The Geopolitical Risks of Trump's Protectionism

If China can't fight back economically, it'll fight back with guns.



President Donald Trump's punch-first-ask-questions-later trade policy yielded one of its first results today when South Korea acquiesced to a new trade pact with the United States. In exchange for being permanently exempted from Trump's stiff tariffs on aluminum and steel, this third largest exporter of steel to America agreed to limit its U.S. steel shipments to about 70 percent of their current levels. Seoul will also double the quota of American cars that can be sold in South Korea without meeting local safety and environmental standards, though that's largely a symbolic concession—American carmakers haven't been able to make full use of their existing quota, because South Koreans don't have a taste for big, badass cars. The deal will also streamline the onerous customs and regulatory procedures that American companies have to endure to do business in South Korea.

Except for the last item, what the Trump administration has pulled off here is an exercise in negotiated protectionism. If this is a blueprint for future deals, especially with China, the world may avoid an all-out trade war, but it will face far more geopolitical conflict.

The Trump administration forced South Korea to swallow such a huge reduction in steel exports despite the fact that virtually everyone on Capitol Hill was up in arms against using tariffs as a cudgel to negotiate with allies. Republicans pleaded with the president not to go there. Even Sen. Chuck Schumer (D–N.Y.), who rarely fails to drool when he sees a protectionist measure, lamented that the tariffs went too far because they were too broad and not limited to America's enemies. Ditto for Sen. Debbie Stabenow (D-Mich.), another known protectionist.

There was no comparable outrage when Trump threatened to slap $60 billion in tariffs on China, the world's second largest economy and America's largest trading partner after the European Union. Even free-trade Republicans were mostly mute. Democrats positively celebrated, with Schumer declaring that Trump deserved a "big pat on the back." Beijing's sole friend in the United States, it seems, was the stock market, which experienced its biggest one-week fall in more than two years.

The political reaction (or lack thereof) to Trump's anti-China policies is not surprising, because China-bashing has been a bipartisan sport for a while. Neoconservatives never wanted President Bill Clinton to normalize trade ties with the Middle Kingdom, but he did it anyway. Nonetheless, Hillary Clinton accused the Bush administration of eroding America's "economic sovereignty" and letting China become America's banker—an allusion to the fact that China owns a big chunk of U.S. debt. Barack Obama imposed tariffs on Chinese tires right off the bat, filed four complaints against Beijing with the World Trade Organization, initiated 24 anti-dumping cases, and—above all—prevented the World Trade Organization from classifying China as a "market economy," something that would have made it harder for the West to impose Trump-style tariffs on China.

Trump, of course, wants to take matters to a whole new orbit.

Some of his complaints against China are bogus, as when he worries that it runs a $350 billion trade deficit and manipulates its currency to encourage exports. Some are real but are none of the government's beeswax, such as the fact that China forces foreign companies to fork over trade secrets to do business there. Some are real and are the government's beeswax: China discriminates against foreign companies by creating all kinds of tariff and non-tariff barriers, disallows majority ownership of Chinese companies by foreigners, and severely restricts foreign presence in its financial, telecom, and other sectors.

No economist of any repute thinks that Trump is right to use the trade deficit as a scorecard to determine winners and losers. All the deficit signifies is that Americans buy more goods from China and have more money to do so. Furthermore, the dollars that China earns this way, it mostly ploughs back into the U.S. by buying American debt. This might enrage Hillary, but it keeps interest rates low for Americans, making their McMansions more affordable. Meanwhile, far from artificially lowering the price of the yuan, China has been trying to ramp it up for about 10 years to curb capital flight. As for China grabbing trade secrets: If American companies are willing to do business in China despite such demands, that's their problem. Europe forces American pharmaceutical companies to sell drugs at severely discounted rates, but not even Trump is suggesting that Uncle Sam needs to take retaliatory action against that.

One consequence of America's big trade deficit with China is that it adds to America's massive monopsony power (the power from being a dominant buyer) to dictate the terms of trade. As George Mason University's Tyler Cowen points out, if America were to stop buying Chinese toys, China couldn't simply reroute the toys and sell them to Indonesia at the same price. So it would have to swallow massive losses. Yet it does not have very many American products to hit back against. Its options are severely limited, which is why it has responded to Trump's threat of $60 billion tariffs with just $3 billion worth of retaliation, leaving completely untouched America's main exports, such as soybeans and Boeing airplanes.

If the Trump administration were to use this power to pry China's markets open further, that would be one thing because it would integrate the two economies even more, which would temper each one's appetite for conflict. But Trump has deeply protectionist instincts. He has been excoriating America's trade deficits since he was on his first wife. In his otherwise capricious mind, that may be the only fixed point.

Getting China to lower some of its tariffs and other barriers on foreign products might diminish the trade deficit a little, but the Chinese simply can't afford America's high-priced goods and services enough to make a significant dent in the deficit. So the odds are that Trump will try to do with China what he did with South Korea and force it to scale back its exports—particularly since, as he sees it, that'll boost domestic manufacturing and bring back "American" jobs.

China, which has its own ideas about its "manifest destiny" and has been smarting over being history's loser for so long, has a nationalism problem of its own. Its rulers, contra Trump, have made a very great effort to keep such populist sentiments in check, in part by keeping growth and development on track. And trade with the West in general and the United States in particular has been an integral part of that. In 1990, before America gave China Most Favored Nation status and supported its bid to the World Trade Organization, bilateral trade between the two countries was a mere $17.6 billion and cross-border investment was trivial. Now bilateral trade touches $600 billion annually and cross-border investments have soared to $90 billion. This dependence on world trade prevented China from too aggressively pursuing its geopolitical ambitions in its and America's sphere of contact.

Trying to reverse or freeze these gains in wealth and status will undo that. Beijing might not be able to respond to Trump's economic bullying in kind without hurting the average Chinese. But it could retaliate on other fronts—for example, by re-igniting its ambition to annex Taiwan, accelerating the militarization of the South China Sea, encouraging North Korea's nuclear ambitions, and expanding its influence in Asia as a counterbalance to America.

That last item might not bother those of us who don't see a unipolar world as an entirely healthy state of affairs. But it will especially trigger Trump and the incoming hawks on his national security team, such as Secretary of State nominee John Pompeo and future National Security Adviser John Bolton.

Regardless of whether Trump's anti-trade zealotry triggers a trade war as devastating as the one in the wake of the 1929 Smoot-Hawley tariffs, it will raise the risk of geopolitical instability, the poisonous fruit of protectionism.