Trade wars in a winner-take-all world

WithPresident Donald Trump’s new trade tariffs, the United States has beentransformed from the global multilateral trading system’s leadingchampion and defender to its nemesis. But it would be very difficult foran erratic politician suddenly to overturn long-established structuresand mechanisms, were it not for a more fundamental economic shift.Thefirst formal manifestation of today’s trade tensions occurred in thesteel sector – an “old economy” industry par excellence, one that isplagued, especially in China, by enormous excess capacity.Excesscapacity is a recurrent phenomenon in the steel sector, and has alwaysproduced friction. Back in 2002, President George W. Bush’sadministration imposed steep tariffs on steel imports, but relented whena World Trade Organisation dispute-resolution panel ruled against theUS. Although Trump administration trade hawks remember this ruling as aloss, most economists agree that it was ultimately good for the USeconomy, which does not gain from taxing a major input for many otherindustries.In any case, today’s tariffs differ from Bush’s in acrucial way: they specifically target China. Under section 301 of the USTrade Act of 1974 – which empowers the president to act if US industryhas been damaged by a foreign government’s unjustified actions – Trumphas imposed steep tariffs on some $50bn worth of Chinese imports. AndChina has already hit back, introducing steep tariffs on imports of 128US-made products.So why is Trump risking a trade war? Hisadministration’s main complaint is that China requires foreign companiesto reveal their intellectual property (IP) as a condition of access tothe domestic market. And it is true that this requirement can do seriousdamage to US tech companies – as long as those companies are dominantin their industries.For a major player in social networks or searchengines, for example, the cost of entering a new market is essentiallyzero. Since the existing software can easily serve many more millions ofusers, they just need to translate their interface into the locallanguage, meaning that entering a new market mostly means more profits.But if such companies are forced to reveal their IP, their businessmodels are destroyed, as local players can then compete effectively inthat market – and potentially in others.This is not the case forcompanies operating in competitive industries. For them, producing andselling more abroad costs much more, limiting the marginal profits thatcan be reaped. In other words, in the more competitive “old” economy,the gains of opening new markets are much smaller. That is why lobbyingby potential exporters for better access to markets with high tariffshas usually been muted – hence the lack of resistance to India’sprotectionism.This is changing in the new “winner-take-all” techeconomy: with IP-owning winners missing out on massive profits when abig market like China is protected or closed, trade conflicts becomemore acute. Meanwhile, trade policy becomes focused primarily onre-distributing rents, with employment and consumer interests viewed assecondary. (Under competitive conditions, policymakers place a higherpriority on maximising trade’s potential to boost productivity andcreate high-quality employment.)Monopoly rents translate into highmarket valuations. And, indeed, the new economy giants have a muchhigher stock-market value than their “old economy” equivalents. Thethree largest US tech companies are worth over 50 times more than thethree largest US steel producers.The looming trade war promises tobe asymmetric. The US – home to all the dominant tech firms – willstruggle to find allies against China. After all, in Europe and Japan,IP-owning companies operate mostly in more competitive industries,meaning that China’s demand for that IP will have less of an impact.MakingEuropean support even harder to come by, some European governments areeager to secure their share of rents from US firms. This is the ultimateaim of European efforts to raise taxes on the profits of digitalmultinationals, though such a tax is unlikely to do the job.Proponentsof that tax argue that profits should be taxed where they are earned,with the implicit argument being that they are earned where theconsumers are. But this is an arbitrary criterion. US firms canlegitimately claim that their “European” profits are just a return ontheir IP, which can formally be localised anywhere, preferably in alow-tax jurisdiction. A European tax on these companies is thus unlikelyto yield substantial revenues.In the old competitive economy, tradewars might be easy to win for a country with a large trade deficit. Butin the emerging winner-take-all economy, a trade war launched with thegoal of forcing the rest of the world to open up, thereby allowing theaggressor’s own winning firms to earn higher rents, is an altogetherdifferent proposition.So the US government is essentially arrangingits diplomatic guns behind its Internet giants, while Europe and Chinaare baying for their monopoly profits. This is more destructive than azero-sum game: it will do serious damage to the global trading system,leaving everyone worse off. – Project Syndicate* Daniel Gros is Director of the Center for European Policy Studies.