Trade wars are inevitable during 2010 between the EU and China and between the US and China.

During 2009, China’s economic growth was spurred by investments in infrastructure, industrial capacity and housing. There are real estate bubbles in several markets in China. The government will try to shift housing construction towards the low end segments of the housing market, where there is a need, in order to maintain or increase investment spending in housing; while at the same time it attempts to curb the bubbles elsewhere.

The rate of growth in infrastructure investment likely cannot be maintained, except possibly in electricity generation and transmission. More industrial capacity is not warranted as capacity utilization rates continue to tumble. So for China to maintain growth rates in the 9% range, exports will have to start growing rapidly.

The Chinese Government will place greater emphasis on exports during the year in order to generate the growth needed to absorb the urban unemployed and underemployed and the steady influx of people from the rural areas. And herein lies the problem.

The Government of China, despite mounting pressures to revalue its currency, likely will keep the renminbi pegged to the US dollar. Furthermore, China will introduce new subsidies to spur its export sectors If the government does allow the renminbi to appreciate, it will increases the range and generosity of the subsidies it provides to its manufacturing firms.

Even though there will be steady growth in the US and throughout most of the EU, high levels of unemployment and large budget deficits will spur politicians in these countries to launch many new subsidy and dumping cases against Chinese companies and industries. The US and EU will have the authority of the GATT to initiate these cases and WTO panels most likely will side with them.

China of course will protest and threaten to retaliate. This in turn will lead to warnings both by China and apologetic trade scholars that a trade war should be avoided. They will point to the experience in the 1930s when protectionism made the economic decline steeper and more prolonged (China does not accept that its currency and subsidy policies are the most serious protectionist measures in play at this time), and they will note that the economic recovery is still fragile. Some also will warn that China could begin to dump its US dollar assets creating turmoil in the financial markets.

However, neither the US nor the EU should succumb to these threats, many of which are not credible. They should pursue their cases vigorously, and impose the countervailing tariffs as soon as they are given the green light by the WTO. If the legal structure for the global trading system, the GATT, is to have any credibility and weight, the rules must be applied equally to all signatories. There can be no exceptions!

China must accept responsibility for its obligations under the GATT, and cannot be allowed to flaunt the rules. If China is given a pass, then the GATT ultimately will collapse to be replaced by bilateral trading arrangements. (For an example of how dysfunctional such a system can be, I refer you to the global aviation industry.) This will create uncertainties and larger costs for investment, outsourcing and trade decisions.

World trade and global growth would suffer as a result, and China likely would find itself worse off. China’s export driven policies have to change.

The opinions expressed in this blog are personal and do not reflect the views of Global Brief or the Glendon School of Public and International Affairs.