Trade war is not a zero-sum game, but a lose-lose for the US and China
With three rounds of tariffs in less than three months, US President Donald Trump has significantly upped his game on trade protectionism, casting doubts over the outlook for Sino-US economic relations.
The latest act – imposing tariffs on up to US$50 billion worth of Chinese imports – following the conclusion of the Section 301 investigation into China’s alleged violation of intellectual property rights and technology transfers, significantly shook global markets.
The first thing to note is that Section 301 is not new to China. Both China and Japan were subject to multiple S301 investigations in the 1980s and 1990s. However, these investigations had mostly resulted in trade deals, and very rarely did they lead to sustained punitive actions (with the exception of Japan’s case in 1987).
That suggests S301 was mostly used by previous US presidents as a bargaining tool to gain concessions from trading partners. Whether Trump abides by the same tradition is becoming increasingly unclear given the recent turn of events.
For China, the newly proposed tariffs will have a greater economic impact than the earlier measures targeting steel and aluminium. Data from the National Bureau of Statistics shows that China exported nearly US$200 billion of electronics, information and communication, and aerospace-related products to the US in 2017, accounting for 46 per cent of its exports to the US, 9 per cent of its total exports, and 1.6 per cent of China’s GDP.
If Trump were to slap a 25 per cent duty – as the US Trade Representative recommends – on US$50 billion worth of Chinese imports, we estimate the direct and first-order impact could be worth 0.1-0.2 percentage point of Chinese GDP.
While this impact could be amplified by a broader list of products, a higher tariff rate, and second-round effects, the order of magnitude is not large enough to derail the Chinese economy. In reality, this impact could be even smaller as the shock will be spread across the global supply chain.
Tech and electronic products, which are on top of the list for tariffs, are prone to supply-chain production, which involves countries specialising in parts of the production with inputs assembled at the end. China is well integrated into this process, with nearly 40 per cent of its exports in 2017 being processing trade with imported materials.
Hitting China on these products will create a negative spillover onto the likes of Japan, Korea and Taiwan. Even the US could suffer from the reverberation, with companies like Apple taking the lion’s share of profits from products that are assembled in China.
Over all, what determines how the situation evolves from here depends as much on China as on the US. China has shown significant restraint, up until now, in preventing an escalation of tension. However, Beijing does not want to show weakness by succumbing to Trump’s ever-rising demands, so some small-scale retaliations are likely to be introduced.
Nevertheless we think China, in general, will respond by offering more “carrots” than “sticks”. The former will include opening up its financial system, which Premier Li and Governor Yi have pledged to do imminently, levelling the playing field for foreign firms to attract investment, and shoring up its protection of intellectual property.
Implementing these measures is not merely trying to please the US and avoid a trade war, but is part of China’s reform strategy to improve quality of growth.
China, therefore, will continue to show willingness to talk over the coming weeks, and how Trump reacts to that will be critical. If diplomacy fails, China could get tough on the US’ imports by imposing tit-for-tat tariffs (China’s Commerce Department has already announced tariffs on US$3 billion worth of American food and industrial products), restraining the activities of US firms in China, and limiting US investment.
It is unlikely, however, that Beijing will use the exchange rate or dumping its holding of US Treasuries as retaliatory tools, as that would probably backfire and create uncontrollable collateral damage for global markets.
Our view on the US remains the same: a trade war is not a zero-sum game, but a lose-lose proposition for both the US and China.
The impact on the US economy may come from higher prices of imports, hitting consumers’ pockets and the profitability of producers who use the levied imports as inputs.
As the newly proposed tariffs are likely to include many consumer products, some pass-through of prices may affect the consumer price index and/or the profitability of US retailers if they decide not to pass on higher costs.
Analyses by many US institutions have shown significant losses by American firms and consumers following previous tariff actions (such as the tyre tariffs imposed by President Bush in 2002). We think the public consultation in the coming weeks will reveal the anxiety of US corporates and may eventually move the needle enough for Trump to re-engage in dialogue with Beijing.
Finally, even though we still hold a benign view on global trade and growth, unswayed by the latest turn of events, the indirect impact on the macro environment from the financial market should be noted. More market gyrations and further declines in equity markets could have a noticeable impact on the real economy, overpowering the direct effects from trade.
Aidan Yao is senior emerging Asia economist of AXA Investment Managers