Long before President Trump began implementing tariffs on imported goods in 2018, the U.S. and the rest of the world had been steadily reducing tariffs and other impediments to trade. See Exhibit 1 be-low. Globalization encouraged opening home markets to foreign competition in order to increase trade and price competition between nations. One positive outcome was lower prices and increased availability of products and services. But another result, was an alteration of the status quo. Globalization produced a new set of industry winners and losers. Although consumers generally benefited from lower prices and greater availability, specific industries who were not globally competitive lost market share and thereby profits. Their employees also suffered as lay-offs ensued. In 2016, Presidential candidate Trump recognized these unsettled conditions and saw them as ripe for political exploit. With a campaign promise of “Make America Great Again,” he indicated that he could restore those ailing industries to their former post WWII dominant status. Examples are: Steel, Alumi-num, Coal, Cars, and Industrial products. But, he hasn’t been able to solve those issues, and in fact, he can’t do this by raising tariffs. In order to deflect the economic pain these industry participants are feeling, the Trump administration is now espousing a new theme captured by the New York Times drawing shown above. The new idea is: Patriotism requires sacrifice. However, without in-vesting in education, retraining, and upgrading, the request for more time and more sacrifice is likely to result in even more anxiety and populist rancor.

Instead of solving the dying industry problem, the Trump administration’s trade policy has now pivoted toward the far more important goal of leveling the playing field in technology goods and services. A major battle lies ahead, and we are quite sure we don’t hold all of the best cards. As the next sections will explain, negotiating technique is important. Bashing China for unfair industrial policies may not be our best negotiating policy as we prepare for the technology wars ahead. “Made In China 2025”- The Real Economic Threat “Made in China 2025” is a strategic plan issued by Chinese Premier Li Keqiang and his cabinet in May 2015. With it, China aims to move away from being the world's "factory" toward producing higher value products and services. Specifically, China wants to be proficient and perhaps dominant in artificial intel-ligence tools, quantum computing, nanotechnology materials, robotics, genetics, and bio-medical prod-ucts. The goal is to raise the domestic content of these products to 40% by 2020 and 70% by 2025. China has thrown down a gauntlet that represents a major challenge to the U.S. because these technolo-gies are the primary sources of future world eco-nomic growth. Trade Tariffs With China Are Not The Main Issue In 2018, the U.S, imported $539 billion of Chinese goods and exported $120 billion of goods to China. But, as shown in Exhibit 2, China’s exports to the U.S. are less than 4% of their GDP and our exports to them are less than 1% of our GDP. Economists have estimated that even with a full 25% tariff applied to all these transactions, our economy’s growth rate would be impaired by .1-.3% and China’s 6% growth rate would be impaired by as much as .5%/ year.

Paragon Month ly JUNE 2019

Trump’s Trade War: Why And What To Expect

Source: https://www.nytimes.com (2019/05/26)

Exhibit 1: Tariffs Applied on Total American Imports

P A G E 2 P A R A G O N M O N T H L Y

Eventually each country would find alternative outlets for their products and the negative effects would diminish. The more important effect of our currently boisterous tariff policy is more psychological. The adversarial method curtails longer-term business decisions, and can temporarily disrupt existing supply chains and employment. However, because the current tariff situation is not yet wide-spread, we don’t expect a major disruption of our 2019 GDP growth rate, nor of the aggregate valuations of our stock and bond markets. We are sticking to our earlier forecast range for the S&P 500 Index of 2400-3000. The volatility we are experiencing regarding trade is so far modest. President Trump’s surprise application of a monthly escalating 5% tariff to Mexican imports (if they don’t reduce illegal immi-gration to the U.S.) is worrisome. We import over $350 billion of goods from Mexico. How, whether, or when the Mexican government responds to the new demand is as yet unknown. At the end of June, President Trump and Chinese President Xi Jinping are scheduled to meet in Japan at the G-20 Summit. There, it is possible that they will both shake hands on an out-lined trade deal that will resolve elements of the current tariff war. However, finalization of terms could well take until Octo-ber. But even if we resolve the current trade war, a more im-portant battle has emerged. The Emerging Technology War Is Different “The technology war is not going to end,” says Alastair New-ton, director of Alavan Business Advisory and a former British diplomat. “Technology is where this battle is going to be fought, even if we do get a trade deal on bilateral goods.” The reason an overt technology war has emerged is because President Trump and his advisors have decided to use the cur-rent tariff war as an opening to negotiate a longer-term prob-lem. The U.S. trade position is that China has been stealing the intellectual property of our industrial, telecommunication, software, and computer products for many years. This conclu-sion is very well documented and the Trump administration has decided that now is the time to advance our position in both the world court (WTO), and with Chinese senior trade officials. However, the U.S. and Chinese political regimes operate on vastly different time horizons. We operate within a 4-year presidential cycle. The Chinese will take a very long-term ap-proach. By threatening the Chinese we risk them building a fortress around themselves or finding ways to “trade away” from us by developing other markets. The stakes for the U.S. are enormous.

What Do We Want? The United States is asking that China create a fair playing field for operating a business in China. To achieve this we require: 1) Access to China’s markets be open, well defined, and that

China codify the terms of commerce in laws such that par-ticipants have a legal system to adjudicate complaints or violations of commercial terms.

2) Implementation of penalties for intellectual property theft with appropriate restitution.

3) Cessation of subsidies for the new technological industries in order to reduce unfair competition.

4) More transparency in business accounting and the sources and uses of investment funds. We are asking China to use the rule of law and existing legal structures to level the competitive playing field.

These requested conditions indicate that the upcoming de-bates, negotiations, and subsequent implementation of a more Western style marketplace could take a long time and be hard to achieve with China. Many of China’s businesses are state owned and operated. As the global economies progress toward a world where cybersecurity is absolutely essential and the digital economy is increasingly prevalent, transparency be-comes more vital to ensure that risk capital will be amply de-ployed and returns on investment are protected. The U.S. and China each have an enormous amount to gain from co-operating in this next phase of global technological development. If we become more fearful and more protection-ist as we attempt to alter the future terms of trade, such emo-tions will prevent optimal win-win solutions from being found. We are watching this next round of trade talks with heightened attention and an optimistic but skeptical mind.

Exhibit 2: The Small Relative Importance of Trade

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