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COMMENTARY: Tariffs Grab Headlines, But Other Trump Measures Will Bite Hard into Relationship

Plunging investment, closed-off market access, and a squeeze on the pipeline of international students and researchers show the U.S. scaling back a partnership that has benefited the world.

Mark Melnicoe
    Feb 02, 2019 3:10 AM  PT
COMMENTARY: Tariffs Grab Headlines, But Other Trump Measures Will Bite Hard into Relationship

Tariffs have taken center stage in the U.S.-China trade war, but it's a raft of other measures that are setting up a very different relationship between the world's two largest economies.

Much of the focus among the hard-liners on Team Trump has been on how China's economy is being hurt by the tariffs and how U.S. pressure will force China to make a deal. Indeed, both sides are speaking optimistically about an agreement after fruitful talks this week in Washington.

But whether the tariffs stay or go, the administration ignores the fact that most of China's current economic problems – and there are plenty – stem from long-simmering conditions at home.

While it's true that American tariffs and other pressures are taking something of a toll in China, the long-term ramifications of U.S. actions have not been well examined. A new report from McKinsey, a global management consulting firm, lays some of them out. The report is aimed at helping businesses plan for internal conditions in China this year, but it also serves as an outline for many of the negative events likely to occur in both countries.

The scenarios laid out by McKinsey reveal far-reaching and damaging actions by the Trump administration as they play out over the next few years. The fallout will range from pain to American businesses to cutting-edge research moving out of American labs.

"The U.S.–China economic equilibrium of the past 20 years has gone, and as we look into 2019, it is not yet clear when and where a new equilibrium will form," the report says.

For those who think the U.S. will "win" the trade war and pry open China's markets without any serious consequences, a number of sobering facts stand in the way.

Tariffs: The bulk of U.S. imports from China go to businesses – close to three-quarters. As they pay more for intermediate goods and capital goods, companies' costs are rising. About half of these imports are already subject to President Trump's tariffs, and he is threatening the other half – with rates on all of them rising to 25 percent – if no trade deal is made.

Businesses will also feel it on the other end. Thousands of American manufacturers from Apple and Caterpillar to small firms run their supply lines through China. If they export much of their product to America, they will be hit hard.

Some are already relocating their contract work to other countries, such as Vietnam, Malaysia, and Indonesia. That process actually began a few years ago as the price of labor in China increased. But China also boasts unparalleled efficiencies, and most manufacturers want to stay. The tariffs, in many cases, will force an unwanted and expensive move.

McKinsey forecasts a 0.5 percent to 0.8 percent hit to China's GDP in the short term. But it notes that if job losses start occurring in China, with a resulting loss of confidence, the impact could be much steeper as consumers pull back on spending.

Investment: Chinese direct investment in the U.S. plunged 70 percent in 2018 due to U.S. scrutiny of technology and other foreign direct investment (FDI) from China. Look for it to fall anew this year as the screws tighten.

"In the U.S. start-up space, this means the loss of investment funds from China that offered enhanced access to the China market in return for investment and also a valuation of up to four to five times what domestic investors offered," McKinsey says. "In some parts of the U.S. start-up world, valuations could fall substantially as Chinese capital withdraws."

Instead, the Chinese are putting their money into the UK, Italy, Israel, and Japan. That's a loss for the U.S.

Market Access: Huawei is the poster child. The U.S. has kept China's most international company (and the world's largest maker of telecom equipment) out of the U.S. cellular market, encouraged other countries to do the same, and had its CFO arrested in Canada while charging the company with fraud. Many countries are weighing what to do, especially after a much-debated Bloomberg story alleged the existence of a hidden chip in Huawei products that could infiltrate American companies.

Other kinds of businesses, including financial services, health care, and other tech firms, are in the U.S. line of fire.

Talent: This one may hurt both countries the most, long-term, as Chinese researchers and graduate students increasingly see the door being slammed shut. Chinese scientists are being issued American visas with more conditions, including shorter stays, which means they can't count on staying long enough to see their research through. President Trump recently stated that all Chinese students attending American universities are spies.

With that kind of welcome, there will doubtless be fewer and fewer of China's best and brightest coming to the U.S. to collaborate on science and technology projects. Instead, they will go to other countries. Trump wants to end a grand tradition of Sino-U.S. cooperation in sci-tech that has yielded mutual benefits. This is no small matter, as more than 350,000 Chinese students currently study in American universities, bringing with them money and talent.

With China now developing its own technology space, Beijing will simply accelerate cooperation with other nations, often luring European or Asian talent to China while investing billions of dollars in world-class labs. China already is on the cutting edge of cancer research, artificial intelligence, and biological drugs. Other key sectors will follow – all without the U.S.

The effects of Trump's trade war, taken in sum, paint a bleak portrait of where the U.S., China, and with them the global economy, are going. Even if a deal is made that has both countries dropping their tariffs, these other, more intractable issues appear likely to remain.