China's Edge in the "Trade Struggle" is More Theoretical than Real
It *should* be easier to replace lost demand than lost supply, but there are good reasons to wonder whether it is actually possible for the party-state to pull it off.
Last week I was in Washington D.C. for Semafor’s World Economic Summit, as well as the spring meetings of the IMF and World Bank. I published a column for Semafor on the contrast between the ways officials from poorer countries try to convey competence and respectability vs. the conduct of officials from the current U.S. administration. Stay tuned for more in-depth analyses of both Argentina and Türkiye, which I discussed in the column. I also had the chance to join the Bookstack podcast to discuss Trade Wars Are Class Wars. Check it out!
Direct trade between China and the U.S. is set to collapse as punitively high tariffs imposed by both countries discourage most bilateral goods transactions. Container traffic to west coast ports is already plunging, while Chinese companies have proactively canceled orders for everything from Boeing jetliners to American liquefied natural gas (LNG). Most people in both countries—and the rest of the world—are going to be worse off as a result.1 But there is a natural temptation, especially among policymakers, to wonder who will come out relatively better from this unnecessary “trade struggle”, to use the Chinese government’s preferred term.
Martin Wolf made a very strong case for why China is in a stronger position, and while I agree with almost everything he wrote, I think he gets one important thing wrong. And that particular claim is so important to his overall argument that, if it does not hold, then much (though not all) of China’s supposed edge in the conflict would vanish.
This is the key passage:
For [China], the trade war is mainly a demand shock, while for the US it is mainly a supply shock. It is easier to replace lost demand than missing supply.
The first sentence is obviously correct. China does not depend much on imports from the U.S.—and much of what it does import from the U.S. (planes, commodities, and microchips) can be secured from others at comparable prices—whereas Americans are remarkably reliant on Chinese production for everything from batteries to children’s books to garlic. Stopping trade between the two societies will squeeze the income of China’s exporters (demand shock) and the volume of goods available to America’s consumers (supply shock).
The problem is that the second sentence, while almost always true, does not seem to be relevant to China now. Even though replacing any drop in foreign demand should be straightforward, there are good reasons to think that China’s policymakers may find themselves unable or unwilling to do what is necessary.
Keynesianism with Chinese Characteristics?
John Maynard Keynes’s entire career was arguably an elaboration of the claim that “it is easier to replace lost demand than missing supply”. He wrote the General Theory because he wanted economists and policymakers to understand that they had more options for managing downturns than they realized.2 That was an incredibly important lesson that many still fail to appreciate. The rich countries alone left tens of trillions on the table by running their economies below potential in the decade leading up to the pandemic.
At the same time, Keynes’s experiences helping the UK manage the material and financial challenges of WWI and WWII gave him a keen understanding of the importance of respecting material constraints.
As I noted 18 months ago, while many people love to quote Keynes’s line that “anything we can actually do we can afford”, it is worth remembering that it was part of a longer presentation on British postwar reconstruction in which he warned about the dangers of what would happen if policymakers failed to “prevent a demand in excess of the physical possibilities of supply”. Keynes’s single most important piece of advice, according to him, was for Britons to make “any reasonable sacrifice in the interests of exports” to generate hard currency needed for essential imports.
From this perspective, China has arguably been the society most committed to Keynesianism over the past few decades. Aggregate growth has been sustained despite large changes in both external and domestic conditions thanks to a high tolerance for debt.