The impact of the trade war: A long-read Q&A with Scott Lincicome

What have been the economic costs of the trade conflict between America and China? Who has borne these costs? How will the struggle end? And how acceptable was the status quo before President Trump initiated this trade war? To unpack these questions, I’m delighted to be joined by Scott Lincicome.

Scott Lincicome is an international trade attorney with experience in trade litigation before the Department of Commerce, the US International Trade Commission, the US Court of International Trade, the European Commission and the World Trade Organization’s Dispute Settlement Body. He has also advised private sector clients on multilateral trade deals and policies. Scott is a visiting lecturer at Duke University as well as an adjunct scholar at the Cato Institute where he researches trade policy.

What follows is a lightly edited transcript of our conversation. You can download the episode here, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.

Pethokoukis: There’s a phrase that you put on merchandise a while back that goes like this:

“Tariffs not only impose immense economic costs, but also fail to achieve to achieve their primary policy aims and foster political dysfunction along the way.”

Let’s take a second to unpack that. Are you now calling this a tariff war? You were calling it a “skirmish” last year — has it become a war?

Lincicome: Yes. I think a year ago, we trade nerds were hesitant to call this a trade war.

At this point, with tariffs on well over half of all Chinese imports and with Chinese tariffs on essentially all American exports, give or take a few things, yeah, you can call it a trade war. Especially when you add the burden with washing machine safeguard tariffs, the solar panel safeguard tariffs, steel and aluminum national security tariffs.

I almost forgot about all of those, too.

Right, we have a litany of what I would call abnormal tariffs. The United States has some standard tariffs and standard trade-remedies regimes, but these are different. And they are far more aggressive and different from the trade status quo pre-Trump.

People who are for the trade war think that the pre-Trump status quo was not sustainable. They’ll say, “Well, all you free-traders are talking about all of these immense costs, but we don’t see it.”

Prices don’t seem to have gone up at all, everything seems fine. Everything at Walmart seems to be about the same price. So where are these “immense costs” meant to be imposed by what you would now call a trade war?

It’s really important to understand where the US tariffs really hit, at least until recently. The vast majority of these tariffs were on manufacturing input. So the reason that there wasn’t a lot of direct consumer price evidence for increases is because manufacturers in the United States were absorbing a lot of the costs. And when they were passing them on, they were doing it over a large variety of goods.

That’s one of the reasons that trade is such a tough political issue, because the benefits of the protectionism are quite significant and concentrated, whereas the costs are quite diffuse. But there have been multiple economic analyses written by really legitimate academic economists that have looked at the tariff costs, and they’ve said that the United States consumer — be it a manufacturer or an end–consumer like you or me — are bearing 95 percent, give or take, of the cost. And the idea that, as President Trump claims, that China is completely eating the costs isn’t true.

So theoretically, you could have “tariff incidence” as we call it, that falls more on the Chinese manufacturers where they lower their price, and the lower price plus the tariff becomes the same price that you and I are paying for. That does not seem to be happening. That gets to part of the “immense economic costs” issue, is that outside of economics there’s a real-world issue here. And that is that American manufacturers have very complex supply chains that take years to develop.

You do not just walk in to a factory and say, “Build me a widget.” There is a testing process, a qualification process, and all of these types of things. And of course there are long-term contracts, and we lawyers tend to tie things up to those.

All of this creates a really impossible situation for American manufacturers where they could not simply pick up and move their supplies, even if they wanted to. And that gets to the last issue — that there’s all of this talk about moving the supply chains.

Right, that they’ll just move to Vietnam. And maybe the ultimate goal is to move it all to Fremont, California so they can make all of the Apple products there. But at least they can move it to a country where we don’t seem to have the same sense of geopolitical conflict.

Exactly, and the problem there is twofold. One, it’s a simple resource issue: Vietnam is a much smaller country and it has a much smaller capacity to handle the magnitude of production that China does. So that’s a simple numbers issue.

But the other issue is that the Chinese market is massive and growing, and it’s a huge middle-class market that a lot of manufacturers, be they American, multinational, foreign, or whatever, are not simply going to abandon that market. So what we’re actually seeing is that the supply chains just bifurcate. You have a US supply chain that has some end–production in a place like Vietnam, and then you still have Chinese production. So even that is not really happening.

I wanted to get into what you see as the policy aims of the trade war. It seems like the administration not only wants goods for the US manufactured close to here, or preferably in the country. But it almost seems like they want goods for China and other countries also manufactured in the US.

We have car companies who build cars in the US under Trumpian trade policy, but if other countries adopted it then, for instance, German cars wouldn’t be made here. Every country would try to make everything in their own country.

It reflects a fundamental misunderstanding of the nature of modern manufacturing. I mentioned the supply chains: so these days, nobody makes 100 percent of a product in a single country. Instead, what manufacturers have done over the last 30 years or so is a classic case of comparative advantage.

You source from the country that has the comparative advantage in that one component, and then you ship all of the components to an assembly source. Typically that has been China, although that’s changing. And then you ship the finished good from that source.

However, at the same time there’s been a newer trend in manufacturing to build very close to your customer. The reason you would do that is because we customers are very fickle and very demanding.

We are so spoiled by things like Amazon that we want to click a button and have a customized widget – be it a cell phone or whatever – at our doorstep three days later, with our name engraved on the back in pink and bedazzled. And that cannot be done in China — it needs to be done closer to home. Particularly for large manufacturers, things like cars need this system.

Again, this whole idea of having this autarchic system where everything is made in the United States for the consumer and then we also export everything abroad is a fundamental misunderstanding of the nature of modern manufacturing.

To go back to supply chains — I think it was in the book The One Device where they told the story of the iPhone being made. I think the screen was originally going to be plastic, and then Steve Jobs decided, “It’s going to get scratched, so let’s make it this Gorilla Glass.”

It was this last minute change, and so they just scrambled the jets in China and woke up everybody and brought in thousands of workers. You really can’t do that in other places — they have a unique ability to do that, if you want to change things or throw a lot of resources at something very quickly.

There is something special because of their immense size and how they’ve developed these capabilities over the years, and you can’t just quickly transpose that to here.

Exactly. And I’ll add that one of the other cool things about the iPhone is this: so many of the iPhone’s components are not made in China. You mentioned the glass — nowadays, Corning Gorilla Glass is now made, I think in Kentucky, and then it’s shipped to China for assembly into an iPhone.

Studies have shown that the actual value-add in China of Chinese-made components from, say, an iPhone, is only about 10, 15 bucks. It used to be 5, now it’s 10 to 15, but still, that’s compared to having over $100 going to other manufacturers around the world — and hundreds more going to Apple’s shareholders, management, and employees in Cupertino.

Another part of the quote is the “policy aims.” I’m not sure of the policy aims. When I hear the president talk, especially if he’s speaking extemporaneously, he sounds the way he did 30 years ago talking about Japan. He thinks we’re being taken advantage of, and the evidence of that is the big trade deficit and he wants them to buy more of everything — more soybean, more sorghum, more products. And that through-line has been very consistent.

I don’t know if that is still what he thinks, because other people in the administration seem to have much broader goals — they want to disentangle the American and Chinese economies for both economic and national security reasons. They think we’re entering a new Cold War, and they’re also concerned about intellectual property and tech transfer. The president will mention that sometimes, especially if he’s reading off a teleprompter.

So is the goal just that they buy more stuff, and that that’d somehow effect the trade deficit even though economists say something different? Is the goal to do that, plus IP and tech-transfer stuff? Or is it also in addition to these bigger geopolitical considerations? [laughs] As you understand it, is it all-of-the-above, and that’s why it’s confusing?

I think the key is that it’s confusing, but I think it’s also really important to separate the tariffs. The steel, aluminum, washing-machine tariffs are just straight-up protectionist tariffs. They were implemented on an expressly protectionist ground. “We have imports that are hurting our domestic industries, and we’re going to put tariffs on the products so that our products can compete on a ‘level playing field,’ and that’ll bring these industries magically back to life.”

Now, that’s a very clear policy objective, and it pretty much has failed. If you’re reading the news these days, you’re seeing that steel–makers are struggling dramatically because the inevitable boomerang happens. Prices spiked, demand collapsed. Then, of course, there was retaliation that further dinged the global market, and the next thing you know steel–makers are over capacity, share prices tank, and now they’re starting to lay people off. I mean, it is a classic protectionist cycle that took about a year to work through. So that’s very straightforward.

China, on the other hand, is very confusing. So on the one hand, it’s “Buy more soybeans, lower the trade deficit. Fix intellectual property.” And yet you also have this geopolitical “Great Separation” of the two economies, this disengagement.

The problem is that all of these things fight against each other. So if you’re buying more from each other, you’re not actually separating the two economies. If you resolve the intellectual property issues — and look, there are some legitimate intellectual property issues in China — then you remove the tariffs and again, you don’t have this great disengagement. And then, of course if you do disengage, then you’re not gonna solve any of those previous two issues. Like you said, it becomes a grab–bag.

And the president also wants a deal, of course. He wants a deal so badly at this point that there are a lot of questions among China–hawks, which I’m certainly not one, but they question whether what we’re going to get is just total worthless garbage.

There’s this political element to all of this, which, again, is why tariffs are such a dumb policy mechanism, the president needs to get reelected and tariffs are punching your own economy in the face. Yes, the other guy is going to get hit too, but you’re hurting yourself in the process. And in a democratic country, particularly one that’s going against an authoritarian regime that doesn’t have elections every two to four years, it is quite difficult to maintain the level of pain needed to fight out the trade war.

And I should add: we were all promised as American consumers and voters, that this was going to be “Good and easy to win!” It was going to be very quick and painless. China was going to cave instantly, we were all going to be fine, and now we see Republican politicians promising to rebate tariff money to Americans so that we all are bearing the patriotic cost together. It’s nonsense!

It seemed as though there was almost a deal last spring, and at the beginning it was the kind of deal you might’ve anticipated: they buy more stuff, and they promise to tighten up intellectual property. But since then, there’s been so much more talk about the new Cold War, so do you think that kind of deal is still possible?

I think so.

Really? Because if we’re now worried about them infiltrating all of our communication systems with Huawei, to have a deal that doesn’t address national security issues? I don’t know what would cause Republicans to criticize the president on this, but it seems to me that there would be a lot of Republican complaints without that kind of deal.

I agree, the president has painted himself into a corner on this. He needs to do something to convince markets that we’re not going into a recession.

Yesterday’s manufacturing numbers were absolutely horrific — some of the worst numbers we’ve had since the Great Recession. And part of the reason for that is the president’s trade war. So he has to do something on that side.

Politically, also, remember that this is a man who sold himself as President Deals. He was going to make all of the deals that all of those stupid trade negotiators and the dumb trade–nerds like me couldn’t handle.

Right, that you had all been taken in by the super-smart Chinese negotiators.

“And they’re so much smarter than our guys, so I’m gonna handle it.” So President Deals needs a deal for political purposes — but like you said, on the other end, if he caves you’ll have national security hawks in his own party hitting him. You’ll have Democrats hitting him, too.

It looks like there is a little eye of a needle that they could thread, and that would be some sort of mini–deal. Essentially pulling back some of the latest tariffs, leaving on some of the other tariffs on industrial inputs, and announcing more soybean purchases and all of that. As well as some tweaks to intellectual property.

It would essentially be getting us back to where we were a few months ago — not a big deal, but something that calms us down.

Do you think the Chinese would go for that? They really want those tariffs off.

I don’t know. I mean, the Chinese economy is struggling, too — partly because of the tariffs but also because, let’s face it, it’s still a command-and-control economy in a lot of ways. There’s lots of distortion in their banking system and the rest. So they’re having problems, too.

You have these two superpowers limping at each other — it’s like round 14 in a Rocky movie. They’re just flailing at each other, all bloody. And it does seem that both sides wouldn’t mind stepping back from the cliff a little bit.

The big question, though, is whether they can find something that threads that needle — that assuages the hawks in the administration and in the Republican party, gives the president some political cover, and gives markets a little breathing room.

Certainly for the super-hawks, they feel like they have China on the mat, and it’s time to step on its neck. The only kind of deal they might accept is complete capitulation. [laughs]

And all of that stuff is so frustrating. Look, I think that everybody in this room, most people in this building and so forth, have very legitimate gripes with China. There are very legitimate criticisms, whether it’s on trade or human rights or military issues, national security issues, whatever. The problem is that the tariffs are just such a horrible mechanism to achieve these changes, and in fact give the Chinese government a ready excuse for the failures of their own economic system.

The hostile, aggressive, frontal attack of tariffs also makes it much harder, typically, for a foreign government to concede to demands that might even be in their interest. What some people don’t understand is that the Chinese government, for all their issues, was actually trying pre-Trump to move away from this distorted export-led economy. They were trying to move towards a more consumption-oriented economy — a more services-based economy while trying to move up the development ladder as all countries do.

Since then, in part because of President Xi’s own demands and desires, but also because of the trade war, we’ve seen them devolving and stepping back from some of these reforms. Empowering SOEs, inflating their banking system — all of these things that they were trying to get away from they’re getting back into because of the trade war.

We’ve mentioned intellectual property and tech-transfer: how big of a problem is that still? You hear some massive numbers on the theft issues, so what IP were they stealing and how significant was that to us economically?

There are two types of IP issues. One that is very serious and should be dealt with forcefully is the state-sponsored hacking. This is where you had Chinese military individuals actually infiltrating American companies’ computer systems and stealing their IP. Okay — that just straight-up needs to be dealt with through sanctions and the rest.

On the other hand, you have tech-transfer. Tech-transfer is a pretty normal thing. What the Chinese were allegedly doing was essentially saying, “Look, if you want to operate in China and have a joint venture here, you have to give your Chinese joint venture partner your IP. And that’s the cost for doing business in China.”

Now that is inconsistent with WTO rules — it’s actually inconsistent with one of China’s WTO-Plus accession commitments, but it still is a voluntary action by the American investor. “I want to be in China, therefore, I am going to give — I’m not having it stolen, I’m giving it — to my JV partner.” You can still say that’s an issue, but that’s very different. The numbers attached to these things are all over the place: USTR’s own report said $50 billion total, but that’s why the tariff level was originally $50 billion.

I’ve certainly heard numbers magnitudes larger than that many times.

These are the types things where anyone can put a number on anything. But there was just a survey a few days ago from the American Chamber of Commerce in China, and tech–transfer was way down on the list of their actual concerns. You know, 10 percent of companies were reporting it as an issue.

So is it worth destroying the bilateral trade relationship over something that American companies see as a minor issue? Probably not.

And they were trying to tighten up the IP stuff also for the benefit of Chinese companies.

Yes. In fact, there was another survey a year or two ago that said that Chinese intellectual property practices were approaching Canadian intellectual property practices. The Americans have some issues with Canadian IP policy, but the point was that China was generally getting better.

Again, we get back to the president’s contradictions: here’s one of the funny things about this. Let’s say China really cleaned up their IP regime and started letting American companies invest freely in China —

I think I know where you’re going with this.

It encourages outsourcing!

Right. It makes them a more attractive place to do business.

So now GM is going to put in another car factory there, and ship more cars back to the United States! So it’s baffling to me that the spear tip of the president’s China policy is something that would actually facilitate additional American offshore investment in China. It’s an incoherent policy when you start thinking about it.

Was the pre-Trump status quo truly sustainable? That status quo of having tariffs pretty low, globally, with big trade deficits between the US and other countries? Another part was that there were some areas of the United States that were hit hard by China more efficiently entering the global economy.

Did these elements of the status quo need to be dealt with or changed in some fashion?

I think that something did need to change, but the key question is what should change and how? One of the issues that the Obama administration is due for some credit on is that they tried to do something important in dealing with China. That was creating a regional trade agreement with a lot of other friendly countries in the Asia-Pacific region to counterbalance China’s influence. That, of course, was the Trans-Pacific Partnership. In that sense, they were trying to work on a balancing strategy for China.

On the other hand, I think that one area where they really didn’t hit the mark was aggressively confronting Chinese trade practices at the World Trade Organization. My Cato colleagues wrote a paper earlier this year about how effective WTO dispute settlement has actually been at convincing China and other countries to change their trade practices. And yes, WTO disputes are boring. Yes, they take a long time. But if you actually dig into the numbers, you see that the United States wins about 100 percent of the disputes it brings.

And China eventually complies partially or fully. Nobody is perfect in the WTO system. The United States has its own warts and everybody has their issues, but the Chinese were tending to comply.

My problem with the Obama administration is that they weren’t bringing nearly enough of these cases, and they should’ve been doing it with more concerted effort with countries like Japan, the EU, India, Brazil, and others. That is an area of quite legitimate criticism.

Otherwise, the China “shock” issues are quite oversold to me. Yes, China joining the global economy in the 1990s and joining the WTO in the early-2000s did increase imports of Chinese goods into the United States. And that import competition did, as it tends to, have an adverse impact on certain American manufacturers and workers. Whether that necessitated a wholesale change in American trade policy is a totally different question.

The fact is that if you look at what was going on at the time — and what’s gone on since — you see that there are two big flaws in the idea that we needed massive tariffs to solve the China shock. The first is that we actually had mechanisms in place that could apply tariffs on Chinese imports: our antidumping and countervailing duty regime allow for a permissive use of duties to go after Chinese imports under US law. And we have hundreds of those duties in place on Chinese goods, for either dumping or subsidy allocations.

We also have a special safeguard mechanism under Section 421 of the US law that China agreed to as part of its WTO accession. The United States could just hit Chinese goods with additional duties, and President Obama did that once on Chinese tires and it was an utter debacle. The reason for this is, as a friend of mine from the Council of Economic Advisors, Phil Levy wrote about when he was there, the big problem with these bilateral tariffs is something called trade diversion.

So, okay, you knock China out of the US market, so what’s going to happen? It’s not actually going to boost American tire production. All you’re going to do is start importing tires from Brazil, Korea, Thailand, and other places, and that’s exactly what happened. So Phil said, “Look, when I was at CEA, we looked at the numbers. What we realized is that if we applied these 421 duties and safeguards, all it would do is increase tariffs from other countries in Southeast Asia and elsewhere.”

That is one of the big flaws in the idea of the China shock necessitating duties. It never really accounts for what the alternative would be without China’s imports. And what you see in the data at the time is that Chinese imports didn’t displace American production as much as they displaced other imports.

In fact, the Congressional Research Service wrote a great report about a year ago where they said that the share of imports into the US from the Pacific Rim countries was 47 percent in the 1990s. The share in 2016 was still 47 percent — the only difference was that China’s share jumped from a few percentage points in 1990 to something like 25 percent later on. And that’s the nature of the supply chains, the nature of China’s competitiveness, and its place in the supply chain.

You mentioned that people don’t look at things that could have happened. Something the more hawkish people say is, “Listen, this whole thing was just a mistake. All we did was enable not only an economic competitor, but a strategic competitor.”

Is there another path we could’ve taken in the 90s or 2000s? I’m not sure what their goal is — maybe to isolate China, keep it poor?

Right, I don’t know their goal.

And it’s a big country.

Right. It’s really a classic case of revisionist history. You have to look at what American policymakers were seeing in the late 1990s. China was a country that was undertaking significant economic reforms that, according to economists, really powered China’s export competitiveness much less so than WTO entry. The economic reforms that the Chinese undertook with privatization, lower import duties, all of these things supercharged China’s export competitiveness.

Also, you had every other WTO member — about 140 of them — that wanted China in the WTO. Every other WTO member had signed off on China’s agreement. So the United States was left with a “choice” of denying China permanent normal trade relations, and instead letting every other country in the world get the benefits of China’s more open markets. The US would’ve been giving a China a free pass to keep discriminating against exports, services, and the rest. That was not much of a choice.

The other thing they say is, “Oh, we could’ve denied China entry into the WTO.” Like you said, there are a couple of problems with that. First, they were going to have to convince 140 other countries that it was the right thing to do. Good luck.

Beyond that, though, you have the issue of denying over a billion people in a modernizing country with nuclear weapons access to an open, multilateral trading system that includes countries like Cuba, former Eastern-bloc countries with command-and-control economies.

It just wasn’t a realistic thing, particularly at the time. Now, yes, have things gone off the rails a bit since then? Yes. And did China’s WTO entry help boost its export competitiveness? Well, probably. But it wasn’t this very simple, “Oh, we should’ve denied them access and then they wouldn’t have risen.”

The other thing to mention is that China has nukes, and has had them for 30 years. So you get a nuclear power, which is very different from other countries like North Korea where maybe keeping them poor might deter their nuclear regime. We don’t have that issue, and let’s face it — we’ve isolated Iran and North Korea and they’re still, slowly but surely, progressing with nuclearization. There wasn’t this really easy alternative.

So I think that it was the right thing to do, but I do think that there have been missteps since then.

What is your best forecast, here? A mini–deal, where these complex tensions will just always be with us? Do you think that this creates more support within the American public for splitting the two economies?

It’s a great question, and I think that when looking at the Democratic Party, unfortunately there doesn’t appear to be a free–trader in the bunch.

No, they have their own version of protectionism that isn’t Trump’s necessarily.

Right. It’s just Trumpian protectionism with green eyeshade, you know? There’s not a whole lot of space in terms of the actual measures, it’s just the justifications for those measures that differ. And there’s also a lot of people wanting to just not touch the issue because trade splits the Democratic Party. So that’s the pessimistic case, particularly in the near term.

There doesn’t seem to be any effort from the political class to go back to a more liberalized trading regime. At least, with respect to China. DC is also weird. There’s sometimes policy momentum, where once a policy starts, regardless of whether it stinks or “fails to achieve its primary goals and fosters dysfunction along the way,” we just have to do it. There’s this really big sunk-cost fallacy, where “We’re in there now — we can’t back out.”

Right, what’s done is done. “How do you get through hell? Just keep going forward.”

And I hate to quote Paul Krugman in a place like this — lightning bolts might strike me — but he called it the next Afghanistan. And there’s part of that where it’s this quagmire, we’re stuck, if we back out now we look like we lost. So in the short–term on the political level it’s very pessimistic.

But I will give you a glimmer of hope for those of you listening out there. The fact is that the polling on trade has never been better. Americans, by and large, particularly younger Americans, not only accept but really appreciate trade and globalization. They think it is good for the American economy, they think it is good for their own pocketbooks. They oppose tariffs.

Now, some of that is inevitably tied to Trump. But the long term trends pre-Trump, through the Obama era, show growing support for trade, globalization, and openness as well as opposition to tariffs and protectionism. In a way, for us free–traders, this is the best of times. Almost every day, I can pick up the newspaper and see headlines about the “immense economic costs” or the “failed policy objectives” of the president’s tariff regime. In that sense, it gives us a ton of ammunition.

And we are teaching, for better or for worse, a lot of people out there about just how stupid tariffs and protectionism are as a trade mechanism. Now, it is unfortunate that I’m having to reteach this, having written a 50-page paper about this two years ago about the failures of American protectionism. But at the very least, we’re having that discussion now.

So I think that in the longer term, once we get the geriatrics out of the White House and slowly move away from the current moment we’re in, I think things can get better.

Scott, thanks for coming on the podcast.

My pleasure.