Port workers wait for the arrival of a container ship on a dock in Qingdao in eastern China’s Shandong province on May 9.The Associated Press
John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).
Tariffs are back in the news as Canada, like all industrial countries, wrestles with what’s been called the second China shock.
In 2021, triggered by the collapse of Evergrande, which had once been the world’s biggest real estate group, China’s property bubble burst. Given the extent to which the country’s middle class puts its savings in real estate, households felt the hit and cut their spending. Beijing tried to restore economic growth by redirecting the country’s huge pool of savings away from property and infrastructure and into manufacturing.
With the country consequently expanding its output of cars, chemicals, machinery and computer chips at the very time households were reducing their spending, industrial supply outstripped demand, producing a huge number of loss-making firms. The scale of the excess capacity is mind-boggling. For example, China currently produces twice as many solar panels as the world buys. As the world is consequently swamped with Chinese goods at bargain-basement prices, manufacturers elsewhere risk going to the wall.
Faced with this challenge, countries with significant manufacturing sectors of their own can basically respond in one of three ways: surrender, defence or attack. None of these is an easy solution to the problem caused by the second China shock.
Surrendering is effectively what countries did during the first China shock at the turn of the millennium. When China’s industrial sector then took off, the rest of the world cut trade barriers, imported cheap Chinese products and paid for them by selling resources and high-end products to China.
This strategy was trumpeted as a great success in Western countries since it kept inflation and interest rates low, thereby allowing Western firms to boost their profits by outsourcing production.
But since it also left a trail of destruction in the industrial sectors of many countries, this strategy has now become politically toxic in democracies. Besides, China is trying to reduce its resource dependence while moving into the production of its own high-end products, the result being that Western firms that previously profited off the growth of China’s middle class now find the Chinese market a tougher nut to crack.
Populists like Donald Trump opted to go with the second strategy, playing defence. This has involved throwing up trade barriers, particularly tariffs, to protect local jobs and keep out China’s subsidized goods. Yet while tariffs are being deployed ever more in the U.S. and Europe, they have obvious downsides. For one thing, they raise prices to local consumers. And as the Trump presidency’s own experience with tariffs showed, they don’t even necessarily succeed in reviving local industry.
Unless tariffs are coupled with a program to boost competitiveness, what could result is a bunch of domestic firms that can’t compete on price with Chinese ones. A very large economy like the U.S. might get away with this, since the national market is big enough to support some firms. But in a smaller one like Canada, the approach would probably save a few jobs in the short term while ultimately leaving the country poorer.
That’s why more governments are beginning to opt for Door No. 3 and going on attack, by reviving the use of industrial policy. The Biden administration has used an approach in which tariffs are to be used only as an interim measure to protect a nascent industry during its embryonic phase. It’s then coupling that protectionism to a subsidy regime that aims to develop new manufacturing capacity in computer chips, renewable energy and electric vehicles.
Unlike surrender and defence, which deliver only short-term victories, there is at least a long-term vision in this third strategy. The problem is that ideas that seem good on paper are often devilishly difficult to convert into reality.
For instance, China developed its EV industry through a well-co-ordinated industrial policy. In Western countries, by contrast, the ‘hollowing out’ of the state by four decades of government retrenchment and the growing power of oligarchic interests in politics has made it harder for governments to ‘pick losers’ – the less dynamic firms the state lets go to the wall as it nurtures national champions – which is an essential element in successful industrial policy. The Biden program is accordingly revealing just how challenging a pivot back to industrial policy can be: Amid slowing demand, Chinese competition and policy uncertainty, an estimated 40 per cent of approved projects are behind schedule.
For now, Western politicians are largely fire-fighting. The kind of vision we need to preserve a long-term future for manufacturing won’t be found in the short timelines of electoral politics. What’s needed is national consensus on the way forward.