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The Unintended Consequences of Trump’s Trade War

Forcing Beijing into economic reform could help it overtake the U.S. in the long run.

Pool/Getty Images

The Trump administration’s year-long quest to reform China’s economic policy has seemed to be motivated by an America First mentality. “Tariffs are working far better than anyone ever anticipated,” the president tweeted last August. “China market has dropped 27% in last 4 months, and they are talking to us. Our market is stronger than ever, and will go up dramatically when these horrible Trade Deals are successfully renegotiated.” The thesis that the trade war is working for America remains precarious: U.S. markets plummeted Monday morning after the president threatened increased tariffs over the weekend, rebounding only when China’s trade delegation announced it would attend talks in Washington this week anyway.

But the greater irony, given President Trump’s apparent motivations, is that it’s far from clear this America First plan will in fact keep America “first” in the long run, either. As many experts in the United States have pointed out, market liberalization could be good for China, as well. And ultimately, some of the reforms the Trump administration is demanding could even help the country overtake the U.S.

Breaking with the forty-year history of constructive engagement with China, many of Trump’s policies appear to be aimed at confronting, and perhaps even containing Beijing. Under the Indo-Pacific Strategy, Washington has stepped up naval patrols in the South China Sea. With regard to technology, the administration has enhanced governmental review of Chinese investments in and acquisitions of American companies, and is strengthening U.S. export controls. The administration is also pushing back on China’s infrastructure investment in other countries, known as the Belt and Road Initiative (BRI), advocating that countries not participate on the grounds that China ensnares developing nations in “debt traps.” Secretary of State Mike Pompeo has gone so far as to say governments should keep their “eyes wide open” when dealing with China.

All of this has increased the sense of U.S.-China competition. Peter Navarro, noted China hawk and director of the Office of Trade and Manufacturing Policy, has framed the current situation as a “zero-sum game now between China and the rest of the world.” Last October, Vice President Mike Pence gave a speech at the Hudson Institute characterizing China as an aggressive, oppressive competitor.

Trump is using the trade war as a means through which to force through economic reforms that, he thinks, will allow the United States to remain the preeminent global power. There is little doubt that increased market access for foreign firms, better intellectual property protections, and the cessation of forced technology transfers will immediately benefit U.S. companies. However, it is unclear whether forcing Beijing to give up subsidizing and otherwise favoring its 51,000 wholly or partially state-owned enterprises will protect America’s economic primacy in the long run.

Beijing has long dealt with the trade-offs between the high degree of economic control that state-owned enterprises provide and their lack of productivity relative to traditional, privately owned or publicly traded companies. From 1997 to 2005, China reduced the number of employees at state-owned enterprises by almost half, and improved profitability. But reform has stalled over the last few years under Chinese President Xi Jinping, who said in September that state-owned enterprises “should continue to become stronger, better and larger.”

State-owned companies are inefficient, provide few new jobs, and contribute to China’s burgeoning debt, the extent of which is currently unknown. These companies also have easier access to loans and financing, resources that private companies, which provide superior profit margins and returns on investment, desperately need.

U.S. concerns about government economic intervention are not limited to state-owned enterprises. Many American policymakers have complained about Beijing’s Made in China 2025, a subsidy-based industrial policy that seeks to help Chinese companies dominate emerging technology fields such as artificial intelligence and advanced robotics, among others.

Former Finance Minister Lou Jiwei has called the policy a waste of taxpayers money, saying it is impossible to predict how high-tech industries will evolve in the future. Prominent Chinese economist Fred Hu does not believe Made in China 2025 will necessarily make China an innovation power, arguing that industrial policies are not surefire paths to technological dominance. Other observers have pointed to the policy’s role in augmenting government debt and potentially contributing to overcapacity in sectors like new energy vehicles.

So, while state-owned enterprises and industrial policies are politically useful, some Chinese experts even welcome the Trump administration’s pressure to abandon them.

In the long term, reforms like these could help revitalize China’s economy. That’s a good thing, but it’s hardly the rationale the Trump administration has offered for its current trade war.

So why, then, is Washington pushing through changes that might actually help Beijing? Adopting Trump’s zero-sum approach, it would make more sense to wait for China’s economy to stagnate under the weight of its own inefficiencies.

Clearly, the Trump administration is more interested in the short-term gain for U.S. companies getting access to China’s vast domestic market. It also seems interested in offering some sort of response—whether or not it’s a fully effective one— to the widespread fear that China’s state-led economic model poses a threat to American companies and economic position.

But what Washington’s current approach to China also shows is creeping doubt about its own economic system. While leaning on China to adopt market-based principles, Trump is enacting protectionist policies and increasingly scrutinizing Chinese investments in the United States. In a recent report, Republican Senator Marco Rubio even seemed to entertain the idea that Beijing’s economic policies, which he has condemned as anti-free market, might also be more successful than U.S. ones.

The United States isn’t alone in questioning the benefits of free markets. Despite previously endorsing the European Union’s market-oriented economic approach, France and Germany recently called for a new European industrial policy, one they think will allow Brussels to better compete with U.S. and Chinese business giants.

With talks set to begin in Washington on Thursday, and the U.S. planning to increase tariffs on Chinese goods from 10 percent to 25 percent on Friday, a conclusion to the current trade war remains up in the air. But any trade deal the sides might strike, regardless of the terms, will not signal the end of U.S.-China trade frictions. Instead, it will likely open up the next can of worms in an increasingly competitive and contentious relationship.