Understanding China's perspective on trade war

By Dominic Morgan

Some argue that U.S. tariffs will force China to make large concessions on trade. But there is a risk that the growing pressure will make Beijing less, not more, likely to compromise on key issues.

The implementation of the $200 billion round of tariffs in September last year did accelerate China's economic slowdown, though domestic factors were possibly more important. As winter rolled on, business sentiment plummeted, the stock market continued its precipitous decline, and exports, retail and property sales all took a hit.

But the theory that China can be pressured into abandoning centrally-controlled industrial policies may be a miscalculation. American discussions of the trade war have focused on the costs for China of not doing a deal, without considering how China weighs up the other side of the ledger.

Capitulating to Washington would have profound political consequences for the Chinese government. Ideology is a foundation of the party's position, trumping all other issues.

For many in Beijing, the trade war confirms long-held suspicions that the United States is determined to thwart China's rise as the world's next superpower. Beijing views the trade war not as an isolated incident, but part of a longer history of U.S. attempts to undermine rival powers.

China pays particular attention to the trade dispute between America and Japan in the 1980s. The lesson Beijing appears to have drawn from the Japan-U.S. dispute is that capitulating to American demands simply emboldens U.S. negotiators to ask for even more.

The upshot is that Beijing may not see striking a deal with Washington as a way to gain relief from U.S. pressure. Rather, it may see the cost of surrender as even higher than that of carrying on the fight.

This will be a tough sell on the issue of "Made in China 2025," as Beijing considers this policy crucial to China's future. For Beijing Made in China 2025 is considered the only way to counter an existential threat to its own economy: rising labor costs in the country's manufacturing sector.

Factory wages rose 64 percent between 2011 and 2016, according to Euromonitor. This is undermining the competitiveness of Chinese manufacturers, which have been the engine of China's growth for decades and still generate nearly 30 percent of the country's gross domestic product (GDP).

These trends are of concern to Beijing because many countries have followed a similar growth trajectory to China in the past but ended up losing their economic dynamism and falling into what economists call the "middle-income trap."

With a per capita GDP of $8,827 as of 2017, China is right at the most challenging stage in the development cycle. Failing to make the transition to a high-income economy is a real prospect.

Making the transition to a high-income economy will need increasing productivity across all sectors, but also moving up the value chain to high-end manufacturing and technology. This is what Made in China 2025 is designed to achieve.

For this reason, China is unlikely ever to agree to roll back Made in China 2025 completely: The potential long-term economic costs are simply too high.

The U.S. is more likely to convince China to make changes to the strategy if it focuses talks on the technicalities of the policy, rather than China's technological ambitions more generally.

This may allow Washington to press Beijing to open Made in China 2025 for more participation by foreign companies. The strategy currently sets targets that 70 percent of core components in key technologies should be domestically-made by 2025, and the foreign business community has repeatedly complained that this is leading local governments to prevent overseas firms from bidding for contracts.

China's large-scale government support for research and development and startups, however, is likely to be nonnegotiable. Beijing's overall support for innovation is almost certain to increase, not decrease. The past year has driven home to Beijing, just as much as Washington, that relying too much on foreign technology could have national security implications.

In November 2018, the U.S. Department of Commerce revealed that it was considering trying to curb exports of a wide range of strategic technologies from fields including artificial intelligence, robotics, microprocessors and quantum computing.

If this policy became law, it would have profound consequences for the Chinese economy. China is still highly dependent on foreign technology in several areas. The country buys 27 percent of the world's industrial robots and imports $260 billion of semiconductors per year.

Even the risk of a U.S. export ban or other restrictions on China's access to key technologies will force Beijing to accelerate the development of domestic technology firms.

How Washington would react to remains to be seen. There will be those urging the White House to hit Beijing harder, in the hope of extracting further concessions. On this issue, however, the extra pressure may simply lead China to retreat further into its shell.

The writer is managing editor of Cheung Kong Graduate School of Business (CKGSB) Knowledge.