The day of reckoning is here and the economic miracle that China has been for over three decades is all set to unravel. The United States has joined the battle with China, and it now appears, with no holds barred. Notwithstanding being the second-largest economy in the world after the US, China is vulnerable in this struggle as it has developed an artificial bubble economy as a creeper on the US tree. An economic storm can now tear the creeper away from the tree and lead to its eventual withering.
With the United States announcing the decision to slap higher tariffs on Chinese imports of around $200 billion, on top of the ones already in the works of no less than $75 billion, almost half of all Chinese exports to the United States now come under higher tariffs. In retaliation, China has imposed higher tariffs on $50 billion of imports from the US and threatens to slap a tariff on more items.
China has threatened the full measure of retaliation. But the catch lies there. China's retaliation could not be taken to a higher level as Chinese imports are much lower than US imports from China. China exports around $500 billion worth of goods to the US and imports about $130 billion. The trade deficit is massive at over $430 billion, which is "unfair" says Donald Trump. Going beyond merchandise trade, China is now considering beating the US by cancelling orders for aircraft (Boeing) and even restricting the operations of US companies in China.
Tariffs inhibit free trade and China has turned out to be the greatest protagonist of global free trade, accruing several benefits from it. Ever since China joined the WTO, some 17 years back, it has benefited from trade and pushed its domestic growth through exports. It has built up massive foreign exchange reserves – over $4 trillion — which is the highest such hoard with any country.
Behind this miracle is a system that has been created with state fiat, which does not, however, recognise the basic tenets of a free market economy, that is, the economic realities of costs, demand, and supplies. In China, nothing had an economic price. All was geared to grabbing as much as possible of the global market, no matter what the hidden costs were. In the process, China offered prices which bore no semblance to costs and could thus beat others who had to operate by paying the market price.
Its single point message was that China offered the lowest price for any product, be that electrical equipment, machine tools, toys and air conditioners. You can beat one person once, but you cannot beat all for all times to come. Such is the moment of reckoning for the country now.
Now that the US is escalating its aggressiveness, the European Union, despite all its shrill disagreements with the US on NATO, is also joining forces against China for its unfair trade practices and intellectual property infringements. While China is taking the trade conflicts with the US to WTO this week, EU and Japan have joined together to launch their offensive against China.
China had rubbed the point about its efficiency in manufacturing over India in a most direct manner. More than a decade ago, China's premiere had visited India and addressed businessmen in Bombay. After the formal meeting, the Chinese team had strayed on to Bombay streets and markets and tested the prices of items from electrical gadgets to kitchenware and industrial equipment. Later, the Chinese leader told reporters that whatever India was manufacturing, China could offer it at half the price. So, he wondered, why is India not importing all that stuff from China and wasting its efforts at manufacturing.
India and China were, at that time, looking into the possibility of concluding a free trade agreement (FTA) and a joint study group, with representatives from both countries, and looking into the pros and cons. The Chinese delegation was insistent on concluding an FTA immediately on the occasion of the visit of the high dignitary. India had opposed and in the end, all that was signed was a Regional Trading Agreement. It meant precious little.
China had also insisted that India change its stance and recognise China as a "free market economy". That had major implications. None of the advanced countries had accorded that to China. Nor has any of them so far given recognition to China as a free market economy, which allows pre-emptive levy on duties on Chinese goods even within the WTO regime.
Behind the boasting of the Chinese leader about his country's efficiency in manufacturing was an elaborate system of subsidies and absence of pricing for any product in the production stream. In the course of a visit to China, I had occasions to interact with some people who were actually running manufacturing units or had set up such ones.
Interactions revealed that land for industry was available almost free of charge or at best at a nominal cost, but units had to ensure that a certain portion of production was compulsorily exported. The amount of exports from a certain municipal area or industrial zone went into the credit score of the authorities in that area, who were invariably functionaries of the Communist Party as well. Any area having a higher export volume was accorded a higher priority and its local authorities gained prominence. No wonder that in such regimes prices did not matter much and costs were ignored at every stage.
Take, for instance, interest rates. These were not related to costs of funds or operating expenses of the financial intermediaries. Export finance was available at a flat rate of 2 per cent when borrowing rates were around 14 per cent or more and exports units got only some marginal interest subvention.
For sure, the trade war is no longer limited. It is spilling over into allied areas. Intellectual property laws are also turning out to be a major concern for the western alliance. Most of all, the US is now taking a pot shot at China's plans for developing technology industries. China has prepared an elaborate plan for establishing its leadership position – the sights have been kept at superseding the US — in high-tech industries like high-performance chips, mobile technology, aerospace, artificial intelligence and several areas of defense related industries.
The US had alleged that China had been stealing technology from the US private sector companies in these areas. It had blocked the purchase of a chipmaker by a Chinese company. Chinese investments in the United States have been curbed under a statute. The spirit of Mar-a-Lago has been soured to a point of no return unless some turns bring the leaders around. Here again, Chinese president Xi Jinping is coming under huge pressure as the economy slows down and social tensions rise.
Through all this, China is seeking to find new friends for the time being and at least look for the release of its huge economic force on to new markets. It will seek to divert trade to other regions. India comes under that line of fire as China would seek greater market access. It will be incumbent upon us to protect our domestic market for the domestic players and not yield ground to others. This is the need for the hour, as they say.
(The views expressed are strictly personal)