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Three factors behind a looming US-China trade war

Early indications suggest tit-for-tat actions could escalate into trade war

| China

Over a matter of days, the world has been treated to a curious spectacle. On the battlefield of globalization, in which trade has become the front line, the presidents of the U.S. and China, speaking to a watching world, seemed to have swapped sides. U.S. President Donald Trump insisted in his inauguration speech that "protection will lead to great prosperity and strength," while Chinese President Xi Jinping said at the recent World Economic Forum in Davos that China would keep its "door wide open." Behind the pitching and posturing, we are witnessing the opening salvos of a global trade conflict.

Trump gave notice within days of his Jan. 20 inauguration that the U.S. would withdraw from the Trans-Pacific Partnership pact and renegotiate the North American Free Trade Agreement. These policies speak worryingly to an America that no longer wishes to champion the liberal, rules-based system of governance that has underpinned the global economy since the end of World War II. Instead, the U.S. will use its economic heft to determine trade outcomes in its own interests.

The White House website also says ominously that the U.S. will "crack down on those nations that violate trade agreements and harm American workers in the process." It does not require a sleuth to conclude that this is aimed principally, though not solely, at China. Indeed, it seems increasingly likely that trade is going to be an important tool in a wider political agenda designed to weaken China, which the Trump administration sees as much more of an adversary than competitor.

From now on, trade conflict will be blatantly political, and quite different from the kind of trade frictions that have permeated the global economy since the financial crisis. There have been more than 6,000 acts of trade protectionism by G-20 countries since 2008, but these have tended to cover a small proportion of global trade in goods and services. The U.S. and China have regularly referred disputes to the World Trade Organization and implemented tariffs and duties on specific products.

To realize the goal of bringing jobs and production back home, the Trump administration is expected to threaten broader tariffs and other policies to force China to offer concessions on what it regards as unfair trade practices. These are deemed to include China's currency management, fiscal and regulatory regimes, as well as special advantages enjoyed by state enterprises, and discrimination against foreign companies. Success will be measured by the fall in the U.S. trade deficit with China, which amounted to $319 billion in the first 11 months of 2016, compared with a total deficit of $454 billion.

U.S. action could backfire

The U.S. strategy, while focusing on some real distortions to trade, is likely to backfire for three reasons.

First, the problem with jobs is much more about digitization and machine intelligence than about trade, and affects China as much as it does America. China's trade and commercial practices might change if it were to pursue reform more rigorously. This would require dialogue with the U.S. and trust. Xi's China will not and cannot afford to be seen to buckle to foreign pressure, least of all from Trump.

Second, trade conflict will probably hurt China, a surplus country, more than the U.S., a deficit country. Yet both sides would dig in. There would be even less reason for optimism about Chinese economic reform, and more backtracking. The newest Chinese capital outflow regulations are already blocking U.S. and foreign companies from repatriating dividends and income.

Third, Xi was right in Davos when he told his audience there were no winners in a trade war. If the U.S. becomes provocative, however, China will retaliate, doubtless aiming its own measures at U.S. businesses in states that voted strongly for Trump. Once this tit-for-tat starts, there is no way of knowing where it will end.

Xi may have sounded constructive in his Davos speech about free trade in the face of an American retreat, and it is not hard to see why. China is the principal beneficiary of globalization and has a vested interest in its economic benefits. At the same time, China has no desire or intent to lead the cause of globalization and free trade as we have grown accustomed to the role played by the U.S.

If it did, it would recognize that its interests would be best served by political and economic reforms that lead to lower savings, and a trade deficit. The world today does not need China's capital, which is the counterpart of its structural trade surpluses, but it does need the demand that would be reflected in deficits. That would be real leadership in globalization.

If only there were members of the Trump administration that could speak this language to the president, U.S. engagement with China might be totally different from the style we now fear. A combination of free-trade Republicans and the U.S. business lobby may yet blunt the president's apparent intent, but the chances of avoiding rising trade conflict do not look good.

George Magnus is an associate at Oxford University's China Centre, and former chief economist at UBS.

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