Maximize costs to Chinese firms but keep US consumers in mind

Stock markets have calmed down as fears of a full-blown trade war have subsided. The steel tariffs, while tenuous on economic grounds, turn out to be so exemption-ridden as to matter little for the U.S. economy.

The larger trade dispute, however, remains outstanding: the prosecution of U.S. complaints against China’s policy of forcing American businesses to transfer technology to Chinese partners, along with other practices such as cyber-intrusions that amount to a pattern of theft of U.S. intellectual property.

{mosads}The U.S. is on solid ground in going after apparent Chinese violations of international trade rules. Taking China to a World Trade Organization (WTO) dispute resolution panel over its technology licensing requirements is an appropriate step to end arbitrary grabs at the returns to the innovative activities that propel U.S. productivity and income growth.

China is no longer a low-income country and can afford to pay for U.S. technology. Moreover, China itself has innovative sectors and world-class researchers that will benefit from a global intellectual property regime in which invention is compensated rather than stolen.

The U.S. effort to protect intellectual property rights should find support from other countries — even if our allies prefer for us to do the work and face any Chinese retribution. 

While the turn to the WTO system is laudable, even unilateral U.S. moves to impose sanctions on China under the Section 301 investigation ultimately can be helpful as well. This is even the case when tariffs on Chinese products have a negative impact on American families and businesses that rely on items made in China.

The calculus is that the long-term benefits of increased revenue from China paying for American technology will offset the near-term costs of tariffs and other measures, such as restrictions on Chinese investment into the United States, that are meant to get China to change its ways.

The key is to target our sanctions carefully to end up with a diversion of trade from Chinese firms to other low-cost global suppliers, rather than to end up with a large price impact as domestic firms jack up prices once sheltered from foreign competition (as has been reported to be the case in some segments of the steel market, even while the overall impact of the steel tariffs are modest).

It will be impossible to impose tariffs only on items for which there are ready alternative low-cost suppliers. After all, the United States imports so many things from China for a reason.

But the U.S. approach as much as possible should focus on imposing tariffs on items for which there are alternative suppliers, even if those are not American suppliers.

The idea is not to boost U.S. producers (as is the intent of the steel tariffs), but instead to maximize the costs on Chinese firms while minimizing the harm to U.S. consumers and businesses that benefit from the availability of greater choices and lower costs brought about by international trade.

A way to maximize the extent to which the Section 301 remedies shift production from China to other countries without raising prices on Americans would be to have the tariffs start at some modest rate such as 5 percent and then gradually increase by 5 or 10 percentage points each year on a schedule set in advance.

This will give American companies now importing from China time to find new suppliers and will lead firms producing in China an incentive to shift to other countries. The point is not to raise costs or even to harm China, but instead to bring about an end to the harmful Chinese practices.

As with tariffs, restrictions on Chinese investment in the United States make sense as a tool to change China’s behavior, but it is essential for U.S. policymakers to make clear to global investors that these sanctions are about the protection of intellectual property and that the United States remains open to investment from other countries. 

It would be an unforced error if U.S. actions or even rhetoric leads foreigners to think that the United States is not open to international trade and investment.

Given the large U.S. fiscal imbalance and our desire to maintain strong investment even while American consumers continue to spend, we need capital to flow into the United States — the availability of foreign capital is what allows us to spend and invest.  

Inadvertently chasing away foreign capital would lead to a damaging rise in U.S. interest rates that would undercut the U.S. economic upswing.

Indeed, it is hard not to notice that the stock market cringes and falls when talk of trade barriers rises, and it recovers when it becomes clear that initial descriptions of trade policy steps turn out to be heavier on rhetoric than impact.

Even so, action on trade makes sense if it ends Chinese practices that are a drain on our long-term prosperity. A trade war would be harmful, but targeted actions that protect U.S. intellectual property make sense if the benefits of such actions outweigh the near-term costs of the tariffs and investment restrictions.

Phillip Swagel is a professor at the University of Maryland’s School of Public Policy and a senior fellow at the Milken Institute. He was assistant secretary for economic policy at the Treasury Department from December 2006 to January 2009.