World War III begins in earnest

When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win. Example, when we are down $100 billion with a certain country and they get cute, don’t trade anymore-we win big. It’s easy. –a Trump tweet, 2 March, 2018. 

When voters with no knowledge of economics elect a ruler equally ignorant in economics, they dig their own grave. It is all right for them to not know philosophy, theology or zoology. But economics? Economics shapes our daily life. Economists playing politics are bad enough, but politicians playing economics cause disasters.

Donald Trump started a trade war with China last year, and accelerated it this month. USA imports a lot more from China than China imports from the USA. Economists will tell you there is nothing intrinsically wrong with this, but the deficit gives Trump an inferiority complex. The solution, conceived by his infantile mind, is to impose import duties. On 10 May, he raised import duties to 25% on $200 billion worth of products imported from China. Mathematically, the US government will collect $50 billion (25% of $200 billion) in duties. Where does this money come from? 

Trump won’t admit it, but the money comes from Americans. American importers and American consumers pay the duties, not the Chinese. Since the start of the tariff war, washing machines have become 12% more expensive. All steel products have become 9% dearer. So far, the American consumers have paid $5.6 billion to the Trump coffers. Why can’t the Chinese share the burden? Let’s look at the i-phone caste-study to find the answer.

I-phone

The components of the i-phone are sourced from different parts of the world. The final assembly takes place in China. Technically, when the final product is shipped from China to the USA, it will be a ‘made in China’ product, and in future Trump may charge 25% duties on it. (Not yet). 

Now look at the slide giving the cost break-up of the i-phone. Nearly 30% of the cost is incurred in the USA and 30% in Japan. China contributes only $8.50 out of the $240 cost of the i-phone 7. (Don’t get shocked at the margins Apple takes, you may have paid $1000 for the same phone). If Trump were to charge 25% on the $240 i-phone from China, the importer will pay $60 at the USA customs. China, providing only the battery and labour for assembly, is in no position to pay anything more. Tim Cook, Apple’s CEO has already clarified that in such a situation Apple will need to move production out of China. Why not move it back to America? That is what Trump wants anyway.

Global supply chains

Let me offer another example of a global supply chain I am more familiar with. Russia has large reserves of diamonds. Yakutia, a Russian republic, produces 99% of the Russian diamonds and 25% of the world diamonds. The raw diamonds from Yakutia are transported to Moscow, 8000 km away. At a monthly auction in Moscow, those uncut diamonds are bought by Indian businessmen from Surat. The auctions have been conducted uninterrupted under Stalin, Brezhnev, Gorbachev, Yeltsin and Putin.  (Diamonds last longer than any political ideology).

After the auction, the diamonds travel another 6000 km to Surat, a city in central India. For the past seventy years, Surat is the world’s largest center for cutting and polishing diamonds. 80% of the world’s diamonds are polished here. Some Surat factories have more than 30,000 workers. It is not uncommon to find three generations from a family devoting their career to diamond polishing.

The polished diamonds, the smooth gems, now travel another 8000 km to Antwerp, Belgium. The gems you see on New York’s Fifth Avenue have further travelled 8000 km from Belgium. In short, the Yakutia-Moscow-Surat-Antwerp-New York journey covers 30,000 km and four countries. Can the process be made more efficient?

The cost of labour in Surat, despite the singular expertise of the diamond polishers, is fairly low. It is unlikely any other country will be able to match it. But more important is the expertise accumulated over seventy years. Moscow auctions, Surat polishing, and Antwerp distribution are functions in which the respective geographies have specialized. They have built the necessary infrastructure and staff. Politicians - nationalists and populists – want to build walls, break unions and bring back jobs, but they forget supply chains are no longer local. They are global and complex, with each place playing a specialized role.  

It’s the same with China. China has specialized as a manufacturing hub for the world. USA, in the last 20 years, has lost one third of its production capacity, shut 90,000 factories, and got rid of 5 million manufacturing jobs. It is estimated that all existing tools and die-makers in the USA can be collected in a small room, whereas in China they will require hundreds of football fields.

USA can’t match the Chinese costs. Foxconn is Apple’s partner in China. At the Foxconn factory, there are regular reports of workers committing suicide due to low wages. Even if costs are ignored, there isn’t enough expertise in the USA to replace the Chinese production.

Stealing intellectual property

Trump also accuses China of stealing America’s intellectual property. The daylight robbery has been going on for three decades.

This is a legitimate grievance. However, much of this stealing happens contractually. Chinese legislation demands technology transfers or obligatory joint ventures for foreign partners. If the USA benefits from cheap Chinese labour and mass production, that is a price it has to pay. In any case, the Chinese engineers are intelligent enough to discover what others invent through reverse engineering.

I am writing these words on my Dell laptop with Microsoft office installed and Google as a screensaver. I communicate with friends and foes through gmail and facebook, order things on amazon, run in Nike shoes, shave with Gillette, book Uber on i-phone, wear Gap jeans, drink chilled water from a Whirlpool fridge and bank with CITIBANK. In what way is the American intellectual property damaged? And if counterfeiting by Chinese is as rampant as claimed by the Americans, how have the earnings and profits of the top American companies risen consistently?

War is a two-way process

In any war, the attacked side needs to retaliate. Because it also has its dignity. China has launched import duties on American products. The Chinese have to scratch their heads because they have such a massive trade surplus, there aren’t enough American goods to tariff. As part of its retaliation, China stopped buying Soybeans from the USA. The American farmers, most of them Trump voters, were shocked. China must be punished through heavy import duties, but how can they stop buying soybean from us? The angered farmers have lobbied Trump, and Trump has now promised to pay $ 12 billion to them. In effect, the American consumers will pay $ 12 billion to the American farmers. This is what happens when protectionism triumphs over market economy.  

China is not bound by market economy, or fluctuating currency or human rights. The American-Chinese trade war is, therefore, uneven to start with. Trump’s protectionism has repercussions everywhere in the world. The stock markets react with sharp falls. Like in any major war, Trump expects allies to dance to his tune. All US allies must now ban Huawei because the USA considers it dangerous for its security. And if they don’t, suitable punishment will be prescribed for them.

The Third World War has started. Those not conversant with economics will think the WW comparison exaggerated, until it pinches their personal finances in a big way.

Jews and Chinese

Surprisingly, there is little difference in what Hitler said before the Second World War, and what Trump is saying now.

Hitler: “The Jews have shown real genius by profiting from politics…. Once I really am in power, my first and foremost task will be the annihilation of the Jews.”

Trump: “We can’t continue to allow China to rape out country, and that’s what they’re doing. It’s the greatest theft in the history of the world.” “… There will be nobody left in China to do business with. Very bad for China, very good for the USA! But China has taken so advantage of the U.S. for so many years, that they are way ahead….” Trump Tweet, 13 May, 2019.

Trump is ignorant not only of economics, but also demographics. Hitler had only 18 million Jews to deal with. China’s population is 1.4 billion.

If this Third World War is allowed to continue, it will inflict severe damage on everyone in the world. There won’t be any winners. But Trump, like Hitler, will go down as the War’s most infamous casualty.

Ravi