Trade with Communists Should Be Uncertain

Businesses are not supposed to have confidence that they can profit in China

The importance of granting China “Permanent Normal Trade Relations” (PNTR) in 2000 lay in the “permanent,” not the “normal.” The United States had already opened its market to China on a provisional basis, but that favorable treatment required annual renewal by Congress. The uncertainty created by that temporary status, by Congress’s reluctance to go further, and by what all that implied about China’s stability and reliability, discouraged investment in the Chinese market and mass offshoring of production. Only after President Clinton affixed his signature to the United States–China Relations Act of 2000 did the floodgates open.

The arrival of certainty for investors brought with it equal measure of uncertainty for workers and their communities, as jobs vanished by the millions. This, lectured the economists, was “creative destruction” and a necessary process in the march of progress. Workers could adapt and move into new, more productive jobs. If some deindustrialized regions depopulated as well, it was the latest manifestation of the great American tradition. The Joads had moved too. We are now in the midst of a reckoning with those failures of judgment.

And yet, with the shoe now lodged firmly on the other foot, we are hearing less about the wonders of disruption and dynamism. Livelihoods destroyed by sudden shifts in the economics of trade with China apparently build less character in business owners, for whom just rebuilding from scratch in some new line of work is apparently much harder than for the typical machinist with a family to feed. On one hand, such parallels might seem churlish. How could investors anticipate the chaos unleashed by the Trump administration’s efforts at reordering the global economic system? On the other hand, the parallels might almost be too kind. Workers had no way to know what was coming with globalization; indeed the experts had promised them the opposite. Businesses could, and should, have anticipated an expiration date on the China gravy train. (Do gravy trains expire?)

As I observed a month before Liberation Day, at the National Association for Business Economics annual policy conference:

I think in 2018 you could have raised the question of the Vermont [small enterprise] who is 90% reliant on China. Everybody would have said “Wow, that’s really terrible, what could happen to them?” I think if in 2028 you’re still trying to say, “well, what did you want us to do, we just built our supply chains in China,” the answer is going to be, “well, that was really, really bad work from you,” just given the actual political landscape and the set of risks. And so I think businesses need to take a lot more seriously the economic-linked-to-political risk they are taking.

Economics reporter John Carney has been making a related point, arguing, “if you’ve built your business on imports from China and are facing ruin from tariffs, you made an incredibly risky business decision and then stuck with it even when the risks became too obvious to overlook, and asking, “I get that people thought prosperity would create stability through liberalization. That failed and the failure has been obvious for at least a decade. Why are you still dependent on China for your business to survive?”

With an especially provocative analogy, he suggested:

Companies that went all in on China and are now complaining about tariffs remind me of those that were all in on subprime loans.

Look. You made your choice. It went really well for quite a while. Some folks saw the end coming and changed directions. You decided to stick with the China plan, forecasting a different outcome than your competitors who diversified away from China. If you had been right, you would have done well.

You were wrong. There’s no crying in baseball. Salvage what you can or accept the cost of getting it wrong.

James Surowiecki, the intrepidly wrong writer for The Atlantic and formerly The New Yorker, responded, “There's no analogy here at all. The subprime business collapsed because the underlying loans were bad. The business of trading with China is perfectly fine. It's only run into trouble because of an arbitrary decision by the government.”

His insertion of the word “arbitrary” begs the question. Let’s stipulate that if the federal government announced one day that it was shutting down all businesses with blue in their logos, it would be unfair to ask why JetBlue had not anticipated the problem. But was “the business of trading with China” really “perfectly fine”? Surely the 20-plus years of China’s absurdly abusing the global trading system is relevant here. So too, the obvious cost that the “business of trading with China” was having on one’s fellow American citizens, and the political demands for corrective action.

If one supports democracy, then it is not some lamentable or unpredictable outcome when a government turns against free trade with China in response to voters turning against free trade with China in response to free trade with China, in fact, failing spectacularly. This is government as it is designed to work, and a business that relies on it not working is not a perfectly fine one.

Taking the risk on China paid off handsomely for many years, while businesses avoiding it likely faced higher costs. The dynamic is a common one across industries: taking risks, cutting corners, ignoring resilience is all fun and games while the weather is fair. All the while, companies behaving more responsibly assume the costs without seeing benefits. Paying insurance premiums when catastrophe does not strike can come to feel like a mug’s game.

But when winter comes and only the ant has food, the grasshopper doesn’t get to scream, “arbitrary decision by the government.” Conversely, of course, no one really wants to see the grasshopper starve. This problem is prevalent in public policy. In many insurance markets, it leads to mandates to maintain coverage. In financial markets, it leads to regulations requiring banks to maintain certain levels of capital or limiting the risks they can take. When it comes to international trade, how might we ensure that businesses betting on the low costs of risky supply chains internalize the costs of taking those risks, insofar as we do not want to just point and laugh when the storm comes? How might we ensure that better alternatives are available? One answer might be to impose some sort of tax or fee on the risky imports, reducing the cost advantage. We could call it a tariff.

In a sense, the “underlying loan”—here, the bet that free trade would liberalize China and convert it into a responsible trading partner—was bad from the start. PNTR only provides authentic certainty while the conditions for PNTR hold. Those conditions probably never held. They definitely have not for the past decade. Certainty was not warranted.

“By preferring the support of domestic to that of foreign industry,” wrote Adam Smith, “he intends only his own security.” It is this principle that works like “an invisible hand” to ensure that the capitalist, “pursuing his own interest, … promotes that of the society.” Presumably we should celebrate its influence reasserting itself.

Of course, the fact that policymakers erred grievously in subjecting workers and communities to sudden, value-destroying disruption is not an argument for now making the same mistake a second time. The nation should want to avoid those costs to the extent possible, even as it insists on accepting costs necessary to correcting course. A more gradual and predictable transition toward a clearly defined end point would be best for the American economy, for business owners, and for workers and their communities too.

But we should reconsider what we mean by “certainty.” Whether tariffs on China are at 145% or 30% or 10% or back up to 50%, the certainty of PNTR was built upon confidence in the irrevocable march toward a liberal world order. That confidence, and with it that certainty, is gone, and will not return. While it’s tempting to blame President Trump for the embarrassing scene, he was merely the one willing to say that the system had no clothes.

Anyone still relying on China today has not been paying attention. Anyone still relying on China three years from now will be guilty of gross negligence. The Trump administration should do a better job conveying its objectives and allowing time for Americans to adapt. Congress should pass legislation locking the trajectory of the U.S.-China relationship into law. But insofar as what businesses need is certainty about whether to run their supply chains through China, they know the answer. They just don’t like it.

- Oren