Advantage China after Trump-Kim summit

For all the talk about China being insecure with regard to potential Donald Trump-Kim Jong Un bonhomie, Beijing is likely to be rather pleased with the events that transpired in Singapore today.

First, soon after the early reports of the agreement came from Singapore, China called for easing sanctions and “establishing a peace mechanism.” The US-DPRK statement also envisions something similar, i.e., the “building of a lasting and robust peace regime.”

Such a framework places Beijing directly at the negotiating table. Foreign Minister Wang Yi underscored this today, saying China had and continues to play a “unique and important role” in the Korean Peninsula issue. The fact that Kim flew on an Air China jet shows Beijing’s continuing influence over Pyongyang.

Second, the formulation of the DPRK committing to work towards complete denuclearisation, while Trump describes US-South Korea drills as “provocative” and talks about ending US force presence in South Korea also works for Beijing in more ways than one. This is essentially what Beijing had been seeking for months, via its double freeze proposal. Moreover, Trump’s characterisation of US force presence in the region isn’t likely to have gone unnoticed in other regional capitals.

For one, the South Korean administration appeared to have been caught off guard with Trump offering the drills as a bargaining chip. The presidency and military both issued statements saying that clarity was needed on “the meaning and intention” of Trump’s remarks.

But more broadly, if US-South Korea military ties and exercises are “provocative,” would Washington under Trump be a reliable partner for states involved in the South China Sea dispute or even Taiwan, irrespective of the Indo-Pacific strategy and Defence Secretary James Mattis’ tough words at the Shangri-La Dialogue.

Also, Trump’s remarks about the cost of military exercises are very damaging. It’s one thing to want allies to carry their weight. But the repeated counting of costs is incredibly short-sighted and likely to raise questions about the costs that the US will be willing to incur to challenge an assertive China in the region.

After today, it appears that for all the rhetoric, Trump is uninterested in incurring those costs. Trump might have sought history in Singapore. But today’s developments mean it’s advantage Beijing.

The Indefatigable Chinese

The US, worried about its increasing trade deficit with China, the decreasing number of jobs created at home, and the ailing steel sector in the US, decided to import a tariff of 25% tariff on all steel imports. It also decided to levy a special 200% import duty on import of Chinese steel and justified it by using the dumping argument.

Briefly, according to the WTO rules, a country cannot impose selective tariffs on goods based on geographical origin. Thus, in case a country is worried about increasing amount of steel being imported from China, it cannot selective put tariffs on only Chinese steel. Thus, the US imposed a tariff on all steel imports, which left many of its trading partners livid. It then made a few exceptions to Canada and Mexico, only to withdraw those later. However, there is one clause in the WTO, which allows you to target a country for tariffs – by showing that the country is involved in a process called dumping. Dumping is a case of price discrimination, where the producer is charging a different price to different customers. This is generally believed to be anti-competitive.

In China’s case, the allegation of dumping is based on the differential pricing of Chinese steel for consumers in China and the rest of the world. Since most Chinese steel companies are state funded, they charge a higher price at home and subsidises the export of steel, in order to conquer the other markets. China denies this, of course.

What is really interesting here though is that the Chinese have found a way to circumvent the additional dumping duties imposed by the US. China state-owned steel manufacturers are buying steel plants in other countries and then, shipping to the US, as reported in this WSJ article.

By owning production abroad, Chinese steelmakers aim to gain largely unfettered access to global markets. Their factories back in China are constrained by steep tariffs imposed by the U.S. and numerous other countries—largely before President Donald Trump took office—to stop Chinese steelmakers from dumping excess production onto world markets. But their factories outside China face few so-called antidumping tariffs.

“China is just moving whole industrial clusters to external geographies and then continuing to overproduce steel, aluminum, cement, plate glass, textiles, etc.,” says Tristan Kenderdine, research director at Future Risk, a consulting firm that tracks China’s overseas investments.

Hesteel, a Chinese state-owned manufacturer, purchased a dying steel mill in Serbia, invested millions of dollars, ramped up production and has started exporting to the US. Not only that, it also gets to circumvent the high tariff on steel by the EU. By producing within the EU common market area, it can export to the rest of the European Union, without any tariffs or customs. Similarly, China is already investing in steel plants in India, Pakistan, Indonesia, Brazil, and many other emerging economies.

What China has managed to do is put US in a very peculiar position. If it wants to stop import of Chinese steel, it would now have to impose higher duties on a whole host of countries. If it does this, it will face severe backlash from these countries, which would end up severely hurting the US.

The cleverest move perhaps is that China has now forged a joint venture with Pittsburgh-based stainless-steel producer Allegheny Technologies Inc. The joint venture is restarting a stainless-steel rolling plant in western Pennsylvania and is importing 300,000 metric tons of semifinished stainless-steel slabs from an Indonesian plant owned by Chinese state-owned companies. This puts the US in a real pickle.


Why has the US Policy Orthodoxy on Iran Sustained for Four Decades?

On 8th May, the US President announced that the US was withdrawing from the Iran nuclear deal. The US would also be reimposing the sanctions on Iran that were in place prior to the deal. Essentially, we are back to a hostile Iran-US relationship after a short break where a change seemed likely. Now, this hostile policy orthodoxy in the US vis-a-vis Iran has sustained itself for nearly 4 decades. And one of the foreign policy mysteries for me has been: why is that the case?

After all, Iran is one of the most “normal” states in West Asia. It is also a regional power and now there is even some alignment between US and Iranian interests in Afghanistan and over ISIS. And yet, the foreign policy of the US towards Iran hasn’t change for nearly forty years. What are the possible reasons? I asked this question to my colleagues. I’m summarising some of their responses and my own views on them.

The oft-repeated reason given is the Iran hostage crisis of 1979. It is argued that this highly televised, 444-day imbroglio is the reason behind the perception of Iran as a ‘rogue state’ in the US. I doubt if that is the case. Even though this crisis might well be the reason that set the current policy orthodoxy in motion, it does not sufficiently explain why the orthodoxy would continue for four decades. In fact, in the same year the US embassy in Islamabad was burnt. Two Americans died as a result. And yet, there was no break in the US-Pakistan relationship. So, it doesn’t seem logical that another contemporary incident of a similar nature, one in which no American hostage was killed, can create and sustain a policy orthodoxy for four decades. 

The second reason given is that the hatred towards Iran is sustained by Iran’s own acts of hostility towards the US. Indeed, Iran has often taken up the gauntlet on various occasions. But again, this reason doesn’t sufficiently explain why the policy orthodoxy did not change even after Iran demonstrated its willingness to change as part of the P5+1 negotiations. The North Korean example shows that the US that a change in relationship terms is possible even with a state belonging to the ‘axis of evil’.

The third reason given is Trump. That’s an easy one to contest though. Long before Trump came into the picture, this policy orthodoxy was still going strong.

The fourth reason give is “follow the money”. The argument is that pro-Israel and pro-Saudi lobbies in the US ensure that there is no foreign policy change in the US on the Iran issue. There is some weight in this argument and it could help explain the longevity of the policy orthodoxy. If that is case, the emergent hypothesis is that the policy change is incumbent on the Iran-Saudi Arabia-Israel triangle. Unless Iran can patch up with at least one of these two West Asian powers, the US will keep the heat on. 

In any case, this question needs methodical research. I think it’s just one of those questions in foreign policy which is not raised enough. Someone should do a study of the kind Nicolas Blarel has done to explain the orthodoxy and change in the India-Israel relationship. Or perhaps, I have been ignorant. If you know of a study that tackles this question systematically, please point me to it!



Trade Policy as a Tool for Coercion

The ongoing trade war between the US and China has highlighted, once again, how trade policy can be deployed as a tool of coercion. Whether it will be effective is not something that I know enough about. But what interests me is this: what are the conditions under which bilateral trade policy can be used as a tool for coercion?

The zeroth condition is that there must be a substantial trade relationship between the to-be-coercive state and the to-be-coerced state. Failing this condition, trade can at best be used as a tool for inducement but not coercion. For example, India cannot use trade as a tool for coercion with Pakistan because there is barely any trading relationship between the two states.

The next condition is that the coercive state must be an overwhelmingly large market compared to the coerced state. Product bans and raising tariffs can be potent tools only if the losses incurred to the coerced state are significant. It is precisely because of this condition that helped imperial China intimidate many of its small neighbours. The message to all its tributary states was clear and consistent across centuries: we have everything in abundance here. It is you who needs access to our market. So, pay tributes and kowtow to the Emperor or you shall never have trading rights.

Robert Blackwill & Jennifer Harris have earlier described how Russia has repeatedly used trade as a tool for coercion against its smaller neighbours.

In the recent past, Georgian wines, Ukrainian chocolates, Tajik nuts, Lithuanian and even American dairy products, and McDonald’s have all fallen afoul of sudden injunctions… While dealing a significant blow to the Ukrainian economy, Moscow’s geoeconomic moves served, first, to remind Ukraine— and others in the region— of the consequences of decreasing ties to Russia in favour of the European Union; second, to reinforce Russia’s role as an economic regional hegemon; and third, to prevent the continued expansion of the North Atlantic Treaty Organisation to Russia’s borders. Facing Russian threats on countless levels, Ukraine halted its plans to sign deals with the EU at the November 2013 Eastern Partnership summit in Vilnius. [War by Other Means, Blackwill & Harris]

The third condition is that the coercive state should have a bilateral trade deficit with the coerced state. This is counterintuitive — most people regard trade deficit as a liability rather than an asset. But it is this deficit which lends a dimension of intimidation to trade policy. This is precisely the reason why the US could use this tool in the first place against China. There are a range of goods on which the US runs a bilateral deficit with China.

My contention is that the presence of all three conditions is necessary for the use of trade policy as a tool for coercion. Seen from this lens, the US trade war against China satisfies conditions one and three but does not meet condition two. Hence, its effect on China is likely to be limited.

In general, trade policy’s effectiveness as a coercive tool additionally depends on what is being demanded from the coerced state. It also depends on the ability of the coercing state to incur the losses resulting from retaliatory actions by the coerced state. 

PS: Read Anupam’s piece that warns about the economic losses emerging out of protectionist policies.

Brush up on Your History, Mr. President

Back in 1930, 1028 prominent economists wrote a letter to Congress urging them to reject the highly protectionist Smoot-Hawley Tariff Act. Messrs Smoot and Hawley, Senator and Representative respectively, sponsored the Tariff Act which raised the tariffs on more than 20,000 imported goods. Congress did not heed to the advice of the economists and went ahead with the Tariff Act. Naturally, other countries followed suit and retaliated against the US protectionist measures. This had disastrous consequences on the American economy and global trade, in general.

US imports decreased 66% between 1929 and 1933, and exports decreased 61% in the same time period. Gross National Product fell from $103 billion in 1929 to $76 billion in 1931 and bottomed out at $56 billion in 1933. Overall, world trade decreased by some 66% between 1929 and 1934. The tariffs, which were meant to protect American jobs, did not do much on that account either. Unemployment was at 8% in 1930 when the Smoot–Hawley tariff was passed. The rate jumped to 16% in 1931, and 25% in 1932–33. To be sure, not all of these effects can be attributed solely to the protectionist measures, given that the economy was in a downturn already, but it did have a significant negative effect.

Now, in 2018, President Trump has introduced a host of protectionist measures and imposed tariffs on washing machines, solar components, and even steel and aluminium used by U.S. manufacturers. With the reintroduction of tariffs, the economists are back once again. More than 1100 economists, including several previous Nobel prize winners, have signed a letter to Trump warning him of the dangers of the new protectionist measures. They draw his attention to history, to the Smoot-Hawley tariff in particular. In fact, the latter half of the letter just reproduces the economic principles laid out in the original letter. They reason that though the components and volume of trade have changed, “the fundamental economic principles as explained at the time have not”.

We are convinced that increased protective duties would be a mistake. They would operate, in general, to increase the prices which domestic consumers would have to pay. A higher level of protection would raise the cost of living and injure the great majority of our citizens.

Few people could hope to gain from such a change. Construction, transportation and public utility workers, professional people and those employed in banks, hotels, newspaper offices, in the wholesale and retail trades, and scores of other occupations would clearly lose, since they produce no products which could be protected by tariff barriers.

The vast majority of farmers, also, would lose through increased duties, and in a double fashion. First, as consumers they would have to pay still higher prices for the products, made of textiles, chemicals, iron, and steel, which they buy. Second, as producers, their ability to sell their products would be further restricted by barriers placed in the way of foreigners who wished to sell goods to us.

Our export trade, in general, would suffer. Countries cannot permanently buy from us unless they are permitted to sell to us, and the more we restrict the importation of goods from them by means of ever higher tariffs the more we reduce the possibility of our exporting to them. Such action would inevitably provoke other countries to pay us back in kind by levying retaliatory duties against our goods.

Finally, we would urge our Government to consider the bitterness which a policy of higher tariffs would inevitably inject into our international relations. A tariff war does not furnish good soil for the growth of world peace.

P.S: I had recorded a “The Seen and The Unseen” Podcast with Amit Varma on the 8 Myths of Protectionism. Check it out:

Is the US immigration policy an opportunity for India?

Earlier in the day, we discussed the impact of a tighter US immigration policy regime on India. At the margin, will it lead skilled Indians to return to India? Nitin Pai in The Print gives a conditional yes as an answer.

Even if pay scales were equivalent (say in terms of purchasing power parity), few NRIs would trade the comfort, security and quality of life in a developed country and come back and face the challenges of daily life in India. Despite sentimental links, patriotic feelings and family connections, most NRIs prefer to live abroad. It won’t change because of government schemes, no matter how attractive they are on paper.

This idea can be conceptualised as two forces acting in the opposite direction. One force is a “India” premium — the extra salary that would compensate for the returnee’s lower quality of life in India. A force in the opposite direction is the “motherland” discount — the discount arising out of patriotic and familial considerations, leading people to stay back or return to India. It is the interplay between these two forces that will decide the direction of skilled labour flows.

As of today, the “India” premium is way larger than the “motherland” discount. Closing this gap is necessary to convert US immigration policy into an opportunity for India.