Adam Smith developed the doctrine of free markets in response. To quote George Magnus of Oxford University’s China Center, he “saw the emphasis of mercantilism on the acquisition of gold and silver, and the associated suppression of imports and promotion of exports, as incompatible with the accumulation of wealth for citizens.”
Smith’s philosophy animated the liberalism that dominated the West for most of the last century. The aim of the tariffs launched on April 2, Trump’s Liberation Day, was to bring back the world that Smith had reacted against. Since that announcement, which imposed trade barriers far higher than had been expected, the progress of the new mercantilism has presented two surprises. First, despite the initial horrified market reaction, the tariffs remain in place at much the same rates. Indeed, they’ve risen for countries as important as India and Brazil. Second, barely anyone has retaliated. The world has acquiesced in tipping the terms of trade sharply in favor of the US.
So far, this looks like a crushing victory for America First. But it ignores one critical factor. There is already one country that has been practicing mercantilism for decades, it’s very good at it, and it appears to be a step ahead of the US as it starts to play the same game: China.
China’s Mercantilism 1.0 — artificially cheap currency and gaming the WTO
Magnus of Oxford University argues that the US is making a belated response to the path that China has blazed since at least the mid-2000s. Once the World Trade Organization admitted the nation in late 2001, Magnus argues, the WTO soon found that it was not equipped nor empowered to keep it in check:
The long march, as we might say, of industrial policies… included an array of initiatives spanning a special status for state enterprises, subsidies, direct grants and lending, below-market borrowing, state-directed credit, and technology transfer and procurement policies, all of which sustained China’s status as a “non-market economy.”That led to the consequences that are now well-known. China steadily allowed its currency to rise from 2005, having long held it artificially cheap, but de-industrialization continued apace in the US, provoking serious social problems and, eventually, a political backlash with the election of Donald Trump. China has steadily moved on from the very cheap, basic manufactures that started its rise, and ceded that business to other emerging countries such as Vietnam and Bangladesh. It also ran into trouble with a clumsy devaluation in 2015 briefly threatening to plunge the world into financial crisis. Its trade balance shrunk more than 40%, from $600 billion to less than $400 billion, between 2015 and 2018. But even as it attempts to transition to a consumer- rather than export-led economy, it still plays the game of mercantilism peerlessly well. Since 2018, the trade balance has trebled, unimpeded by US tariffs. It now stands at a record, just below $1.2 trillion.
China’s Mercantilism 2.0 — dumping products on everyone else and skirting the US
Even as the countries are in talks to come to a workable relationship, Chinese exports to the US suffer an extreme tariff of 57%. It’s not surprising that they have fallen by almost a quarter from the peak three years ago. And yet overall exports to all countries (including the US) so far this year are at an all-time high.
The response to the new US mercantilist policy was to export everywhere else at prices nobody else can match — what trade-policy wonks call “dumping.”
For years, China was accused of exporting deflation to the rest of the world. Cheap imports allowed the US economy to run very hot without generating inflation. Now, it is effectively exporting involution — the name the Chinese authorities have given to the destructive competition and overcapacity that bedevils many of the country’s industries. One way to deal with a glut of products, manufactured at uneconomic profit margins, is to dump them on the rest of the world. That is what China is doing, very effectively — even though protectionism has closed the US market to them.
This is a new development. After accession to the WTO, China’s exports to the US rose almost exactly in line with its overall global exports for the best part of two decades. By 2019, they had risen 852%, while trade to all countries was up 849%. The pandemic, and the Trump 1.0 tariffs, which Biden maintained, changed that.
Neil Shearing, chief economist of Capital Economics in London, argues that the biggest forces reshaping trade today stem from Beijing, not Washington. China’s efforts to export its overcapacity and compensate for the loss of US business could cause more problems even than the Trump 2.0 tariffs. He contrasts this with the way China dealt with the first Trump administration’s trade levies. Then, its chief remedy was to route exports through third nations such as Vietnam and Mexico. This time:
So far, there has been much less rerouting. Our estimates suggest that the share of China’s exports going to the US has fallen by about 4 percentage points this year, whereas the share being shipped indirectly to the US has increased by only 0.5 percentage points. In other words, only around one-eighth of the decline… has been offset by rerouting.
In 2018, as much as a third of the decline in direct Chinese exports found their way to the US by indirect routes. But countries like Mexico gain little from this, and risk incurring America’s ire. So, before Trump had even returned to power, China embarked on an alternative policy of dumping. In the 12 months from October 2022, when Beijing began lifting its disastrously tight Covid-Zero restrictions and attempted to rebuild, Chinese export prices dropped 22%. Prices elsewhere were broadly flat.
China’s Mercantilism 3.0 — establishing dominance in the coming technologies before anyone else can match them
Mercantilism is a backward-looking philosophy. That’s a fair description of the Trump goal of bringing back manufacturing jobs to the US, and putting up trade barriers against countries whose chief exports are cheap commodity products like T-shirts. The aim is a return to a previous era of American greatness.
But China’s new mercantilism is distinctly forward-looking. Chris Watling, chief executive of Longview Economics in London, points to its dominance in a series of critical growing industries. Last year, the country produced more than 70% of the world’s electric vehicles, 92% of global solar cells, 98% of solar wafers, and 85% of solar panels, according to the International Energy Agency. It made more than three-quarters of all batteries sold globally — Chinese battery prices have dropped by nearly 30%.
Products like these are subject to fierce over-competition in China, as new entrants crowd into exciting, nascent sectors. That has driven prices down, eaten at corporate profits — and prompted the government to launch its “anti-involution” campaign. The obvious fate for a glut of uneconomically cheap products is to dump them on the rest of the world. That could cement China’s global dominance in these sectors.
The US under Trump is committed to the view that green energy is a “scam.” It needs to be right about this, as it will take a terrible mercantilist defeat if carbon fuels are indeed on the way out. Even if not, China is establishing a crucial advantage in access to cheap energy. As Watling says, China’s cost of producing electricity now stands to be less than half that of the US.
Mercantilism, is now the way of the world. But Americans are not the best players of this new game. China has the world’s most-experienced mercantilists, and the chances are that they will profit more than anyone from the order that the US is creating.
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