Trade War or a War of Words?
With the US and China trading threats of future tariffs, Harvard Business School faculty Bill Kirby and Willy Shih trade theories on the best path forward for the world's two largest economies.
06 Apr 2018   Christian Camerota

On Tuesday, the Trump administration published a list of more than 1,000 Chinese exports it plans to target with 25 percent tariffs amounting to some $50 billion annually. The Chinese Ministry of Commerce responded a day later with a list of 106 US products on which it plans to impose similarly priced tariffs.

Is this just posturing or the sign of a tipping point in economic and political relations between the world’s two largest and most powerful markets?

Harvard Business School turned to two faculty experts on China, Bill Kirby and Willy Shih, to discuss the situation, including historical context and precedents, the impact on consumers, and suggestions for both countries in moving forward.

BILL KIRBY: One way of looking at this is that Mr. Trump’s mindset on international trade was really formed in the 1980s, when Japan was seen as a threat to America’s standing in manufacturing and trade. He’s assuming (and he’s not entirely wrong) that China is in the position that Japan was during that same decade—enormous trade surpluses with the US, not playing fair in terms of access to a domestic market, and so on. Part of the Japanese response to that was to invest deeply in the American economy. Automobiles were at the heart of the public trade disputes of those days, and today we now see that Honda, Toyota, and Nissan have greatly strengthened the American-based automobile industry.

A chief question we’d have to ask the Trump administration is: If Chinese companies wanted to improve access to American markets by investing in the US, would the administration be open to it? They ought to be, in my view. But my suspicion is that that’s not the outcome that this administration is looking for. They’re looking for a miraculous recovery of American-based manufacturing exporting to a Chinese market, not a particularly good match.

WILLY SHIH: I would take a slightly different view. I think the real issue is industrial policy on the Chinese side competing with a lack of industrial policy on the US side and the consequences of that. Going back to the mid-1980s, the Chinese government has been mapping a pathway for the country to become a modern country (just as the Koreans, Taiwanese, and the Japanese did before, except on a much larger scale). The Chinese have identified core capabilities that they want to see inside the country, and they’ve been methodically working on that over the last 30-plus years. I’d argue the positive trade balance with the US reflects the progress they’ve made. But the trade balance is a lagging indicator, not a leading one. So I think the Trump administration should be looking more broadly toward technological leadership. Where are the areas in the US where we’re going to maintain our position or further invest? We need to take a bigger-picture, longer-term view on it.

BK: Agreed. We have very good journalists writing about this, but they generally omit the historical context of long-term development in both countries. The US has been forever averse (or at least since the New Deal or maybe the Eisenhower administration) to setting national economic goals, whereas in China you could go back to the late Qing dynasty in the early 1900s and find a strong emphasis on import substitution, that is, the acquisition of technology and manufacture of machinery that they would no longer need to import from abroad. The Nationalist government made it the cornerstone of their economic policy in the 1930s in order to make China increasingly self-sufficient in industrial and military capacities. Every Chinese government since has had at its core a sense of bringing in foreign technology and domesticating it, quickly moving up the learning curve in new technologies.

They have, as Sun Yat-sen once put it, used international capitalism to develop socialism in China. And the current government is extremely organized and aggressive in seeking Chinese parity and, in time, leadership in a number of these leading-edge technologies. It shouldn’t surprise us, give China’s historical trajectory.


WS: I’d add that many of the complaints we hear about intellectual property and copying and protection of local markets—we see that with China today, but we saw that with Korea and Taiwan before them, and we saw that with Japan before that. In fact if you go back to the 19th century, we saw it in the US with, for example, the copying of textile machinery from the UK. I’d argue that post-WWII, when we saw the development of Japan and Taiwan and the so-called Asian tigers, we looked the other way for geopolitical reasons. The difference with China is that the geopolitical environment is different, and the size and economic muscle of China make it quite different from before. We can’t afford to look the other way now.

It’s also worth noting that the Trump administration is proposing tariffs on rocket launchers, flamethrowers, grenade launchers, torpedo tubes, and similar projectors. We import none of those from China; almost 40 percent of that list are from Germany. So, that does seem to indicate this is posturing in preparation for a larger negotiation.

BK: To this we have to add the political insecurity of the Chinese regime, which makes it even more difficult for American companies to compete. For example, government censorship led Google to exit China, giving Baidu, a much less sophisticated search engine, a near monopoly in that market. Microsoft sells lots of operating systems in China but makes basically no money in the process, giving them away and hoping that someday market share will result in a payout. And while Facebook has been banned for political reasons, WeChat has captured the market, and its parent company, TenCent, has become one of the most innovative tech companies in the world. Even if Facebook were allowed into China tomorrow, it would face major challenges. WeChat has swept up that market, has continued to innovate, and has become a real leader in multiple services. The Chinese policy environment has been a real boon to Chinese companies, and a real hindrance to American ones.

WS: This is at the core of a lot of insecurity. Looking ahead, the size of the Chinese market and population will confer heavy advantages to local producers and local companies in China. We haven’t seen anything like that since the US in the 20th century, which had the world’s single largest market. China is the world’s largest market for automobiles today, for example—it’s 29 million vehicles versus not quite 18 million sold in the US (and China produces most of those 29 million, whereas in the US we only produce about 11 million and import the rest)—now you have a combination of the world’s largest market (for smartphones, automobiles, and in the future commercial aviation)—and the combination of that heft with the strength of the government’s industrial policy. That’s at the core of insecurity not just of the Trump administration but of many American companies, as well.

WK: We have insecurity on both sides of the Pacific, where it’s difficult to overstate how intertwined these two economies now are. Nixon and Mao Zedong had their famous meeting in 1972, and trade wasn’t mentioned once. They had no idea that there was going to be an important economic relationship—Nixon couldn’t have imagined it, and Mao wouldn’t have wanted it. The phrase in those days was that China and the US were “sleeping in the same bed, but had very different dreams.” But today we are in bed together in every possible way, especially in economic matters. When one of us rolls over, the other is going to notice it. The automobile industry is a case, however, where being embedded can be good for us both. The manufacturing of Buicks in China was one of the key factors that saved General Motors as a company. It was an enormously important investment when Rick Wagoner (MBA 1977) was the CEO. It was a very bold move on his part and was something that brought a prized brand back to China for the first time since 1949.

WS: What I tell a lot of people is that business is conducted on a playing field, much like a football pitch, and you have a set of rules. The rules that have been enforced for the last 20 years have favored free trade. In North America, we have NAFTA. Business has organized supply chains based on those sets of rules. We have a complex web of supply chains—really a global sequential production system—where we have products that will move in intermediate states of completion across borders as if they were almost not there. I think the real fear of starting a trade war is you’re going to put up all these new barriers to the movement of intermediate goods, not just the final products, and we’ll get unexpected consequences that nobody planned on.


BK: A more logical response to having a tit-for-tat trade war is this: If these rules are no longer the proper ones, you need to find a proper mechanism for revisiting what these rules ought to be. You have a great example right across the street at Harvard Stadium, which is famous for creating the game of football that we now know. Somewhere around 1913, about 10 to 15 American students were dying every year during football games because of the violence of the match. Officials were either going to end the game altogether or revisit the rules. Harvard Stadium’s size didn’t allow for widening the field so they legalized the forward pass. You can change the rules to improve things. But a tit-for-tat trade war, be it on soybeans or sorgum or whatever, is a child’s approach to international relations.

WS: When I was younger, I used to laugh at the question of China’s five-year plans because they often led to epic disasters like the great famine caused by Mao Zedong’s agricultural policy. But I don’t laugh anymore, because what the Chinese have done very well is learned from their mistakes. They’re really trying to plan the future of their country. Industrial planning is anathema in the United States—I’m not necessarily advocating it explicitly. But we need to have a conversation about the future of our country and what kinds of investments we need to make to ensure the well-being of our people.

BK: That is our challenge. We’re faced with a China that is armed with the strong belief that it’s government’s responsibility to plan the long-term parameters of economic development and to assist the development of leading industries. Here in the US, we don’t do that. We don’t even talk about it.

Here we are in Boston. A train to New York takes the same amount of time it did 100 years ago. We’ve been talking for years about the need to build more and better infrastructure in the US. Nowhere in the world does better than China on that. Chinese built the first rail system in the US, the transcontinental railroad. Maybe we should invite them to build the second one, and this time we can pay them for it.


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