China Started The Trade War

If there’s a trade war between the U.S. and China, don’t blame Donald Trump.

China started it long before he became president.

The classic case for free trade predicts that each country specializes where it has a comparative advantage.  By doing so, they lower costs and raise incomes for everyone. If China subsidizes exports of steel to the U.S., in theory the U.S. still benefits because consumers and steel-using industries will have lower costs.  Is as a result some steel jobs will disappear, more productive jobs elsewhere will take their place.

However, starting in the 1980s, economists recognized that comparative advantage couldn’t explain success in many industries.  These include commercial jetliners, microprocessors and software. These industries are difficult for competitors to enter.  There are steep costs for research and development, previously established technical standards, increasing returns to scale (costs drop the more you sell), and network effects (the more customers use the product, the more valuable it becomes).

In such industries, a handful of firms may reap the lion’s share of the wages and profits at the expense of others.  China’s efforts are aimed at achieving such dominance in many of these industries by 2025.

The potential collateral damage of a trade war, and thus the risks of Mr. Trump’s strategy, are great.  The breadth of his action elevates the potential harm to American consumers, supply chains and exporters.  However, those who criticize him seem to be at a loss to propose a better approach.

“China is undermining or taking away some of our rents, so we are relatively worse off and they are better off.”  This according to Dartmouth College economist Douglas Irwin.  Unlike Mr. Trump’s tariffs on steel and aluminum, “a lot of economists would hold their fire in terms of attacking Trump for his China actions. I don’t think anyone can really defend the way China has moved in the past few years, violating intellectual property and forced technology transfer.”  Mr. Irwin says it isn’t clear that Mr. Trump’s strategy is right.  However, “no one is saying we shouldn’t do anything.”

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