polite assumption that all economies are similarly structured. In other words, that costs, subsidies, and protections are transparent.

  Unfortunately, the biggest trading power in the world does not meet these criteria. If the People’s Republic of China violates this assumption, then the entire trading system is built on a lie. It is to this baseline problem that US actions, and those of others from the European Union to India, are responding.

  China’s accession to the WTO was premised on the assumption that its economy was, or eventually would be, comparable to the market economies that designed the system. The fact that it was not then; nor has it tried hard enough since to become one. As a consequence, it has built up imbalances domestically — and, thanks to its sheer size, those imbalances have expanded and mutated till they cover the entire world.

  The fundamental imbalance in the Chinese economy is born of the financial repression and economic limitations that the Chinese Communist Party has built into the system it controls. Chinese households cannot spend as much as they should, and are given poor returns on their own savings. Overall consumption and household wealth are thus too low in comparison to what would have been the case in a normal economy. What they are deprived of flows instead to the state sector, where it is then either spent to subsidise state-owned enterprises, or to subsidise inputs into specific parts of the private sector — inputs such as electricity and investment capital.

  This process has been bad for China because it limits the country’s growth and reduces the productivity of invested capital. In real terms, the country builds too much infrastructure in the wrong places, while actual housing remains too expensive for working families. But it is hard to rebalance its economy — a promise for over a decade now — because of the party’s political economy constraints. It desires control over the private sector, and the renegotiation and losses involved in rebalancing away from the current form of investment-led growth would create discontent within the elite and sap the party leadership’s power.

  But this politically-driven imbalance within the Chinese economy has also warped the global economy. Hidden subsidies to power, land, and capital mean that competing with Chinese manufacturing has become very difficult for more transparently-run economies. By some estimates, China has the lowest average electricity price for industrial users among major economies. It is about 60 per cent of the equivalent in India, and about a quarter that of Germany’s. Meanwhile, it has increased and is still increasing the use of targeted tax subsidies in export-oriented sectors such as electric cars, batteries, and solar panels.

  There is no recourse within the WTO system for China’s trading partners if they want to correct this issue. It is not entirely surprising that both parties in the US have lost faith in WTO dispute settlement.

  As walls are erected against Chinese goods in the West — whether through tariffs, in the US, or by unilateral trade measures such as carbon border taxes or supply-chain transparency rules, in Europe — Chinese excess capacity will begin to consume poorer nations’ sectors. These other countries should currently be at the point where they are able to substitute for China — where wage and other costs should have been increasing alongside the country’s wealth and rendering it less competitive. But, instead, they are being forced to fall further behind. Indonesia may have lost a quarter of a million jobs in the export-focused labour-intensive garments and textiles sector in just two years, and may lose another half million in the coming two. Instead of substituting China, they are still being substituted by China. This has never happened before in global economic history.

  Meanwhile, the corresponding macro-economic imbalances to China’s unbalanced domestic economy have caused too much capital to flow into the US, giving its government an effective blank cheque that distorts its politics and causes it to overuse debt-funded subsidies in turn. This distorts the flow of global capital, hurting investment in emerging markets, and causing Europe to struggle to raise public funds to compete with the treasuries of the US and China. 

Countries have been unable or unwilling to target the consequences of Chinese overcapacity directly. The US has instead raised tariffs on Europe, Canada, and India. And New Delhi has tried a return to the licence-permit raj through “quality control orders” — which cannot target Chinese goods directly, and so instead hurt Indian traders and foreign investors.

  Such poorly conceptualised trade measures will leave us all poorer off. If we are to recover the mutual benefits provided by trade, then let us diagnose the problem properly and seek to address the root cause of the problem — Chinese domestic policies.

  The author is director, Centre for the Economy and Growth, Observer Research Foundation, New Delhi