6.5: Mercantilist Trade Policy

A U.S. reporter asked a Chinese engineer where they got the money for their huge Three Gorges Dam. The engineer laughed incredulously and said, “From you!”

In contrast to the free traders, Realists see trade as another aspect of competition among nation-states. Therefore, they believe in using government to develop a strong industrial and technology base, helping domestic industries with tariff protection and subsidies, managing trade to develop a trade surplus (exporting more than they import), and building up foreign exchange reserves. In earlier centuries, trade surpluses were used to increase gold and silver holdings to gain a financial and military advantage. Today, they are used for economic development by making investments in infrastructure, education, technology and research and development.

For instance, in 2016 the Chinese government embarked on a $300 billion Made in China 2025 program to develop world dominance in high-tech industries such as chip design and production, robotics, artificial intelligence, pharmaceuticals, aerospace, biotechnology and electric cars. Accordingly, companies like telecom giant Huawei receive large government subsidies, contracts and infrastructure funding, enabling them to sometimes sell their products for less than the cost of production. (The company’s 2018 annual report lists $222 million in government grants.) Huawei also has $100 billion in customer financing available from a Chinese government bank. Its equipment is cheap and reliable, and has been installed in 120 countries, including the U.S. As China increasingly develops its own system of fast innovation, in some fields such as 5G, voice recognition and facial recognition, they are now ahead of the U.S. For example, Tencent’s WeChat allows messaging, purchases, games, flight and restaurant reservations and many other functions all in one app.

Behind their free-trade rhetoric, China, Germany, Japan and many others actually manage their trade to earn surpluses, protect jobs and accumulate foreign currency reserves. China now has a trade surplus of over $400 bil/yr with the U.S. After China kept its currency and prices artificially low for years by buying U.S. dollars, it has accumulated over $3 trillion in the Treasury bills that the U.S. issues to finance budget deficits. So there is now a peculiar situation in which China finances U.S. budget deficits so that the U.S. can buy Chinese goods. Obviously this gives the Chinese some leverage. On the other hand, they need the U.S. market and technology to keep growing. Trump’s tariff war with China has thrown this co-dependency into sharp focus. However, as China’s technology improves, its domestic market grows and it diversifies its exports to more countries, it is becoming less dependent on the U.S. market.

The U.S has relatively low tariffs, mostly engages in free trade and has a deficit with many of its trade partners. Partly this is because during the Cold War it wanted to help its allies develop their economies. Partly it is because American companies are satisfied with the large U.S. domestic market and have not tried hard enough to increase exports. Contrast their poor export performance with Germany, which has an economy only one-fifth the size of the U.S. but is the world’s second largest exporter. The Obama administration did succeed in increasing exports, even as Republicans cut funds for the Export-Import Bank, but the U.S. has a long way to go to become an export power.

There is also a constant struggle over technology transfer. In the 1600s and 1700s, Western priests stole silkworms from China to start a European silk industry and European potters copied Chinese porcelains. In the 1700s, Americans stole British textile technology, which had been stolen from the Dutch. In the 1970s and 80s, Japan used various legal and illegal tactics to gain access to U.S. technology and wipe out whole sectors such as video recorders and the machine-tool industry. For decades, China has routinely pirated Western technology by reverse engineering Russian fighter jets, Ford F-150s, etc. (Huawei first became successful by copying Cisco servers.) More recently, it has engaged in by large-scale hacking, e.g. copying the new F-35 fighter jet. It also picks the brains of U.S. scientists in the high-paying Thousand Talents program, and asks Chinese scientists, tech workers and students in the West to pass on what they learn. Chinese businessmen have even been caught digging up Iowa corn fields in order to steal seeds. In 2019, the FBI reported that it has about 1,000 espionage cases, virtually of which lead back to China.

In addition, in order to do business in China, Western companies must share their technology. Once Chinese workers and managers master the technology, the government helps them set up competing companies. For example, European and Japanese high-speed train companies and American solar and wind power companies now must compete against their own technology, sold cheaper by Chinese companies who dominate the world market. Westinghouse recently gave the Chinese tens of thousands of pages of specifications of its nuclear power plants, and will no doubt face Chinese competition using that same technology.

Meanwhile, 90% of the software, DVDs and CDs sold in China are pirated, costing Hollywood, Microsoft and others billions of dollars a year in lost sales. The Chinese government periodically engages in symbolic acts such as crushing illegal DVDs with bulldozers, but the production of pirated technology and consumer goods continues, sometimes in factories owned by the government.