Since the U.S. launched its trade war with China in March 2018, we have seen negotiations stall, tariffs raised, and markets falter. Judging by this past week’s actions on both sides, including currency depreciation, the brewing trade battles could well evolve into a war of attrition.
Amid the tit-for-tat and unpredictability, China’s remarkably consistent response to the trade war since 2019 has been overlooked. It took the better part of 2018 for Beijing to get a handle on the nature of the trade war. It then devised a strategy that prepared its economy to withstand the inevitable pain, while using the trade war as justification to focus on neglected long-term priorities.
Beijing so far has been relatively successful with this strategy, which means it increasingly believes that time is on its side when it comes to negotiating with the U.S.
Here’s why. Beijing is unlikely to defend growth at 6 percent if it comes to that. The same principle applies to defending the currency at 7 yuan to $1. Both are manufactured psychological thresholds that no longer hold much water.
The latest official thinking about the headline GDP growth marks a decisive shift away from short-termism and the tendency to juice growth at the first sign of weakness. This shift not only makes China more immune to the impact of additional tariffs, it has also led to a different approach in how the government manages the economy.
Rather than the credit-fueled binges that have come to define Chinese stimulus, Beijing has chosen to stimulate tactically as a way to spread the costs of the trade war. That’s because the pain of tariffs falls disproportionately on the private sector that makes up the bulk of exports. And concentrated pain in one interest group can lead to destabilizing forces that most governments want to prevent—just ask U.S. farmers caught in the current skirmish.
The private sector also holds political clout because it constitutes some 80 percent of urban jobs in China. If a cascade of failures happens among these private firms, the Chinese government will have a tough challenge on its hands.
So, in a twist of irony, the trade war has led Beijing to bend over backwards to support the private sector, even allowing state banks to provide cheap financing, a privilege that was once only conferred on large state firms. In short, this is the equivalent of redistributing from the state to the private sector that forces the former to share the pain.
In addition, any stimulus will take the form of interest rate cuts and tax cuts among consumers and corporates rather than another round of shovel-ready projects. That’s because Beijing is now only interested in doing the minimum necessary to put a floor on growth without sacrificing its main agenda of reducing debt and de-risking the financial system. The government no longer wants a stimulus program that will come at the expense of these longer-term priorities.
Of course, Beijing’s newfound reluctance on stimulus and the added downward pressure from the trade war means that it will have little choice but to sacrifice headline growth. This is why it’s important that the groundwork has been laid for a material shift in the government’s longstanding fixation on defending the GDP target.
In this context, even if headline growth dips below 6 percent, it is unlikely Beijing will step in to significantly pump up the economy. So long as the pain points from the trade war are being addressed – such as the private sector – Beijing will more or less settle for slower growth. This is indeed a far departure from the previous Hu Jintao and Wen Jiabao administration, in which it insisted on “protecting the eight” or defending growth at 8 percent no matter the cost.
But the much higher tolerance for slower growth also means that stepping up tariffs will have diminishing returns in bringing China back to the negotiating table. That’s because Beijing has prepared its economy for what it believes could become a protracted war.
Damien Ma is the director of Macropolo, the think tank of The Paulson Institute. Follow him on Twitter @damienics.