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When the giants fight, the world suffers


May 27, 2019

It always appeared to be an uneasy truce between the globe’s two largest economies, trading nations and trade partners. It was on the cards that US President Donald Trump, who believes that the most effective way to grind down Beijing’s global ambitions is to land a blow on the mainspring of its strength – exports – will run out of patience and slap fresh punitive tariffs on imports from China.

This he did on May 14, some five and a half months into the truce, by more than doubling customs duties on $200 billion worth of Chinese products. Beijing retaliated by announcing to escalate tariffs on American imports valuing $60 billion.

So far the Trump administration has imposed additional tariffs on $450 billion worth of Chinese products. In 2018, the total US imports from China amounted to $540 billion. Thus in terms of value, more than 82 percent of Chinese products entering the US are subject to additional tariffs. Likewise, China has slapped tariffs on American goods valuing $110 billion. In 2018, the total imports of China from the US amounted to $120 billion, which means 92 percent of American exports to China are facing higher duties.

Not only that, with Washington putting the curbs on Huawei by requiring US-based firms to seek government approval for trading with the Chinese smartphone maker, the trade war has assumed a new dimension – non-tariff barriers (NTBs). The decision has been occasioned by concerns that Beijing may use Huawei for surveillance. Huawei may be an independent enterprise, but it’s a potent symbol of China’s growing technological prowess. So it was only a matter of time that it would be hammered by the White House.

Opinion is divided over who the tariff war will sting more: China or the US. The burden of increased tariffs will be borne by consumers in each country in the form of higher prices. However, the Trump administration is confident that a spike in tariffs on Chinese goods will wind down their demand in their single largest market and thus create a hole in the Asian giant’s overall export basket as well give a leg-up to domestic manufacturing.

Since China is an export driven economy, a considerable fall in exports will put the brakes on its economic growth. This may force Beijing to accede to the long-standing Washington demand to correct the alleged distortions in its trade and investment regimes, such as currency manipulations to keep the yuan undervalued, heavy subsidization of domestic businesses, making it obligatory on foreign companies to transfer technology to their Chinese counterparts, and violation of intellectual property rights (IPRs).

On the flip side, such unfair trade practices have underpinned much of China’s competitive advantage and its spectacular export performance over the years. Therefore, once these distortions are removed, the domestic enterprises will by and large be hard pressed to compete with those from developed nations, particularly the US.

While it’s a toss-up whether the tariff war will make Washington or Beijing worse off, there’s little doubt that the stand-off between the world’s two most powerful nations will cast its pall over the global economy as well as the multilateral trading system.

Economists steeped in neoclassical or liberal tradition argue that since as a rule inefficient industries are the ones that need protection, tariff escalation makes the importing country worse off. It also dials down the welfare of consumers, who have to purchase more expensive or lower quality domestic products than they would otherwise. This argument, however, does not fully apply to mega economies, such as the US and China, which account for a substantial share in global imports. By cutting back on their purchases, they can bring down the international price of a product. Hence, tariff increase by a large economy tends to depress world prices and lower output.

Countries like Pakistan, which rely on a handful of products to generate export revenue, are hit harder. As per IMF projections made in April, global economic growth will slow down to 3.3 percent in 2019, compared with 3.6 percent in 2018. The resumption and intensification of the Sino-US trade war coupled with escalating tensions in the oil-rich Middle East makes even this modest projection optimistic.

In the trade war, China has quite a few aces up its sleeve other than tariff hike. China, for instance, can devalue its currency to offset the tariff escalation-induced fall in competitiveness of its exports to the US. Over the years, Washington has accused Beijing of maintaining an undervalued yuan with a view to racking up exports and discouraging imports. In recent years, the yuan has been allowed to appreciate – albeit not by much – to boost consumers’ purchasing power. Possible yuan depreciation will adversely affect not only the US but all other trading partners of China as well. These countries will find it exceedingly difficult to compete with Chinese products both at home and abroad. One option for such countries will be to devalue their currencies, which may lead to a zero-sum currency war.

As Pakistan’s recent experience brings out, currency depreciation dials down purchasing power and is thus inflationary. Not only that, depreciation makes imported capital equipment costlier, which may lower productivity and thus put the skids under economic growth and expansion of international trade. Such a situation will be more painful for economies like Pakistan, which are already enmeshed in an unenviable combination of low growth and high inflation.

The trade war has put the relevance of the World Trade Organization (WTO) under question. If countries or blocs can impose punitive tariffs on each other’s imports in tit-for-tat moves, the existence or extirpation of the multilateral organization, which sets the rules for international trade, hardly matters.

WTO agreements confer certain rights and obligations on members with regard to both general rules or principles, which together define what members are entitled to do and what they cannot do, and specific commitments which each member has undertaken, such as tariff reductions and elimination of quantitative restrictions.

As the WTO is a rule-based system, the members can impose additional tariffs on imports over and above their commitments, only subject to following a due process. The WTO body of agreements spells out the special circumstances in which additional tariffs can be imposed, together with the procedure which must be followed. Resort to retaliatory tariffs is in principle prohibited.

The US decision to levy punitive tariffs up to 25 percent on import of aluminium and steel from China, EU, Canada, and some other countries, which represented the first shot in the trade war, was based on national security reasons. However, neither that act nor the subsequent moves followed the prescribed procedure. Likewise, China has been accused by the US of intellectual property rights (IPR) violation. But instead of challenging the alleged IPR violations in the WTO, the US penalized Chinese imports on its own.

The response of US trading partners has also been equally arbitrary and no less unlawful. Instead of taking the US to the WTO and waiting for adjudication by independent panels, they have proceeded unilaterally. These developments indicate that powerful countries can set aside the relevant rules and institutions without much ado.

Rule-making as well as rule-breaking is an act of power and a strategy for domination. In the international context, when a country openly flouts the agreed rules, it sends out the message that it is powerful enough not to care about the laid down mechanism. It also lends credence to the impression that inter-state relations are characterized by anarchy, where a combination of economic and military firepower is the only limit on what a country can do.

The writer is an Islamabad-based columnist.

Email: [email protected]

Twitter: @hussainhzaidi