Feb 14, 2019 05:10 PM

Book Review: Lawrence Lau’s Trade War Analysis Offers a Route to Peace

Deng Xiaoping once said that no other country was more important than the United States in China’s foreign relations. Today, the same can be said of the United States, as China has risen to be a world power. The United States and China have become the two most important countries in the world; the United States is the largest economy and China is the second largest. The United States and China are the two largest trading nations in the world economy; China and the United States are the largest and the second largest trading partners for the top 20 trading countries in goods. In the 40 years since China opened its door to the world and less than two decades after Deng passed away, China’s economic development has caught up with every country except the United States. It is inevitable that China’s leaps-and-bounds growth would cause frictions as China tries to overtake the world’s largest economy sometime in the early 2030s.

History shows that frictions and conflicts, if not properly managed, can lead to major confrontations between a rising power and an established power. Professor Lawrence Lau’s book on the China-U.S. trade war is a timely study that uses hard data to gain an in-depth understanding of the nature of Sino-U.S. trade war at the time when political rhetoric is often fueling populism and nationalism in both countries. In his book, Professor Lau makes three major arguments, supported with rich data and careful analysis. His first major argument is that despite the damage done by the current trade war to both economies, it is still possible for the United States and China to overcome the negative and grow the economy. Professor Lau’s argument is based on his comprehensive analysis of U.S.-China trade data used by the U.S., China and the IMF. Taking into account different methods of calculating import/export value, the rules of origin, and service trade, the author concluded that the adjusted estimates of U.S.-China trade deficit in goods and services combined for 2017 was $254 billion, which was lower than the U.S. estimate of $376 billion and the Chinese figure of $278 billion for goods only.

Besides coming up with more realistic and reliable estimates of trade deficit figures in gross value, Professor Lau’s main contribution to studying and understanding the U.S.-China trade relationship is his adjusted estimates of the bilateral trade balance in goods and services in value-added terms. Most of the previous studies of trade did not include the spillover effects of exports on domestic value-added (GDP) and employment. Due to the different factor endowments of the two countries, the United States enjoyed more real benefits to the economy from exports than China did. According to Lau, the direct domestic value-added content of Chinese exports of goods to the U.S. was 24.8% on average in 2015, as compared to that of U.S. exports of goods to China of an average of 50.8%. By adding all rounds of value-added effects in the production of the exported goods, the total domestic value-added (GDP) was estimated at 66% of the value of Chinese exports to the U.S., and 88.7% of the value of U.S. exports to China. Thus, the total U.S.-China trade deficit in goods and services combined was estimated as $111 billion in terms of total value-added in 2017, a figure that was much lower than commonly estimated by both countries.

Professor Lau further argued that although the real impact of the trade war has been limited and can be easily managed by both the U.S. and China, in the long term economic and technological competition between the two countries could become the “new normal.” China may even gain a certain competitive edge over the U.S. in some areas in the 21st century such as artificial intelligence, quantum computing and communication, electric cars, and alternative energy. However, China, as the second largest economy, still has a long way to catch up with the United States in terms of GDP per capita, scientific and technological development, and innovative capacity, even if China may overtake the U.S. economy in real GDP terms in 2030s. This projection generally falls in line with mainstream economists’ estimates.

Professor Lau’s third argument focuses on the economic rationality of how to develop a win-win trade relationship between the United States and China. He held that the two economies are essentially different when comparing factor endowments and stages of development. For example, China has large primary and secondary sectors and its service sector just barely contributed 50% of its GDP, while the United States has much smaller primary and secondary sectors ( 1% and 19% of its GDP respectively), and a much larger service sector (80%). What China needs is manufactured goods such as automobiles and appliances as opposed to U.S. needs of services and leisure.

As such, Professor Lau concluded that both economies are highly complementary and there is more room to enhance interdependence of the two economies. To do so, both countries need to adopt a win-win trade policy that emphasizes collaboration and cooperation leading to fuller utilization of resources endowed in both countries. China and the United States can benefit a great deal from mutual trade and investment, since the U.S. has comparative advantage in energy, agriculture, and water and China has comparative advantage in human resources and savings. In fact, Professor Lau optimistically argued that given such economic complementarities between the two countries, aided with a bilateral free trade policy, it is entirely feasible for the U.S. to wipe out its trade deficit with China and for both countries to achieve a balance of trade in goods and services within five years. Although China has long complained about U.S. export control policies that restrict high-tech, dual-use technology products to China, such an argument can hardly justify and solve the U.S. trade deficit with China.

But Professor Lau’s proposal to increase exports to China in agricultural commodities and energy products such as natural gas and shale oil will be less controversial and practical. He estimated that additional exports in agriculture and energy areas can reach $100 billion a year, and will be almost 100% U.S. value-added. Of course, food and energy are sensitive and hinge on reliability in price and supply, which requires long-term stable collaboration and cooperation between the two countries.

A long-term and stable trade relationship, however, is also a function of political, strategic, and power plays between the United States and China. The U.S.-China trade war is only one of many issues affecting the bilateral relations. Instead of minimizing or setting aside some of the issues as both countries did in the past, China and the United States have today increasingly hardened and stiffened their positions on the issue of Taiwan, the South China Sea and strategic intentions. Any escalation of those issues could lead to the Thucydides Trap for both countries and adversely affect bilateral trade. This scenario of political relations is clearly on the author’s mind and that is why Professor Lau at the end briefly discusses a “New Type of Major-Power Relationship” a concept proposed by President Xi and yet to be understood and embraced by the United States. This book is about trade and written by an economist, but readers can not only learn from Professor Lau’s masterful use of data and all-pervading and balanced analysis, but also his insightful and practical policy solutions to U.S.-China trade issues.

The China-U.S. Trade War and Future Economic Relations, by Lawrence J. Lau, (Hong Kong: The Chinese University of Hong Kong), 2019.

Qingshan Tan is a professor at Cleveland State University’s Department of Political Science

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