Trade War Between China and the United States has intensified, Trump reportedly wants to hit China with tariffs on $200 billion worth of goods, which would be a massive escalation of the trade war:

• President Donald Trump wants to move forward with tariffs on another $200 billion worth of Chinese imports to the US, according to a new report.
• The move would be a massive escalation of the trade war with China — over 50% of Chinese imports would be subject to tariffs.
• US stock indexes fell following the news.

Why Does Everyone Hate Made in China 2025?

What is Made in China 2025? Made in China 2025 is a blueprint for Beijing’s plan to transform the country into a hi-tech powerhouse that dominates advanced industries like robotics, advanced information technology, aviation, and new energy vehicles. The ambition makes sense within the context of China’s development trajectory: countries typically aim to transition away from labor-intensive industries and climb the value-added chain as wages rise, lest they fall into the so-called “middle-income trap.” Chinese policymakers have diligently studied the German concept “Industry 4.0,” which shows how advanced technology like wireless sensors and robotics, when combined with the internet, can yield significant gains in productivity, efficiency, and precision.

However, China’s intention through Made in China 2025 is not so much to join the ranks of hi-tech economies like Germany, the United States, South Korea, and Japan, as much as replace them altogether. Made in China 2025 calls for achieving “self-sufficiency” through technology substitution while becoming a “manufacturing superpower” that dominates the global market in critical high-tech industries. That could be a problem for countries that rely on exporting high-tech products or the global supply chain for high-tech components.

What’s wrong with China setting quotas for self-sufficiency? For one, such quotas violate WTO rules against technology substitution. Made in China 2025 lays out targets for achieving 70% “self-sufficiency” in core components and basic materials in industries like aerospace equipment and telecommunication equipment by 2025. That could devastate countries like South Korea and Germany, where hi-tech sectors constitute a large share of industrial output and exports.

The supply chains for hi-tech products usually span across many borders, with highly specialized components often produced in one country and modified or assembled somewhere else. Rather than abiding by the free market and rule-based trade, China is intent on subsuming the entire global hi-tech supply chain through subsidizing domestic industry and mercantilist industrial policies. Semi-official documents lay out even more specific quotas for Chinese manufacturers. Officials at China’s Ministry of Industry and Information Technology (MIIT) insist these targets are not official policy, though a report from the Mercator Institute for Chinese Studies argues that officials are using internal or semi-official documents to communicate targets to Chinese enterprises in order not to openly violate WTO rules.

How is Beijing acquiring advance technology for Made in China 2025?  Equally problematic to Beijing’s goal of “self-sufficiency” and becoming a “manufacturing superpower” is how it plans to achieve it. Chinese officials know that China lags behind in critical hi-tech sectors and hence are pushing a strategy of promoting foreign acquisitions, forced technology transfer agreements, and, in many cases, commercial cyber espionage to gain cutting-edge technologies and know-how.

While the Obama administration spent years pressuring Beijing to rein in commercial cyber espionage, Washington and other capitals are only beginning to grapple with the repercussions of Chinese investment and technology transfer agreements. Unlike cyber theft, neither is illegal per se. Surging Chinese investment in the United States and Europe have been a recurring story over the past few years. However, lawmakers are increasingly concerned that such investments, especially in high-tech sectors, are not just a product of market forces, but guided by Beijing as well.

Circumstantial evidence confirms this suspicion. Chinese investment in the United States and elsewhere, especially in hi-tech sectors, has skyrocketed since 2015. Often these investments evince a broader coordinated strategy. Take the example of Fujian Grand Chips, a purportedly private Chinese company that attempted to acquire German machine maker Aixtron in 2016. Shortly before it staged a public takeover of Aixtron, another Fujian-based company San’an Optoelectronics canceled a critical order from Aixtron on dubious grounds, sending its stock tumbling and presenting Fujian Grand Chips with an opportunity to swoop in. Both Fujian Grand Chip and San’an Optoelectronics shared a common investor: an important national semiconductor fund controlled by Beijing. The acquisition was stymied by an 11th-hour intervention by government officials but demonstrated how Beijing can drive investing abroad, often in a highly coordinated manner.

Technology transfer agreements and restrictive market practices in China present a similar problem. Foreign companies often enter agreements to transfer valuable intellectual property to Chinese partner in exchange for market access. These agreements can be exploitative and highlight the asymmetries in market access between China and the rest of the world. Speaking about Chinese takeovers of German firms, Germany’s Economic Minister Sigmar Gabriel said Germany should not sacrifice “its companies on the altar of free markets” while China denies German firms equal access to invest in the Chinese market.

Who Can Benefit From Trade Tar?

Trump believes that a trade deficit is bad, and a trade surplus is good.  The fact that America runs a chronic trade deficit means that the way international trade is conducted today is bad for America.  The current system of international trade is somehow biased against the U.S., and America’s trading partners are running trade surpluses against the U.S. because they are not playing fair. Trump is fighting a trade war to eliminate America’s trade deficit.

However, if this is what Trump thinks, then eliminating the trade deficit is insufficient to make America great again. Assuming miraculously that the U.S. has a perfectly balanced trade with all its trading partners tomorrow, that would only mean standing still for Trump. To make America great again needs a trade surplus. So a victory in the trade war, in this version of Trump think, requires a U.S. trade surplus.

Yes, I know, this version of Trump think makes the president look too simplistic, that’s why here is the second, and more sophisticated, version. And Trump does have sophisticated advisers, like Navarro and Ross. In fact, they co-authored a White Paper in September 2016 that has pretty much formed the basis of Trump’s subsequent economic strategy.[1]  Tellingly in their analysis of the problems that the U.S. has in trading with China, they pretty much dismissed the standard complaint of China as a “currency manipulator” as of marginal significance; instead, they argued that China is an unfair trading partner, period. Their argument is that, ultimately, China enjoys an unfair advantage because its wage rate is so low compared with American’s.

This is deep. It amounts to repudiating one of the most brilliant, powerful and profoundly counter-intuitive economic principles that has stood the test of time for over two centuries: David Ricardo’s theory of comparative advantage.  Simply put, two countries can both benefit from trading with each other even if one is more efficient in producing everything than the other. Using Ricardo’s example, workers in the UK are better at producing wool compared with wine. In Portugal, workers are better in making wine than wool. However, even if workers in the UK are more efficient than workers in Portugal in making both wool and wine, it would still benefit both the UK and Portugal if UK can export wool to Portugal (more UK workers producing wool, being more productive than in making wine) and import wine from Portugal (more Portuguese workers producing wine, being more productive than in making wool).

In interpreting China’s lower wage rate as an absolute and unfair advantage, Navarro and Ross are effectively rejecting the principle of comparative advantage and the mutual benefits of international trade. And to generalize their argument against China, any other country with a wage rate lower than that of the U.S. would have an absolute and unfair advantage as a trading partner. Given that the vast majority of countries today have wage rates much lower than that of the U.S., winning the trade war in this version of Trump think means stopping trade with all these countries all together.

Running a trade surplus in the U.S. is theoretically possible, but the consequences would be prohibitively expensive imports of any kind; impoverishing American households and debilitating American businesses. Not exactly the right way to make America great again. Retreating into economic isolationism would produce a similar outcome. In both versions of Trump think, winning a trade war means losing, big time.

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