The much feared trade war with China  is the least of the problems we have with that great nation. The People’s Republic of China appears to be hardwired to seek world domination. Their means toward this end are primarily economic. Nevertheless, in addition they are building their military capabilities. Our current trade war promises to morph into a cold war that will dominate international affairs. And as with the cold war against the Soviet Union, there is every possibility that cold war could transform into a very, very hot war.

Chinese Ideology and Intentions

Ever since Deng Xiaoping took supreme power  in 1978, Western nations harbored the hope China would become a regular member of the family of nations. The economic and social reforms under Deng generated and nourished that hope. Many in the West thought economic integration with the world economy, together with exposure to Western ideas, would transform the socialist giant into a quasi-capitalist partner. Perhaps they might even become democratic. Under Deng, China was to move away from state socialism to a kind of “state capitalism.” China even allowed the existence of private companies and of stock markets. Attempting to encourage China’s economic ties with the world, the West allowed China to join the World Trade Organization in 2001.

Alas, autocrats have great difficulty in giving up power. The siren song of government power is an addictive drug-like force, and one the leaders of the Chinese Communist Party (CCP) could not resist. They have retained absolute power over their economy by reserving the right to control investments. Capital allocation is a rather murky affair in China, with the Chinese government trying to direct capital flows through state-owned investment banks. It should be no surprise that a great deal of wasted malinvestments of scarce Chinese economic resources were made. Approximately $6.8 trillions worth of waste from 2010 to 2014. That is the amount estimated in a joint report by China’s National Development and Reform Commission and the Academy of Macroeconomic Research. That is about 40% of U.S. GDP and two years of output for the entire German nation. This horrendous quantity of waste is approximately half of all Chinese investment in the years covered by the report between 2009 and 2013. Some of that bad investment went to build ghost cities, cities essentially without any population!  It is no wonder the Chinese economy is currently suffering.

The CCP leaders have never had any use for democratic ideals. This is the major lesson we learned from the Tiananmen Square protests of 1989. Those student-led demonstrations were inspired by Deng Xiaoping’s rapid liberalization of the Chinese economy, together with anxieties the new freedoms might be lost. Authoritarian party leaders opposed to Deng’s reforms had forced the resignation of Hu Yaobang, a leader of the reforms.

At first government authorities reacted to the protests with both uncompromising and conciliatory tactics, demonstrating the division of party leaders over Deng’s reforms. Eventually, however, Deng and other CCP elders were persuaded the protests were a threat to CCP power and needed to be suppressed. On June 4, 1989, elements of the Chinese army advanced through central Beijing, killing both demonstrators and bystanders alike.

As time passed by, the CCP reverted ever more toward Mao’s totalitarian control of society. This reversion has culminated in the absolute dictatorship of President Xi Jinping. As President of China, he forced a change in China’s constitution that removed term limits on the presidency, making Xi president for life.  Those term limits were imposed under Deng Xiaoping to prevent another Mao Zedong and another “Great Proletarian Cultural Revolution.”  Now the term limits have been removed, Xi has come to resemble Mao in his power. The Australian Broadcasting Corporation video below is a revealing summary of Xi’s life.

Chinese authoritarian ideology is reflected in its imperial foreign policies. Ever since the U.S. withdrew from the Philippines in 1992, China has sought to dominate the Far East through control of the South China Sea and the East China Sea. More recently, Xi’s China has unveiled much greater foreign ambitions. These can be seen in two projects: the Belt and Road Initiative and the “Made in China 2025” plan.

The Belt and Road Initiative is a Chinese project to revive and expand the ancient “Silk Road” connecting China with nations to their West.

At first sight, this project appears to be merely a laudable attempt to increase global trade and prosperity. In a McKinsey & Company podcast transcript, McKinsey senior partner Kevin Sneador states,

Therefore it’s very ambitious—potentially ambitious—covering about 65 percent of the world’s population, about one-third of the world’s GDP, and about a quarter of all the goods and services the world moves.

Yet, given China’s past behavior, many suspect China has more nefarious goals. How can we explain infrastructure investment to expand the new Silk Road into the many countries where economic losses are expected? According to The Economist, China expects losses of 80% in Pakistan, 50% in Myanmar, and 30% in Central Asia. Clearly, there must be more than economic motivations at work. The mercantilist policies of China seem more aimed at making the rest of the world dependent on China.

In fact, the Belt and Road Initiative can be seen as just one aspect of China’s “Made in China 2025” policy. This is a Chinese government policy to make China globally dominant in high-tech manufacturing by 2025. In 2015 China’s State Council, the country’s highest executive authority, specified ten high-tech sectors on which to concentrate. These include:

1. Information technology
2. Numerically controlled machine tools and robots
3. Aerospace equipment
4. Ocean engineering equipment and high-end vessels
5. Rail transportation equipment
6. Energy-saving cars and “new energy” cars
7. Electrical equipment
8. Farming machines
9. New materials such as polymers
10. Bio-medicine and high-end medical equipment

The government’s stated motive is to transform China from a low-wage, low-cost manufacturing country into a high-wage, high-end producer. Yet China’s past history of mercantilist policies have created international suspicions about “Made in China 2025”. Their mercantilist policies include:

• Internationally dominating industries, e.g. the steel industry, by selling below cost.
• High differential tariffs to encourage Chinese exports and discourage imports. For example, in the past the U.S. charged only 2.5% for a car entering America, but China levied 25% for a car entering their country.
• Limitation of international participation in the Chinese economy. For a foreign company to have access to China, they must share their technology and relocate R&D centers to China.
• Theft of intellectual property
• Government subsidies for China’s companies
• Currency manipulation

The Chinese government has been very circumspect in advertising the program internationally. In order to limit international fears of Chinese dominance, it has portrayed the plan as aspirational and informal. As some Western leaders have increasingly expressed concerns, Chinese officials and media outlets have begun to drop international public references to the program. Yet other countries have every reason to fear China wants to control them by making them economically dependent.

The Dimensions of the Trade War

When one looks  at the quantity of exports and imports between the U.S. and China, China is revealed as much more vulnerable to a trade war than the U.S. I went through this exercise in the post How Probable Is a Trade War With China?, and it is worth looking at a couple of the graphs from that essay. The first plot is the value of U.S. imports from and exports to China in nominal dollars.

Clearly, American imports of Chinese goods are much larger than its exports to China. In 2017 the U.S. imported more than four times as much as it exported. China would be more vulnerable to U.S. import tariffs than the U.S. would be to a Chinese increase in import tariffs on American goods. This conclusion is made much stronger by looking at export and import values as a fraction of the two countries’ GDPs.

U.S. exports to China in 2017 were 0.67 percent of U.S. GDP, and imports were 2.6 percent of U.S. GDP. These exports and imports were much larger as a fraction of China’s GDP, illustrating how much more vulnerable China is. In 2016, the last year for which the World Bank had data on China’s GDP, China’s exports were 4.13 percent of their GDP and their imports were 1.03 percent. Although some U.S. economic agents such as soybean farmers might be hurt, the Chinese would hurt far more.

However, the major American motivation for engaging in a trade war should China refuse to abandon mercantilist policies is not economic. Even the economic reasons for staying out of a trade war are suspect. I explored this subject in the post Trump Becomes More Convincing About Foreign Trade. The universal justification for international free-trade is Ricardo’s Law of Comparative Advantage. Yet, there is a big difference between the law of comparative advantage and the other three great neoclassical economic laws (supply and demand, Say’s law of markets, and the law of marginal utility). The other three laws will operate no matter whether free-markets exist or not,  They might express themselves differently in a socialist economy than in a capitalist one, but they are always operational. Comparative advantage will work only if the two trading countries both have free-markets.

The central point of comparative advantage is that free-trade between free-market economies allows both trading nations to allocate their capital in the most productive ways. The law of comparative advantage points out there can be a division of labor between the trading nations that leaves both countries more productive. However, this can only happen if both countries are driven by market forces to allocate capital most productively. In a situation where one country is predominantly socialist and one is only partially free-market, devotion to what passes for “free-trade” can bring very bad consequences. Those bad effects can be more than economic, causing problems for national security.

Suppose one trading nation using mercantilist policies makes others economically dependent on it for vital economic resources. Then the dependent nations can be blackmailed for continued access to those resources. Examples of such dependencies of the West on China are supplies of steel and rare earth metals.

There is then both an economic case and a national security case for fighting Chinese mercantilism. If China can not be persuaded to abandon mercantilist policies, the West might be safest if it totally disengaged its economies from that of China.

The Coming Cold War

The totalitarian ideology  of the Chinese Communist Party, together with their mercantilist policies to dominate other nations, strongly suggest a cold war developing between China and the West.

As with the cold war between the West and the Soviet Union and Mao’s China, this new cold war has a military dimension. And as in the previous cold war, the most powerful authoritarian nations — China, Russia, and Iran — have formed a de facto alliance against the West. China and Russia have both aided Iran in the development of nuclear weapons and missiles, China has held joint naval exercises in the Baltic Sea with Russia. Both China and Russia have aided Iran in shoring up Syria’s Bashar al-Asad.

The theme images at the top of this post demonstrate how seriously China is striving to be able to challenge U.S. armed  forces. Building aircraft carriers, and developing stealth aircraft and hypersonic glide vehicles for delivering nuclear weapons, as well as maintaining an enormous army, China is posing an increasing military threat against the U.S.

Yet, China also has significant weaknesses. Most of these weaknesses are of their own making. Chief among them is their reversion to self-defeating socialism and their dependence on mercantilist policies. Several years ago, I noted in the post Achilles Heel of Autocrats: Their Economy how authoritarian nations tend to destroy their own economies. The economic collapse of Venezuela is just the latest example of this tendency.

The developing cold war, fueled by stark ideological differences and Chinese imperialistic ambitions, is a far greater problem for the West than any trade war with them. The trade war is almost required to insure we do not become fatally dependent on China economically. Should that happen, we can expect no mercy at Chinese hands.

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