Brace for Impact
Trump is playing chicken with the world economy
Seven years ago, Donald Trump tweeted that “trade wars are good, and easy to win.” This post explains why he is likely wrong and why his ill-considered tariffs have suddenly increased the risk of both inflation and a recession.
In early April, Trump declared a trade war on the rest of the world, especially China.1 It will take a few months for consumers and workers to feel the impact.
Most Americans pay no attention to global trade. When we do, we are likely to harbor three misconceptions about China. We believe that because the US is the larger economy, we are likely to win a trade war. We underestimate the scale and flexibility of Chinese manufacturing companies. And we imagine that China’s industrial advantage rests primarily on currency manipulation, low-cost labor, trade barriers, and intellectual property theft.
None of these beliefs is true. Let’s take a closer look.
The United States can lose a trade war with China
Trump launched a trade war with no clear plan to win. He not only declared his trade war against China without first rallying our friends, but he also attacked our allies alongside our adversaries. The balance of economic power suggests that this may end badly for the US.
US tariffs will not cripple China. The US accounts for 14 percent of China's exports. American tariffs on those exports are an inconvenience to China, not a threat.
China can wait us out or cut us off. China may simply wait for our mercurial president to change his mind, which happens frequently. However, if China wants to send a sterner message, it can easily cut off key ingredients for our antibiotics. It can stop shipping us industrial water pumps, which are vital for clean water and are not easily obtainable elsewhere. It can cut off rare-earth metals, which are used in products from vacuum cleaners to fighter jets.2 Or China can dump US Treasury bonds, which would raise the cost of our mortgages, corporate loans, and government debt service.
China can substitute for most US imports. China can buy its soybeans from Brazil more easily than we can buy air conditioners from anybody else, since China makes 80% of the world’s air conditioners. There are only a handful of products that China gets from the US and cannot easily substitute. These include advanced semiconductors and chip-making equipment targeted by the CHIPS Act, biotech inputs and research tools, as well as a few aerospace and defense-adjacent components, such as precision navigation tools, sensors, and aerospace alloys.
When Treasury Secretary Scott Bessent argued that China is “playing with a pair of twos ... We export one-fifth to them of what they export to us, so that is a losing hand for them,” economists quickly schooled him on his error. Americans want what China makes. If Trump makes these products more expensive or causes them to disappear altogether, it is America that suffers, not China. (For the funny version of this argument, watch Bowen Yang as Chinese Trade Minister Chen Biao on SNL.)
Trump changes his mind like most people change their socks. No sooner had he imposed tariffs on Chinese imports than he declared an exemption for smartphones and computer equipment. By doing this, Trump admitted what he has long denied: that importers and consumers bear the cost of tariffs. (He had long maintained that exporters pay these costs. He did not appear to notice his U-turn.)
Can America or our allies manufacture phones, air conditioners, computers, bicycles, toys, and every other Chinese import sold at Target or Walmart? If we really want to, we probably can – but not cheaply and not next week. It takes time to set up factories and establish domestic suppliers. This requires investment, which requires certainty that the rules will not change when the polls or the markets react. It requires road, port, and rail infrastructure, as well as trained workers. It requires assistance from allies such as Korea, Vietnam, and Japan. It requires a trade treaty like the Trans-Pacific Partnership, which Trump scotched in 2017.
China excels at infrastructure investments, and we should learn from their expertise. In the early 2010s, both California and China decided to build high-speed rail lines. In fourteen years, China built 30,000 miles of high-speed rail, accounting for about 70% of the world's total. California is still working on a 120-mile segment between Madera and Bakersfield – two towns that will not use high-speed rail if we ever finish it.
China’s manufacturing ecosystem is unimaginably large and robust
Many Americans fail to comprehend the scale of modern China. I wish that more of us could visit more often.
The scale and flexibility of Chinese manufacturing are hard to grasp. China’s urban population is far more educated than most Americans realize. It is generating a tidal wave of technical and managerial innovation that threatens not textiles and toys, but biotech, AI, and aerospace.3 Leading Chinese companies have redefined the role of supply chains and churn out products at a scale that is difficult to comprehend.
In China, if a manufacturer needs a thousand rubber gaskets, a supplier is often nearby. If a component requires a design modification, vendors can often implement the change in hours, rather than days or weeks. This hyper-localized and interconnected ecosystem enables Chinese manufacturers to rapidly build and test prototypes. They can iterate product designs, source specialized components from nearby suppliers with minimal lead times, customize parts, and scale up production almost instantly in response to market demand. This drastically reduces logistics costs and time. America has not lost this capacity; we never had it to begin with.
This is not an advantage built mainly on cheap labor or raw materials, and it is not one that the US can quickly duplicate, any more than China can quickly replicate the ecosystems of startup innovation in Silicon Valley.
Two of China’s fastest-growing car companies illustrate the point. China now dominates the global car market. They build thirty million vehicles annually – three times as many as the US and one in three new cars worldwide. BYD is China’s largest auto manufacturer.
BYD is a battery maker that began producing cars twenty years ago. Their first car was a reverse-engineered Toyota Corolla. They introduced their first plug-in hybrid in 2008 and their first electric vehicle (EV) in 2009. The company began exporting early, introducing dozens of new models targeted at specific export markets in Europe, Southeast Asia, and Latin America. In 2023, BYD overtook Volkswagen to become the best-selling car brand in China. BYD produced 4.2 million vehicles last year and is now the world’s third most valuable car manufacturer.
What does a BYD factory look like? They operate nine plants in China. Please take a moment and click here to see a drone’s eye view of their superfactory in Zhengzhou. At 50 square miles, it is larger than the city of San Francisco.4 The plant is expected to produce one million EVs per year.5
Xiaomi has grown even faster than BYD. As a smartphone company that recognized its core market was stagnating, Xiaomi entered the car business in 2021 to develop intelligent EVs. They assembled an R&D team of more than 3,400 engineers to design the first car, which was completed just two years later. Xiaomi has built a highly automated factory outside Beijing that utilizes over 700 robots to produce a new car every 76 seconds. They delivered their first car one year ago, on April 3, 2024 (Ford’s CEO drives one and is stunned by its quality). They made 135,000 cars last year and expect to double production in 2025. See an advertisement for their impressive factory here.
China cheats, but its real advantage is a large and flexible industrial ecosystem.
Many Americans believe that China has succeeded because it underpays its workers, manipulates its currency, erects trade barriers, and steals intellectual property. China does these things, but this is not the main reason it dominates global manufacturing.
Low pay. Despite their productivity, workers in China are poorly paid. Few Americans would enjoy working in a Chinese factory. Benefits are limited, and there is almost no social safety net.
Cheap currency. During the 2000s, China pegged its currency to the US dollar at a low rate to promote its exports. As a result, China sold much more than it purchased and accumulated massive foreign exchange reserves, which peaked at over $4 trillion in 2014. These large current account surpluses required active intervention in foreign exchange markets by the People’s Bank of China to prevent the yuan from appreciating. Under US pressure, China revalued its currency in 2005 and again from 2010 to 2013.
Non-tariff barriers. China has mastered non-tariff barriers and appears to be targeting them at products produced in Trump-friendly red states. For example, China has alleged that some US chicken products contain unwanted drugs and has banned their import. They found reasons to stop importing US natural gas. These are industries that employ many of the president’s most ardent political supporters.
IP theft. China has been even more brazen about stealing American intellectual property than we were about stealing from Britain when we industrialized. More than one US company invested in China, built a factory there, and discovered that competitors had obtained its IP. Elon Musk sued an engineer who worked in his Shanghai gigafactory and allegedly stole Tesla IP to start a rival car company.
These actions would justify US tariffs on Chinese goods, but they are not the primary basis for China’s industrial advantage. China has an advantage that is difficult to steal or replicate – the knowledge of how to scale large, complex manufacturing operations and supply chains.
Only one American appears to be truly world-class in this regard. Elon Musk has rapidly scaled up global production at both Tesla and SpaceX. Unfortunately, Trump put Musk in charge of something he has proven to be terrible at, rather than asking him to craft America’s trade policy, where his experience is highly relevant.
Musk knows that Trump’s tariffs are imbecilic and recently said so. When Trump trade czar Peter Navarro dismissed Musk as a “car assembler”, Musk called him a “moron” and “Peter Retardo”. Pass the popcorn. A juvenile MAGA food fight would be entertaining if only the stakes were lower.
The Dumb Decoupling
Some decoupling from China is plainly warranted – we do not want to rely on the benevolence of the Chinese Communist Party for strategic goods such as rare earth metals, semiconductors, drones, and battery components.
A strategic decoupling requires the United States to divide the world into two trading zones: China and the rest of the world. But the rest of the world grew accustomed to American power rooted not just in the might of our markets but in the discipline and foresight of our leadership. Trump’s attack blindsided them. They expected the United States to attack its adversaries, not its allies.
Instead of rallying the West into a trading bloc that excludes China and forces it to reform its mercantilist ways, Trump’s tariff tantrums are isolating America, fueling inflation, and accelerating China's rise as the world’s dominant manufacturing and technological power.
If America were serious about building a handful of industries of obvious strategic importance, we would open our doors to foreign talent. We would set tariffs based on the level of Chinese content, whether the item came from China directly or via Mexico or Vietnam. This requires systems and staffing to collect, validate, and update this information. Memo to DOGE: We need to build state capacity in this area.
An effective decoupling requires investments in research, not attacks on universities and the withholding of research grants for narrow political purposes. It demands that we place education, training, and scientific ambition ahead of culture wars and sectarian political attacks. It also requires the United States to address soaring healthcare costs, the needs of an aging population, and the burden of a federal debt that nobody wants to discuss.
Several economists foresee a trade-induced recession, but to date, debt and equity markets have remained relatively calm. They may be betting that Trump’s allergy to bad headlines will make this all go away. Rather than endure the pain of shortages and inflation, they expect him to peddle tariff exemptions like papal indulgences. Large company CEOs will line up outside the newly gilted Oval Office. But 99.9% of our companies are small businesses that cannot afford to hire lobbyists.
Or maybe the financial markets are wrong and China will call Trump’s bluff. If this happens, count on Trump to proclaim his strategic genius even as he folds: “It’s textbook Art of the Deal!”
Musical Coda
John Lee Hooker was the consummate Delta bluesman. I often pay my respects to the King of the Boogie, who was laid to rest across the street from my house.
Trump initiated his tariff circus by imposing an additional 50 percent tariff on Chinese imports. This increased the total to more than 104 percent. Beijing immediately upped its own tariffs on US goods to a total of 84 percent. Twelve hours later, Trump increased tariffs on China to 145 percent. The next day, Beijing announced a counter-tariff reprisal, raising levies on US imports to 125 percent. Then Trump exempted iPhones. Then China cancelled its contracts with Boeing.
Rare earth metals are relatively plentiful, but refining them is labor-intensive and polluting. Demand for them grows steadily, but the real scarcity is logistical and economic, not geological.
The data can be confusing because it relies on averages. China, on average, has a lower level of educational attainment than the United States. A higher proportion of American adults earn high school and college degrees. However, educational disparities between urban and rural China are substantial. Many urban students study engineering, so China graduates at least six times more engineers each year than the United States does. This fact matters more than average educational attainment.
For comparison, America’s largest car plant, Ford’s sprawling River Rouge complex, was 3 square miles at its peak.
BYD has opened eight new EV assembly plants in Thailand, Brazil, Hungary, Turkey, Uzbekistan, Indonesia, Pakistan, and India.