Bullying China now will just leave us with welts later

It is perfectly legitimate for governments to use the tools at their disposal to achieve their goals in multilateral and bilateral negotiations. The United States has at its disposal a vast array of bargaining chips to advance its interests, especially when it comes to trade matters.

These include access to the U.S. consumer market, technology, military might and the power of argument itself. In using that arsenal, however, we need to be conscious of the long-term implications. 

{mosads}The current battle with China over the bilateral trade deficit and technology espionage and theft is a case in point. The administration is correct in arguing that intellectual property rights need to be respected.

But there are serious problems associated with both setting a reduction in the bilateral trade deficit as a main goal of the negotiations and with the specific tools used to attain that goal.

Bilateral trade deficits don’t really matter much. What’s relevant is the overall current account deficit with the rest of the world because it determines our capital needs in order to compensate for it.

The current account deficit includes merchandise trade, trade in services, the income from U.S. capital and labor employed abroad versus the income from foreign capital and labor employed in the U.S. and transfers, such as worker remittances and foreign aid.

The U.S. has a sizable deficit only in merchandise trade, and not just with China, but with virtually every major economy.

Let’s focus, then, on merchandise trade. Much of our deficit with China refers to products that contain components made in other countries. Take the iPhone, for example, which is assembled in China. Less than 10 percent of its manufacturing value originates from China. The rest is components made elsewhere.

If you decompose all of the assembled products the U.S. imports from China and attribute each component to the country where it is made, the bilateral trade deficit with China shrinks to about half of what usually gets reported.

The other half is ultimately due to components made in Japan, Germany, South Korea and other manufacturing powerhouses. Thus, our merchandise trade deficit with China is not as large as everyone — including many in the Trump administration — claims it to be. 

Thus, it is highly alarming that the administration is so focused on reducing the trade deficit with China when it is not the most important issue to begin with.

But the problem gets compounded by the use of tariffs as the main tool in negotiations. Tariffs distort prices, hurt poor consumers and trigger retaliatory measures — as Chinese actions have so far shown.

But the more important problem with using tariffs and other protectionist measures is that this may be the last time the U.S. can use its consumer market as leverage in trade negotiations.

In about 10 years, the Chinese consumer market will be significantly bigger than America’s. Twenty years further down the road, the Indian consumer market will be the world’s largest, given its young population profile and rate of economic growth. Once we lose the No. 1 spot, we will not be able to use that weapon anymore. 

So should we use protectionism as a weapon now before it becomes ineffective? Absolutely not. All we are accomplishing in the long run is accelerating our own relative decline. The countries affected by our tariffs will look elsewhere in the world for growth.

Companies will develop a different approach to their manufacturing strategies and find new ways of being competitive that bypass the U.S. market. This trade war with China imposes hardship on the poorest Americans —whose purchases of foreign-made goods become more expensive — and it will ultimately turn the world against us.

But the most important reason not to use tariffs is that companies become lazy when they are protected. We should never provide incentives for American firms not to innovate. Unfortunately, every tariff is an invitation to take it easy and postpone necessary adjustments and improvements. It is bad policy, period. 

Mauro F. Guillén is the Zandman Professor of International Management at the Wharton School at the University of Pennsylvania. Follow him on Twitter: @MauroFGuillen.