LONGREAD: trade war? Gimme shelter

Not many others stand to lose more if a rules-based global trading system, embodied in the World Trade Organisation (successor to the General Agreements on Tariffs and Trade [GATT]), collapses.

“Washington is in the business of not simply hedging Beijing’s ambitions but containing them.”

What is in prospect without American and Chinese leadership is a global trading free-for-all. So are we approaching a point of no return?

Moreover, Australia has the further challenge of its “co-dependency” on China - for trade - and America - for security.

It’s a dangerous vortex for Australia at a time when an assertive US China policy is threatening to de-stabilise the global economic system, obliging America’s allies to make difficult choices.

Consider trade: in 2018, 33.7 percent or $A106.3 billion of Australian merchandise exports went to China, led by iron ore and coal. In the same year 19.2 percent or $A16.9 billion of services, including principally tourism and education, derived from China.

In both merchandise and services China ranked first among Australia’s business partners - or “customers”, as described by Prime Minister Scott Morrison in remarks that put him at odds with former Foreign Minister Julie Bishop who refers to the Chinese as co-equals in business.

Hedging their bets

In other words, about one third of Australian exports (merchandise and services) derive from China. Whatever your view of that dependency, it makes Australia particularly vulnerable to a disruption in the global trading system.

In hindsight, a speech given by Vice President Mike Pence on 4 October 2018 to the Hudson Institute in Washington established a new paradigm for US dealings with China.

At the time, Pence’s speech was given less weight than it deserved as an indication of American determination to push back against China’s rise. It is now clear Washington is in the business of not simply hedging Beijing’s ambitions but containing them.

This has clear implications for Australia which should avoid, if it can, being drawn into a big power contest with China beyond legitimate investments in its maritime capabilities to secure trade routes vital to its economic well-being and otherwise countering Beijing attempts to influence domestic politics.

No need to choose

Briefly, Pence spoke of a “new era of great power competition’’, one that has been interpreted as heralding a “new cold war”.

“As we respond to China’s trade practices, we will continue to demand an economic relationship with China that is free, fair and reciprocal. We will demand that Beijing break down its trade barriers, fulfil its obligations, fully open its economy - just as we have opened ours.”

“We’ll continue to take actions against Beijing until the theft of American intellectual property ends once and for all. And we will continue to stand strong until Beijing the predatory practice of forced technology transfer. We will protect the private property interests of American enterprise,” he said.

Beijing cannot say it was not warned nor can Australia pretend it has been taken by surprise by a hardening US position on China.

In China’s inexorable economic rise to this point Australia has benefited from both its history and its geography - without needing to choose.

In a broader sense, these are the stakes in a widening trade and geopolitical conflict between an established and a rising power.

This includes what is now clearly a US policy to crimp China ambitions more or less across the board, starting with - what is perceived to be in Washington - Beijing’s mercantilist trading policies in which it manipulates its currency to advantage and uses tariffs and non-tariff barrier to stifle competition in its own markets.

Bad news

Then there are US decisions to restrict or ban Chinese companies from establishing businesses in America while pressuring US allies to do the same. US pressure on its fellow “five eyes’’ members to bar the telecommunications equipment giant Huawei from participating in the buildout of their 5G networks is a case in point.

Australia fell into line on this, as did Canada and New Zealand. Britain took another course, enabling Huawei to participate in “non-core’’ aspects of the 5G network.

What is striking about the US-China trade dispute is the marginalisation of the WTO, reduced to the role of an anxious spectator.

That is not least of reasons why the slippage in efforts to firm up the foundations of a trade agreement in Washington last week is bad news from an Australian perspective.

That news got worse when Beijing announced it would, in retaliation, increase tariffs on a previously announced $US60 billion of imports from the US. These measures would take effect from June 1 unless progress is made in negotiations.

The US had already gazetted an increase to 25 per cent from 10 per cent on $US200 billion of Chinese imports with threats to extend tariff increases across the board.

That leaves less than two weeks for officials on both sides to return to the negotiating table to head off what is shaping as the most disruptive trade war in modern history.

This is brinkmanship on steroids on both sides.

Signed contract

President Donald Trump’s bluster via tweets and impromptu comments at the White House underscores disappointment in Washington at what appears to be Chinese backsliding on a deal.

US officials are reporting credibly that Beijing went back on earlier undertakings on a range of contentious market-opening issues achieved in negotiations over the past several months.

Reuters reveals that on the eve of trade talks in Washington a cable from Beijing arrived with “systematic edits to a nearly 150-page draft trade agreement that would blow up months of negotiations”.

According to Reuters, “the document was riddled with reversals by China that undermined core US demands. In each of the seven chapters of the draft deal, China had deleted its commitments to change laws to resolve core complaints that caused the United States to launch a trade war: theft of US intellectual property and trade secrets; forced technology transfers; competition policy; access to financial services and currency manipulation.”

This backsliding on understandings reached would be characteristic of negotiating tactics deployed over many years in which Chinese entities seek to wear down the other side in protracted negotiations.

In the early days of doing business in China, western business seeking to close a deal would joke negotiations only really began once a contract was signed.

Bitter fruit

The Communist Party mouthpiece, the People’s Daily, responded to Trump in an unusually strong commentary on what China clearly regards as American provocations.

“At no time will China forfeit the country’s respect, and no one should expect China to swallow bitter FRUIT that harms its core interests,” People’s Daily said.

What the Chinese commentary is saying is China now regards arguments with the US over trade as a “face” issue in which its self-esteem is being challenged.

This is fraught terrain in any negotiation with China especially one in which Chinese sovereignty, or “face”, is involved. This will add a layer of uncertainty to negotiations.

For its own reasons, Washington is testing Beijing in what is shaping as the most contentious moment in relations between an established and a rising power since China began its remarkable economic transformation in the late 1970s.

The problem for the rest of the world, including Australia in particular given its dependence on a stable trading relationship with China, is that uncertainty, even antagonism, in US-China relations more or less across the board is weighing on markets, business confidence, and global growth.

It’s not being melodramatic to assert that if the US and China fail to reach an accord on outstanding differences and a full-blown trade war ensues beyond the present trade disruption chances of a global recession will increase.

These are the stakes involved.

Economic order at risk

In its latest World Economic Outlook, the International Monetary Fund pegged back global growth partly because of a slowing Chinese economy, and risks involved in a US-China trade deal going awry.

The IMF reduced global growth predictions this year to 3.3 per cent from 3.6 per cent in 2018. It did not at that stage foresee a US-China trade deal running into the sort of difficulties that have now materialised but it did conclude the “main priority is for countries to resolve trade disagreements cooperatively without raising distortionary barriers that would further de-stabilise a slowing global economy’’.

In a separate report, the IMF modelled the effects of 25 per cent tariffs on all goods traded by both the US and China. This would cause the US and Chinese economies to lose further momentum.

The US would yield between 0.3 and 0.6 per cent and the Chinese economy would lose between 0.5 and 1.5 per cent. These are big numbers in the global context.

As things stand, it is hard to believe Washington and Beijing can afford to allow the US-China relationship to slide to the point where a global economic order is put at risk.

But these are strange times geopolitically. The Trump administration appears to have convinced itself that brinkmanship on trade and other issues is the best way to deal with an emerging China.

Among risks in all of this is that Australia could get swept up in a US-China stand-off.

Paper tiger

James Laurenceson, acting director of Australia-China Relations Institute at the University of Technology, Sydney warns against Australia getting drawn into an un-nuanced American view of China as an “aggressive, expansionist and totalitarian state”.

“The Australian government has legitimate concerns about China’s actions in the South China Sea,” Laurenceson says. “But equally China’s security push has less to do with expansionist aims than it does with a desire to protect its trade routes and its paranoia about its dependence on traffic through the Strait of Malacca.”

In all of this, calculations are being made about risk and reward for Australia of a full-blown trade war. At the alarmist end of the spectrum KPMG Economics Australia suggests an escalation could last for a decade with a loss to the economy of nearly half-a-trillion dollars over 10 years, the equivalent of losing just over 40 per cent of last year’s household disposable income.

Job losses would also be significant under such a scenario, falling almost 60,000 and pushing real wages down by about $A16 a week for the average worker.

In a limited trade war, KPMG’s modelling suggests Australia’s GDP would be about 0.3 per cent lower after five years and the nation would incur a real gross domestic product loss of $A436 billion over a decade. This would be mainly due to the reliance of Australian commodities as intermediate inputs in the production process in China and the likely loss of services exports in education and tourism to China.

On the other hand, as happened during the Global Financial Crisis, China may respond by again stepping up its infrastructure spending to maintain economic growth and stability. This has in the past has benefited Australian commodities suppliers. In 2009, the value of Australian exports to China jumped by 30 per cent.

Other beneficiaries of an intensifying US-China trade would likely include the wine industry in competition with California winemakers. Agricultural commodities may also benefit, along with natural gas. Since early this year China has stopped taking US LNG.

However, in all of this the downside for a global trading system is that any blanket tariffs imposed by the US arbitrarily would put it in breach of its international obligations. In Chinese terminology this would expose the WTO as a paper tiger and thus incapable of asserting itself - a scenario to no-one’s benefit, least of all Australia.

The world would find itself in uncharted trade waters, bereft of American leadership and at the mercy of a China intent on forging its own course.

 Tony Walker is a bluenotes contributor, former Financial Times correspondent in China and former Australian Financial Review political editor.