The Unintended Consequences of a Trade War With China

August 3, 2018

After Japan invaded French Indochina in 1940, Franklin Roosevelt began to freeze all Japanese assets and established an oil embargo in August 1941. These actions were swiftly mirrored by the British, and Japan eventually lost three-quarters of its overseas trade and almost all its oil imports. Left with less than three years’ worth of oil reserves, Japan sought out reserves in the Dutch East Indies – which would surely push it into direct conflict with America and Britain.

America’s actions had the unintended consequence of sweeping away more moderate influences within the Japanese government and strengthening the remaining pro-imperialist factions. Japan sought to secure its resource stream by opting for decisive military action, but conflict may not have been inevitable. A 1948 Atlantic article suggested that America’s “increasing economic pressure on Japan, plus the militaristic cast of the government … and their partial loss of face in China, spelled a probable resumption of [Japan’s] policy of conquest.”

The U.S. embargo directly threatened Japanese leadership and became a pretext for confrontation and conflict. Might the same be true with China today? As the Trump administration ratchets up its trade war on China with proposed tariffs on hundreds of billions of dollars’ worth of imports, American policymakers should consider that further disrupting a Chinese economy that is already showing signs of weakness may inadvertently deal a fatal blow to the legitimacy of the Chinese Communist Party. Much of the party’s prestige and power is linked directly to the success of its economic policies – a tradition President Xi Jinping has zealously championed. Though the Chinese Communist Party has proven resilient to past economic hardships, American protectionist moves could have the unintended consequence of sparking a larger, more protracted confrontation with China.

China’s Tacit Pact

The Chinese Communist Party has a tacit agreement – described as a “social contract” by the Asian Century Institute – with the Chinese people that essentially offers economic benefits, progress, and opportunities in exchange for the public’s political cooperation. Xu Zhangrun, law professor at Tsinghua University has described the deal as a “security and stability” pact that extends to include “economic comfort.” Even though official Chinese sources do not specifically articulate this agreement as such, many official pronouncements allude to its basic premise. Article 42 of the Chinese Constitution stipulates that the “citizens of the People’s Republic of China have the right as well as the duty to work” and the “state creates conditions for employment.” The genesis of this arrangement traces its roots back to Deng Xiaoping. Consensus around this agreement has mostly solidified since then with one major exception – the outburst of protests at Tiananmen Square in 1989.

But there are signs that this tacit agreement may be eroding. After decades of growth, the Chinese economy is beginning to lose steam and is facing simultaneous, severe headwinds. Exports and manufacturing are slowing, state debt in both the private and public sector is ballooning, foreign reserves are shrinking, and the yuan is losing value. The party’s overseas economic ambitions may also be faltering, with cracks visible in China’s so-called “debt-trap diplomacy,” linked to the expansive One Belt, One Road initiative in countries such as Sri Lanka and Pakistan. All the while, financial reports hint at “bubbles” and economic fragility, with the opaque Chinese public and private financial institutions offering little transparency.

On top of all this, America is preparing to level tariffs on billions of dollars’ worth of Chinese imports that may destabilize the country’s economic order. Some Chinese sources contend that China will consider “all options” on the table in its response as it lacks the corresponding value of imports for leverage.boycottspirals out of control, the economic consequences could have domestic political repercussions for the Chinese Communist Party. Specifically, an economic downturn, further driven down by a tariff war, would be anathema for a generation of Chinese citizens that has enjoyed rising standards of living, increasing urbanization, and generally higher socioeconomic expectations.

Chinese Economic Turmoil Throughout History

The Chinese Communist Party has weathered many economic privations – many of them self-inflicted. In the 1930s and 1940s, the party foraged the countryside and sought meager assistance from abroad to wage its Maoist guerilla war against the Japanese occupation and Nationalist forces. After ejecting the Nationalists to Taiwan and gaining control in 1949, the party sought to rebuild, centralize, and collectivize the remnants of the Chinese economy. It soon launched the disastrous “Great Leap Forward,” which is believed to have killed 45 million people and further devastated the small economic gains made since the civil war. As Chris Bramall’s expansive Chinese Economic Development indicates, China once again saw economic instability during the Cultural Revolution starting in the 1960s, as well as during the follow-on internecine party conflict which lasted into the 1970s.

With the reemergence of Deng and his efforts to consolidate the party in the late 1970s, the party seemed to find a way to sustain economic performance, therefore maintaining party control. For nearly four decades, the country enjoyed growth and relative stability as it shifted more and more to the authoritarian capitalism model. But the transition to a more market-based economy has not been without challenges. In 2008, China initiated a large $586 billion stimulus package to bolster its economy against the “Great Recession.” A few years later in 2015, as an overvalued and much-hyped Chinese stock market teetered on the verge of collapse, it is reckoned that China injected more than $1 trillion into its stock market to avert catastrophe.

This time, however, the potential economic and political fallout from a trade war could be more difficult to gauge and contain than a quick infusion of liquidity. Beijing doesn’t have much experience dealing with this sort of tariff. These are distinct from the international sanctions leveled against China after Tiananmen, which were tied almost solely to military materiel and military relations – not consumer goods. Of course, it is difficult at this early stage to discuss exactly how many Chinese jobs or precisely what economic interests will be threatened by a trade war. Furthermore, economic details from Chinese sources are scarce. However, some estimates of the likely impact of the U.S. tariffs and retaliatory Chinese measures offer a general picture of the scope of the potential damage: affected American workers could number in the tens of thousands.

China could try to offset the tariffs’ detrimental impacts on afflicted workers and industries through stimulus packages or other measures. But that presupposes that China has available resources to bear the brunt or at least dull the effects of the tariffs. On the other hand, China may be more constrained this time around, finding itself unable to spend its way out. Dragged down by a broader economic slowdown in China, the tariff war may imperil the party’s ambitious economic agenda, thereby challenging its implicit contract with the Chinese people.

If the party finds its legitimacy and control being undermined by economic turmoil, it may turn to drastic measures. Indeed,China is already stepping up efforts to more effectively control its populace. From new artificial intelligence-driven facial recognition networks to a “social credit” scoring system to inculcation of China’s populace in “Xi Jinping Thought,” the party has for some time now seemed more willing to corral its population. Economic dissatisfaction could push the leadership to crack down even further. Moreover, there may be international implications. The Chinese Communist Party could turn the tariff war into a rallying cry, weaving a narrative of China as “victim” of a hostile America. More provocative actions abroad could be seen as a way to shore up support at home. If the social contract is genuinely threatened, more direct and confrontational maneuvers by Beijing against Washington could be the result.

Navigating Uncertainty

Could economic stability be to China today what oil dependency was to Japan in the 1940s? While all predictions about how a trade war could play inside China are necessarily speculative, American policymakers should be aware of the connection between China’s economy and the fortunes of its political leadership. It is true that the party has shown its resilience in past economic challenges but that may not be so this time around. An economically aggrieved China could act in unforeseen and damaging ways.

Assuredly, 1941 Japan is not present-day China, and a full-blown confrontation is not the ideal solution to either party’s economic disagreements. Moreover, implicit private arrangements to defuse tensions may be in place or developing. Even so, as Beijing and Washington steer their way through this trade war, a look at the lessons from history as well as a more solid understanding of China’s economic and political system can help policymakers avoid a similar calamity.


Wilson VornDick is a China analyst and Commander in the Navy Reserve. These are his personal views and are not associated with a U.S. government or U.S. Navy policy.

Image: Remko Tanis/Flickr