Trump should increase US exports to China, not launch a trade war

President Donald Trump wishes to reduce the US-China trade deficit. Just how large is this deficit? The 2017 trade deficit in goods, according to official US data, was US$376 billion, compared to the official Chinese data of US$275 billion. There are many reasons for the discrepancy. 

After adjustments for the difference in the valuation of exports and imports and in the treatment of re-exports through Hong Kong, the discrepancy can be reduced to between US$325 billion (Chinese data) and US$362 billion (US data). If trade in services, in which the US has a surplus, is included, the 2017 deficit is estimated to be between US$287 billion and US$323 billion. 

Moreover, the service trade figures exclude royalty and licence fee payments to third-country subsidiaries and affiliates of US corporations, such as Apple and Qualcomm. These are properly revenues received by US entities but attributed to third countries such as Ireland and the Netherlands. The precise values of these payments are not publicly available, but they are substantial. Thus, the true value of the US-China trade deficit, before adjustment to a value-added basis, is probably no larger than US$250 billion a year, which is still a large figure.

Trump wishes to reduce the trade deficit by US$100 billion. He proposes to accomplish this by imposing tariffs on Chinese exports to the US. Whether this can be done in a manner consistent with the World Trade Organisation rules is not so clear, but it is unlikely to deter Trump. 

China poised to slap US$60 billion in annual tariffs against China

Trump’s opening salvo in trade war with China misses the mark

Under the new tariffs, Chinese exports to the US will fall. However, the most likely net outcome is that while the US trade deficit with China falls, its trade deficit with other countries will rise. Imports from China will be substituted by imports from other countries. The overall US trade deficit with the rest of the world will not be significantly changed, and, by implication, neither US gross domestic product nor US employment will change much, unless the tariffs apply worldwide. 

The history of the apparel trade provides an example. Between 1989 and 2015, the share of US apparel imports from Hong Kong, Taiwan and South Korea combined declined from 36.9 per cent to 1.8 per cent, only to be replaced by Chinese imports, which rose from 11.7 per cent to 38.6 per cent.

In addition, if China retaliates against the new tariffs, US exports to China will also fall, and the US trade deficit may not be reduced after all. The problem with a trade war is that there are no winners – both countries lose because their feasible choices are reduced. Exporters in both countries will be hurt because of the reduction in their exports, and importers in both countries will see their businesses decline. And the consumers and producers who rely on imported goods and inputs in both countries will have to pay higher prices.

Imports can help to keep the rate of inflation low. Research has shown that between 1989 and 2015, a one-percentage-point increase in the Chinese share of US non-oil imports reduced the annual rate of growth of the US non-oil price index by one percentage point. The Chinese share of total US non-oil imports rose more or less continuously from 2.7 per cent in 1989 to almost 22 per cent in 2009, where it more or less remained through to 2017. Between 1989 and 2015, the average annual rate of growth of the US non-oil price index was 2.5 per cent, a big drop from the 5.4 per cent in the previous 26-year period of 1963-1989. The slowdown in the rate of inflation, which in turn permitted a lower rate of interest, can be partially attributed to Chinese imports.

There is, however, a better alternative to reducing the trade deficit than by reducing Chinese imports: the US can increase its exports to China. 

There are two ways for the US to increase its exports. The first is to re-route its existing exports to other countries to China, and the second is to produce new output for export to China. 

The first way is mostly cosmetic. US GDP and employment will not increase much even though the US-China trade deficit will fall. There is little net real benefit to the US.

The second way, however, will lead to genuine improvement in economic well-being in both nations. US producers and exporters will benefit, as will Chinese importers and consumers and producers who use the new imported goods and inputs. As long as the trade is voluntary, both countries will benefit in the aggregate.

The US doesn’t have the stomach for a full-blown trade war

The production of new output resulting from new export demand generates GDP and employment, making use of the underutilised productive potential in the US. 

Two areas of potential exports that can be huge and are relatively uncontroversial are agricultural commodities and energy. China has a huge demand for agricultural commodities, and, in addition, there is also potential in increasing the value-added content in US agricultural exports, for example, by exporting meat instead of feed grains (corn and soybeans) to China. 

There is also a huge and growing Chinese demand for energy, which can be met by exports of liquefied natural gas from Alaska and shale oil. 

It is easy to envisage that additional exports in these two areas alone can amount to more than US$100 billion a year, with almost 100 per cent US value-added. However, for both US producers and Chinese importers, long-term contracts with credible enforcement are necessary to sustain the trade. 

China tech push likely to increase trade tensions with US, Europe

Increasing US exports of hi-tech products to China is also a possibility as Chinese demand for them is high. However, this is likely to be more controversial for national security and competitiveness considerations. For the same reasons that the US government is discouraging the use of Huawei servers and cellphones in the US, the Chinese government may also decide that it is too risky to rely on US hi-tech products. This mutual stand-off is likely to create implicit protection in both countries.

It is also useful to note that expenditure of Chinese nationals (including tourists and students) in the US is a significant component of the US-China surplus in trade in services. Actions such as changing visa requirements and reducing the number of visas issued to Chinese students are likely to widen, rather than narrow, the US-China trade deficit.

Lawrence J. Lau is the Ralph and Claire Landau Professor of Economics at the Chinese University of Hong Kong