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Forget About Taiwan, The Real War Is Trade

Forget About Taiwan, The Real War Is Trade

China is a Dagger Pointed at the Heart of Global Manufacturing

Alan Pentz
September 08, 2024

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Let’s dive in…

My God what a difference 5 years makes. This was actually in the Wall Street Journal:

“China is cranking up its massive export machine again, and this time there’s nowhere for competitors to hide.

A Massachusetts startup called CubicPV bet on silicon wafers, a high-tech component in solar panels. Buoyed by President Biden’s climate legislation enacted two years ago, with billions of dollars in tax credits and government loans, CubicPV announced plans in late 2022 for a $1.4 billion wafer plant in Texas.

Since then, China has nearly doubled its output of silicon wafers, way more than it needs. The extra wafers had to go somewhere—and they went overseas, pushing prices down by 70%. CubicPV had to halt its production plan early this year, putting engineers and other employees out of work, citing “a distorted market as a result of China’s overcapacity.”

I just can’t believe that the paper of neo-liberal free marketism has this good a summary of China’s weaponized trade policies. I could excerpt every single word.

This isn’t just a problem in the US as the story points out, the EU, Chile, Pakistan, Turkey, and many others are raising trader barriers against China’s excesses.

This chart from the article says it all:

While China’s subsidy machine has been destroying manufacturing in the US for two decades, it was at least tempered by the fact that they were also over investing in property and domestic infrastructure. You can’t export property or domestic infrastructure. That changed coming out of the pandemic as the government had to pop the real estate bubble that had formed and the 200th bullet train to nowhere became untenable.

Instead of allowing the market to reallocate those resources, China quickly pivoted to a series of “strategic” technology manufacturing sectors: semiconductors, solar panels, batteries, electric vehicles, etc.

China’s Choice

Many “free trade” commentators in the West have characterized the tepid push back against China’s export subsidization by decrying the trade war we started with tariffs in the first Trump Administration.

This view boggles my mind. China declared a trade war 24 years ago when it joined the WTO. We were just too stupid (and some too greedy) to realize it. As you can see in the two charts below. US manufacturing employment plummeted at the exact time that Chinese export surpluses began to rise.

China’s Trade Surplus (Macrotrends.net)

The Free Trade Propaganda

We’re often told that this is a good and natural process. The three main arguments I’ve heard are:

We get cheaper goods
US manufacturing is “uncompetitive.”
Technology was the key reasons manufacturing employment has fallen not trade.

The closest to true is the cheap goods argument. There is no doubt that many manufactured goods became cheaper because of low Chinese wages. The US would have lost some amount of low-end manufacturing in a real free trade system.

But the compensation for that would be that as China mastered low-end manufacturing, its workers would be paid more and that pay would go to consumption. Additionally, the Chinese currency, the Yuan, would increase in value against the US Dollar as we sent more and more Dollars East in return for those goods.

Over time that low wage and low value currency advantage would erode and Chinese consumers would begin buying now cheaper US and Western goods. That’s how free trade works but the Chinese don’t engage in free trade.

Of course Chinese consumers bought some Western goods: BMWs, iPhones, Rolexes and some other products. However, China blunted the natural evolution of trade with policies to artificially suppress the wages of its workers, weaken the Yuan against the Dollar, and subsidize its manufacturers. That subsidy has now reach 5% of Chinese GDP, 10 times the level of any other advance economy.

Even with those manipulations, had China remained content to focus on low end manufacturing, I don’t think we’d be in the situation we are today. Inevitably China used that dominance in lower-end manufacturing to move into increasingly sophisticated areas.

The Atlas of Economic Complexity, led by Ricardo Hausmann. 2024

As you can see in this chart (pointer from Alice Evans), China steadily increased the level of complexity in its manufacturing base. This was in large part driven by forced technology transfers from US firms (as Alice Evans outlines here) in a very deliberate state run strategy.

That’s smart and we should have realized what was happening far sooner.

Finally, there is a trope amongst economists that it was technology and not China that caused the job losses in US manufacturing. There are certainly instances where this happened but if it were truly technology then why don’t my Walmart products say Made In America but With Technology instead of Made in China? This line seems absurd to me after just a cursory review of press clips of factory after factory closing down to move production to China.

I could be “efficient” too if if you gave me subsidized loans, a cheap currency, cheap workers, and the ability to run over any regulation in my path. US manufacturers are competing with both hands tied behind their backs.

Why It Matters

Others say that this process is just an inevitable consequence of economic development. More mature economies should naturally increase consumption and turn more to services rather than actually making stuff.

While I do agree that there is some natural tendency for advanced economies to shift into services, China itself shows how limited this view is. As it has grown from a low income to a middle income country, the percentage of its GDP that goes to consumption has actually FALLEN 10%. Other developed countries like Germany, Japan, and South Korea also have disproportionate shares of global manufacturing.

The goal here should not be to grab disproportionate shares of global manufacturing but to balance the distortions. If we want free trade to work, countries need to allow the competitiveness of their exports pay for imports. That is a balanced system and allows each country to produce what it has a competitive advantage in.

It’s important for the US and most other countries to maintain a manufacturing base for 3 reasons:

Defense: Without a manufacturing capability, it’s difficult for a country to maintain a sufficient military to protect itself. We’re seeing some of these problems in Ukraine where the US and its allies are having trouble keeping ammunition in stock.
Innovation: While the US has excelled in innovation in the world of software and bytes, the whole world doesn’t take place in cyberspace. We live in a real world of atoms and many of the innovations that will secure our future prosperity will have to be manufactured. We need a solid industrial capability to ensure we can remain relevant.
Jobs: Manufacturing provides good paying jobs that require skills that service sector jobs don’t. Men have been particularly hard hit by the loss of these types of jobs. I think we can trace many societal ills such as the breakdown of two parent families and the opioid and male suicide crisis to a lack of manufacturing jobs. The rise of Trump and the recent riots in Britain are directly tied to this.

Conclusion

China’s trade policies are an active war on other countries’ economies. We need to act quickly and decisively. In my next piece on trade I’ll explore why China and Xi in particular are so intent on waging this war and then go into some potential solutions such as a cooperative agreement amongst countries to balance their economies (not happening), tariffs (suboptimal), and capital controls which are my favored policy.

Keep growing,

Alan

P.S.

P.P.S.

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