The worsening US-China trade war might cost the world much more than US$430 billion of lost GDP
Aidan Yao says the US-China trade war threatens to be a drawn-out affair, pulling down the global economy. The IMF has put the cost of the conflict at 0.5 per cent of world GDP, but there might be more serious consequences ahead
President Donald Trump’s announcement last week that the US was going ahead with additional tariffs on US$200 billion of Chinese imports dashed renewed hopes that trade talks between Beijing and Washington officials would defuse tensions between the world’s two largest economies.
The market was fooled again by the mixed signals from the United States: the Treasury Department appeared eager to get the trade negotiations back on track, while the White House showed no intention of easing the pressure on China.
Such conflicting signs had also preceded the first round of tariffs in July. Back then, trade talks led by US Treasury Secretary Steven Mnuchin and Chinese Vice-Premier Liu He had appeared to be going smoothly until they were overruled by Trump, who fired the first shot in the trade war.
The latest action from the Trump administration has taken the trade conflict to a whole new level. Not only is the amount of goods subject to tariffs four times larger than in the first round, Trump has also threatened to slap punitive taxes on everything China exports to the US if Beijing retaliates.
That threat has proved ineffective, however. With China announcing counter-tariffs on US$60 billion of US products, we are now waiting for the next move from Trump that would officially turn the market’s worst nightmare into reality.
Politically, it is difficult to see how things could turn around in the near term. After having taken such a tough stance in front of domestic and international audiences, neither side can realistically back down without a significant loss of face.
Where Trump is concerned, it is not obvious he wants to relent, even if he is given a chance to do so in a face-saving way. Since China bashing has worked well for his popularity, Trump may even find it opportune to show more hostility towards China, with the midterm elections looming large.
For President Xi Jinping, making sure China stands up to the bullying of the US could be critical to preserving national pride.
Watch: Are Chinese less willing to buy US goods?
These political considerations are important hurdles to deal-making in the near term, and it might be difficult to end the impasse until after the November elections. What is worrying is that this political game of chicken could take the world economy down a very dangerous path.
An all-out trade war could cost the US economy almost 0.5 per cent of gross domestic product once the domestic and international feedback effects are considered. A nasty financial market reaction could cause more damage to the US economy, raising the cost to almost 1 per cent of GDP over the next 24 months.
China stands to lose more given its larger exports to the US. Based on the tariffs already proposed, there would be a GDP shock of almost 1 per cent over the next 12 months. That damage will widen to more than 2 per cent of Chinese GDP if Trump decides to hit all Chinese exports to the US with higher taxes.
Such a shock will deal a severe blow to investors’ confidence, and in turn, drive a substantial correction in Chinese asset markets. Once again, the combined impact of real economic and financial shocks is likely to be significantly larger than what standard economic modelling implies, because the technique does not capture financial shock very well.
The trade war will also be seriously contagious, spreading beyond the two involved parties. The global supply chain and financial markets are major transmission mechanisms that can propagate the shock across the world economy. While everyone will suffer, Asia will take the worst hit, given its high degree of supply chain integration with China’s manufacturing and assembly operations.
In its latest World Economic Outlook report in July, the International Monetary Fund put the cost of the trade war at US$430 billion, or 0.5 per cent of world GDP. This seems conservative now, as conditions have since deteriorated markedly. In a worst-case scenario, a full-blown US-China trade war will cause economic and financial carnage on the scale of the 2008 global financial crisis.
Let’s hope cooler heads will eventually prevail and an economic train wreck can be avoided.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers