US, China War Really a Tech War

(Dow Jones) -- With the latest Presidential tweets about imposing tariffs on hundreds of billions of dollars in U.S. imports from China, it seems possible that a full-blown trade war could start between the world's two largest economies. The question we have to ask is: why?

President Trump likes to complain about the large U.S. trade deficit. But economists know that trade balances have little to do with trade policy because a current account deficit is just the mirror image of an excess of domestic investment over domestic savings. What's more, the current account surplus of China has disappeared as the Chinese consumer starts to spend more. The economy with the largest current account surplus is now (and has been for some time) the euro area.

And China is not as protectionist as widely perceived, at least in the traditional sense. The average tariff rate applied by China is less than 4%, only a little higher than that of the U.S. Independent assessments of so-called non-tariff barriers suggest that China is more often sinned against than it sins itself.

By contrast, there is evidence of a different problem: that China rebuffs foreign direct investment unless foreign investors are asked to make their technology locally available. It is only natural that American and European companies will argue that they'd be better off if they had not been "forced" to transfer their proprietary technology to local Chinese partners. However, these statements do not take into account the fact that local authorities often provided strong inducements (cheap land, low taxes) to these foreign firms to attract them to their particular city or province. This resulted in profits that offset the expected losses from the "forced" technology transfer. Perhaps that's why, despite executives' complaints about "forced" transfers, their investments continue to flow into China and profits on FDI remain healthy.

But something has recently changed: today, there is less emphasis on growth in the evaluation criteria of provincial leaders, which means local authorities have less reason to provide incentives to foreign investors. So while in the past, technology transfers were easier to swallow, as the eagerness of provincial authorities to attract foreign investment has waned, so have the inducements they offer.

Moreover, the technology gap between Chinese and foreign enterprises is shrinking rapidly in many sectors. Government restrictions on majority foreign ownership mattered little when the formally majority Chinese partner (often owning 51%) had an incentive to acquiesce to the de facto control of a foreign investor who had superior technology or market access abroad. With Chinese firms producing technology to rival what U.S. firms can offer (for example, see the fight over 5G), the restrictions on foreign majority ownership really start to matter.

So perhaps instead of speaking of the "trade war," it would be appropriate to speak about a "technology war." Here, the U.S. should be asking itself: should advanced U.S. technology be sold to China, even if it is properly paid for? This is no longer an economic, but a political issue.

The U.S. thus faces two strategic problems: If it considers the problem with China an economic one, it needs to realize that although the United States and China account for a large share of global trade, they do not dominate the global economy, much less global trade. A narrow "trade war" can be won only with the support of neutral powers, otherwise U.S. tariffs (and Chinese retaliation) will only lead to higher sales by European and Japanese firms. However, Europe and Japan share the narrower U.S. concerns about an uneven playing field generated by persistent Chinese state intervention in the economy. A global coalition thus remains possible, but only if the U.S. keeps to reasonable trade measures.

For those for whom the issue is about technological and strategic dominance, it might better if the "trade war" is not settled. The outflow of U.S. technology would only accelerate if China were to open its economy to high tech U.S. companies. The end-result might be an ever-stronger Chinese economy, presenting a stronger challenge to U.S. technological supremacy.

The key issue thus this: is it about more trading opportunities, which are win-win; or about strategic dominance, which is necessarily "you win, I lose"? How the U.S. chooses to answer this question will determine what happens next.

Daniel Gros is Director of the Centre for European Policy Studies (CEPS) in Brussels.