What Set the Stage for the US-China Trade War: The Long Competition

The trade war with China has dominated newspaper and investing headlines for months. I’ve heard many pundits opine on what the outcome will be; how it will affect markets and the economy; who will win and who will lose. None of us knows what the outcome of this situation will be. 

This is more than just a trade war. Even after some agreement is hammered out, we’ll still have ongoing tensions that will last for decades to come. But it isn’t a cold war, either. China and the US will continue trading in ways we never did with the Soviets. This is really a prolonged competition--like the seemingly endless Federer/Djokovic Wimbleton final, but with much higher stakes. 

Another misperception I see sometimes in the media is that this is a partisan issue. I disagree.  It’s clear that the trade war is a battle in a larger competition--one in which any Administration, Republican or Democrat, will be engaged.

To fully understand, though, we need to put it into context. What led us into this current trade war? 

3 Factors that Set the Trade War Stage

#1: US-China engagement. Our first response to China’s rise as an economic power was to welcome them. We helped usher them into international order, and then traded with them. Because of this, China became deeply intertwined with the world’s supply chains. The West got cheap goods and China built a manufacturing powerhouse, and started making real money. 

There were victims in that scenario (manufacturing jobs, low wage workers, etc.), but by and large the United States, the West, and China were happy with the arrangement. China lifted the greatest number of people out of poverty in the history of the world, and the West used the Chinese supply chain to maximize efficiency and build the cloud-based technology revolution that is currently disrupting every industry known to humans. Large amounts of US capital went from funding business with lots of assets to ones with almost none. In essence, moving production to China freed up capital to invest in the knowledge economy. Again, many regret the effects of this shift--but it has undeniably unleashed the Cloud economy.

#2: The Great Financial Crisis, combined with the “Cloud Tsunami.” Another effect of the engagement with China was the gusher of cash coming out of China that it sank into Treasury bills. This allowed interest rates to stay low along with the deflationary effects of reducing manufacturing costs. In the 2000s, many Americans funded their lifestyle out of home mortgage loans and appreciating real estate driven by these low interest rates. 

Of course, that came to a screeching to a halt during the crisis. At the same time, cloud computing and other technology advances began gutting low wage jobs, increasing the returns to intellectual capital, and generally deflating the cost of everything except the two things you need to live and get ahead: health care and education.

#3: China 2025. After the GFC, while the US accelerated its transition to a knowledge-based economy, further hollowing out blue collar and unskilled work, China began a different shift. The manufacturing boom that lifted people out of poverty began to peak. Labor costs were increasing and China’s ability to keep investing in core infrastructure productively was going down. For the Chinese, this meant several things, but most applicable to this argument is the focus on advanced manufacturing and general advanced technology. In other words, China was saying, “we don’t just want to assemble the iPhone; we want to design the iPhone.” 

This ambition is a direct threat to US dominance. China’s efforts to own the technologies of the future is a dagger pointed at the heart of what keeps the United States on top in the private and public sectors alike. This plan was enshrined in Made in China 2025, a roadmap for achieving global leadership in a series of key future technologies by 2025. We can speculate about the ability of the Chinese to deliver, but clearly the threat is there. 

At the same time, China’s economy kept growing and it went from “Who cares?” in the 2000s to “Wow! They are going to be bigger than us in 10 years,” in the mid to late 2010s. Let’s be clear: technological, economic, and military supremacy all flow from one another. The US should know--we’ve been doing it for over 100 years.

Looking Ahead

I see little prospect in China giving up its ambitions. They will inevitably seek to climb up the technology mountain, which will lead to a larger economy and more military prowess. And the US won’t willingly cede its place as king of the mountain, so we are left with a competition for that spot. 

As of now, the possibility of an actual war seems remote. The most likely outcome appears to be a protracted competition, in which each side marshalls its resources to pursue technological, economic, and military dominance. This will differ substantially from our conflict with the Soviets. China has a far more powerful economic engine that can generate real economic growth. At the same time, there are good reasons for both countries to trade and interact with each other, in ways the Soviet Bloc and West did not, so I don’t see it as a fully “cold” war. 

The best term I can come up with? The Long Competition.

Stay tuned for future CEO Corner posts on the US-China Trade War. Next up: How will the trade war play out?