Looking For The Upside Of Tariffs On China

What's interesting is that this is very similar to how
Japan
promoted manufacturing from the 1950s through the 1980s. As Chalmers Johnson explains in his book
“Miti and the Japanese Miracle”, a key component of Japanese industrial policy was“overloaning” to manufacturers, using a combination of public and private banks.

Japan found that if it promoted domestic overcapacity, it didn't even need to promote exports much – they would just happen as a side effect of the domestic glut.

The big difference between Japan and China is that Japan's government tried to balance out this overproduction with measures to raise prices, in order to save its private companies from becoming unprofitable. Cartels and other price-fixing measures – basically, antidotes to overcapacity – were one of the core features of Japan's industrial policy.

China's industrial policy, in contrast, leans in to overcapacity by dispensing absolutely massive government subsidies to manufacturers. This is why China's overcapacity problem is much worse than Japan's in the 20th century, which is why countries around the world are getting mad and putting up tariffs .

At the same time, China's industrial policy is just exacerbating the price wars that are making its manufacturers unprofitable. It's also hurting Chinese consumption - yes, there's a glut of cheap products, but Chinese consumers can't afford them because their employers had to cut their wages in order to sell more products so they could make their loan payments.

This system ought to change - creating an ocean of rusting metal and bankrupt companies helps no one. Interestingly, though, Liu thinks tariffs aren't the solution. Instead, she thinks countries should encourage China to voluntarily restrict its exports and subsidize its manufacturers less:

But the keen-eyed reader will notice that Liu contradicts her own argument here. She notes that China began exploring voluntary export restrictions, currency appreciation, domestic consumption promotion, etc. only because Trump put up tariffs on Chinese goods. It stands to reason that if the US wants to get Chinese policymakers to consider these salutary options even harder, there needs to be some sort of penalty for
not
taking these steps.

In fact, earlier in her post, Liu lists tariffs as a big downside of China's current overcapacity-promoting policies:

For the US and other countries to spontaneously and voluntarily remove the threat of tariffs would thus
remove one of the major downsides
of overcapacity. Trying to wheedle China into enacting voluntary export restrictions would be useless if China could simply ignore the wheedling and use the rest of the world as its dumping ground for excess capacity.

Yes, it would benefit the
people
of China if their government changed the country's economic model to raise the living standards of ordinary consumers instead of encouraging unprofitable overproduction. But if benefitting the ordinary people of China was what the government cared about,
they would have done it already.

China's government thus needs an additional incentive to shift its economic model. That incentive is tariffs. By stopping China from being able to use the rest of the world as the release valve for its overproduction, the US and other countries can hasten the day of reckoning when Chinese companies find themselves unable to offload their products at any price. That reckoning will force the Chinese government to figure out how to cut back on production.

At that point, the US and other countries can offer to remove tariffs if China agrees to voluntary export restriction and currency appreciation. But without the“stick” of tariffs to force China to deal with its own overcapacity, nothing is likely to change.

Tariffs on China could speed up development across the Global South - and maybe even in the US

There's another important way in which tariffs on China could help the rest of the world. One way for Chinese companies to partially avoid tariffs is to move their factories out of China to other countries, like Vietnam, Mexico, or Morocco.

This results in somewhat less revenue for China because the Chinese companies have to pay the labor, land, and energy costs in the country where they set up their factories. But Chinese companies still get to sell materials, parts, and components to their overseas assemblers, and they still get to keep the profits. So they get to partially avoid the impact of tariffs.

The US and other countries could close this partial loophole, if they really wanted to, by imposing tariffs on goods made by Chinese-owned companies instead of just on goods made in China. This would set up a cat-and-mouse game where Chinese companies would try to set up elaborate systems of shell companies and overseas partners to avoid detection by the tariff regime.

Ultimately, though, it would make it enough of a hassle for Chinese companies to sell things to America and other tariff countries that they might just give up and go looking for other markets.

But if the tariff countries don't close this loophole – or close it only partially, e.g. by putting tariffs on Chinese-made components but not on Chinese brands – then it creates a huge incentive for Chinese companies to build factories overseas. In fact, as
The Economist reports , this is already happening on a large scale:

And here is The Economist's chart of where the Chinese investment is going:

It's difficult not to see this as a good thing. Leaving out Saudi Arabia and Kazakhstan - which are clearly just energy plays - the countries where China is investing are mostly quite a bit poorer than China.

Mexico is still slightly richer, but it's stagnant.

In other words, these are all countries that could badly use Chinese manufacturing investment. China is becoming a mature economy, while Vietnam, Indonesia, Egypt, and Morocco still badly need the growth in living standards that foreign-owned factories help provide.

And it's tariffs in the US and other countries that are making this happen. As The Economist notes, other reasons are pushing Chinese companies to build factories overseas – rising Chinese labor costs and slowing Chinese domestic demand – but tariffs are proving to be the decisive factor.

Many strong factors bias Chinese companies toward keeping their factories in China – lack of language barriers, ease of navigating local regulations, political pressure, and so on. Tariffs generate the key push to overcome this home bias and spread the wealth throughout the developing world.

Now, cynics might respond that Chinese companies will only move low-value assembly work to these other countries while hoarding high-value component manufacturing for themselves. Indeed, this is exactly what multinational companies did to China for many years!

As recently as the early 2010s, many Chinese factories
were still stuck
doing low-value assembly work on high-value components made in Korea, Taiwan, Japan, or the US, using machines made in Germany or Japan. It was only recently that China started doing more of the high-value component manufacturing, design, branding, and marketing.

But if China could climb up the value chain, then so can Vietnam, Indonesia, Morocco and Egypt. Over time, the companies in these countries that do assembly for China will learn enough of the tricks of the trade that they're able to make more and more of the harder, more valuable stuff.

The US and other tariff countries can help accelerate that process. By putting tariffs on Chinese components, but not on Chinese brands, they can incentivize Chinese companies to move more of their high-value work to poorer countries in Asia, the Middle East and Latin America. Companies like BYD will then be able to circumvent tariffs, but only if they transfer their technology to developing countries.

In other words, tariffs by the US, Europe, and others might help usher in
the next phase of globalization . They're a costly inefficient policy that sometimes backfires but that might be an acceptable price to pay for smashing the unsustainable, toxic pattern of China-centric globalization that prevailed in the 2000s and 2010s.

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1 Of course, you can get around this problem by only putting tariffs finished consumer goods, like cars or appliances. But the problem is that intermediate goods are most of what China sells to the U.S. , and since one primary goal of tariffs is to secure US supply chains against a possible war, then tariffs on intermediate goods are unfortunately necessary.

This
article
was first published on Noah Smith's Noahpinion
Substack and is republished with kind permission. Read the original here and become a Noahopinion
subscriber
here.

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