Donald Trump’s trade war is about protecting intellectual property
WITH Donald Trump’s new trade tariffs, the United States has been transformed from the global, multilateral trading system’s leading champion to its nemesis.
But it would be difficult for an erratic politician to overturn long-established structures and mechanisms were it not for a more fundamental economic shift.
The first formal manifestation of today’s trade tensions occurred in the steel sector — an “old economy” industry par excellence, plagued, especially in China, by enormous excess capacity.
Excess capacity is a recurrent phenomenon in the steel sector, and has always produced friction.
In 2002, then president George W Bush’s administration imposed steep tariffs on steel imports, but relented when a World Trade Organisation dispute-resolution panel ruled against the US.
Although Trump administration trade hawks remember this ruling as a loss, most economists agree that it was ultimately good for the US economy, which does not gain from taxing a major input for other industries.
Today’s tariffs differ from Bush’s in a crucial way: they target China. Under section 301 of the US Trade Act of 1974 — which empowers the president to act, if US industry has been damaged by a foreign government’s unjustified actions — Trump has imposed steep tariffs on $50bn worth of Chinese imports.
And China has hit back, introducing steep tariffs on imports of 128 US-made products.
So why is Trump risking a trade war? His administration’s main complaint is that China requires foreign companies to reveal their intellectual property (IP) as a condition of access to their market.
And it is true that this requirement can damage US tech companies, if those companies are dominant in their industries.
For a major player in social networks or search engines, for example, the
cost of entering a new market is essentially zero. Since the existing software can easily serve many more millions of users, they just need to translate their interface into the local language, so that entering a new market mostly means more profits.
But if such companies are forced to reveal their IP, their business models are destroyed, as local players can then compete effectively in that market, and potentially in others.
This is not the case for companies operating in competitive industries. For them, producing and selling more abroad costs more, limiting the marginal profits. In other words, in the more competitive old economy, the gains of opening new markets are much smaller.
That is why lobbying by potential exporters for better access to markets with high tariffs has usually been muted, hence the lack of resistance to India’s protectionism.
This is changing in the new winner-take-all tech economy: With IP-owning winners missing out on massive profits when a big market like China is protected or closed, trade conflicts become more acute.
Meanwhile, trade policy becomes focused primarily on redistributing rents, with employment and consumer interests viewed as secondary. (Under competitive conditions, policymakers place a higher priority on maximising trade’s potential to boost productivity and create high-quality employment.)
Monopoly rents translate into high market valuations. And, indeed, the new economy giants have a much higher stock-market value than their old economy equivalents. The three largest US tech companies are worth 50 times more than the three largest US steel producers.
The looming trade war promises to be asymmetric. The US — home to all the dominant tech firms — will struggle 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.
And some European governments are eager to secure their share of rents from US firms. This is the ultimate aim of European efforts to raise taxes on the profits of digital multinationals, though such a tax is unlikely to do the job.
Proponents of that tax argue that profits should be taxed where they are earned, with the implicit argument that they are earned where the consumers are. But this is an arbitrary criterion.
US firms can legitimately claim that their “European profits” are just a
return on their IP, which can formally be localised anywhere, preferably in a low-tax jurisdiction. A European tax on these companies is thus unlikely to yield substantial revenues.
In the old, competitive economy, trade wars might be easy to win for a country with a large trade deficit. But in the emerging winner-take-all economy, a trade war launched with the goal of forcing the rest of the world to open up, thereby allowing the aggressor’s own winning firms to earn higher rents, is an altogether different proposition.
So the US government is essentially arranging its diplomatic guns behind its internet giants, while Europe and China are baying for their monopoly profits. This is more destructive than a zero-sum game: it will do serious damage to the global trading system.
