Does Anyone Win in a US-China Trade War?

A looming 1 March deadline to prevent another round of escalating tariffs between the United States and China is more fraught than typical trade disputes. If that wasn’t already clear to observers, U.S. President Donald Trump made it abundantly so during his State of the Union address on 5 February.

Trump said any trade deal with China “must include real, structural change to end unfair trade practices, reduce our chronic trade deficit and protect American jobs.”

It remains to be seen how palatable such changes might be to China’s government following two days of talks in Washington, D.C., on 30-31 January between U.S. and Chinese negotiators. Those talks reportedly produced little progress, though China did end the talks with “soybean diplomacy” — a promise to buy an additional 5 million metric tons of U.S. soybeans.

On the other hand, China has already signaled its intention to retaliate with new tariffs once the 90-day trade truce between the two countries negotiated by Trump and China President Xi Jinping expires on 2 March, if the U.S. moves ahead with stated plans for a massive round of tariff increases on Chinese imports.

The stakes are high as United States Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin traveled to China in mid-February to continue talks.

To help understand the underlying issues of the trade dispute and what could happen to the two nations’ economies if a trade war escalates, Dr. Ha Jiming, economist and former vice chairman and chief investment strategist at Goldman Sachs in China, recently spoke to the University of Virginia Darden School of Business chapter of the Adam Smith Society. He focused on what would happen when the tariffs were raised and which countries could advance as a result of the conflict.

Economic Impacts: The Vicious Cycle of Tariffs

The Office of the United States Trade Representative (USTR) has promised a tariff rate increase from 10 percent to 25 percent on $200 billion worth of Chinese products on 2 March, which comes in addition to a 25 percent tariff already placed on $50 billion of goods such as vehicles and semiconductors last summer. The U.S. government said it would impose the tariffs as part of its “continuing response to China’s theft of American intellectual property and forced transfer of American technology,” and to reduce its trade deficit with China and bring jobs back from overseas.

Ha predicted a 25 percent tariff would lead to an overall 0.1 percent decrease in China’s gross domestic product (GDP) growth. While this would cause some problems for the world’s economy, Ha said, he predicted a more negative outcome if the tariffs encouraged China to retaliate with additional tariffs — perhaps up to a 1 percent decline in China’s GDP. When the USTR announced the tariff increase on the $200 billion of Chinese products in September, China quickly announced it would raise tariffs on $60 billion of U.S. goods, once the new U.S. tariffs were enacted.

If the trade war deepens, Ha said the Chinese government could depreciate its currency and the U.S. dollar would become stronger, making the exports of U.S. goods more expensive, which could neutralize the U.S. goal to close the trade gap. Changes in the value of the currencies of the world’s two largest economies could potentially exert significant  pressure on both the Chinese and U.S. stock markets. Darden Professor Robert F. Bruner predicted a similar potential for a currency-driven shock in a recent Darden Ideas to Action article on threats to the U.S. economy.

Ha said China and the U.S. will likely try to limit dependence on the other, in the event of a full-blown trade war. The World Trade Organization indicates that the U.S. is the largest importer, having imported physical goods totaling $2.4 trillion in 2017 compared to $1.8 trillion for China. But what is the U.S. importing and who are the major contributors?

Ha cited data from the UN Comtrade international statistics database from 2016, which indicate the top products imported to the U.S. were electrical equipment, mechanical equipment, furniture, clothing, toys, cars and accessories, plastics, and footwear. China is a leading exporter in all of those categories except cars and accessories, Ha said.

While Trump has said his intent with the tariffs is to relocate industries back to the U.S., Ha said he was not so sure the measures would result in that outcome. Ha believes there could be a relocation of the supply chain, but industries would likely relocate to another export leader such as Mexico.

Surveying the Landscape for Clues and Vulnerability

Professor Dennis Yang, academic director of Darden’s Asia Initiative, has conducted research into the U.S.-China trade relationship, including current and potential impacts of the ongoing trade dispute. He identified several factors that shed light on the consequences of the tariffs and on areas in which each nation has leverage in negotiations:

• Amid the ongoing trade negotiations, there has been significant weakening of the Chinese economy with lowered GDP growth and increasing corporate borrowings. The 6.4 percent year-over-year growth rate in China in the fourth quarter of 2018 was the lowest since the global financial crisis. For the full year, China’s economy only expanded 6.6 percent, the slowest pace since 1990.
• Adverse global macroeconomic conditions have begun to influence corporate earnings in the U.S., affecting a wide range of industries. 
• Apple and many of its suppliers recently cut sales forecasts, citing weak China demand and the uncertainty surrounding trade talks between Washington and Beijing. Deteriorating macroeconomic conditions, particularly in China, also impacted companies like heavy equipment producer Caterpillar and NVIDIA, where consumer demand for gaming graphics processing units slowed.
• Based on research by Chinese University of Hong Kong economics professor Sheng Liugang and GF Securities senior economist Zhao Hongyan, with summaries published in the Financial Times, foreign-owned firms in China will bear much of the tariff burden. If the U.S. imposes its planned 25 percent tariffs on 2 March, 47 percent of the burden will be borne by Chinese private companies, while 32 percent of the burden will be  borne by foreign companies, including many U.S. companies operating in China. 

Which Issues Are Key to a Deal?

After analyzing the vulnerabilities of each economy and potential economic implications of a trade war escalation following 2 March, Yang predicted several core issues must be resolved for a successful U.S.-China trade deal to be reached.

“On the surface, the central issue of the negotiation is the trade gap,” Yang said. “But the real core of the issue is intellectual rights protection, China’s state-sponsored industrial policies, and fairness and competition in technological advancement.”

The arrest in Canada and attempted U.S. extradition of Huawei CFO Meng Wanzhou highlights the issue. Yang said the arrest was seemingly independent of the trade negotiations, but both aim at resolving issues related to intellectual property and future strategic competition in tech.

Regarding the trade gap, China’s offer to buy more U.S. soybeans provides the basis for a trade deal, but Yang said the more important issue is what agreements can be made on structural reforms.

“It is hard to imagine China can change its industrial policies,” Yang said. “In addition, implementation of certain agreements would be obscure and difficult.”

There is still hope that a trade war between the U.S. and China will not occur, but Ha said he suspects things will get worse before they get better. He believes the two countries are culturally very different and their trade associations have kept their relationship intact. When asked if he thought there was a possibility of military conflict, Ha said it was not a topic to which he could speak, but that global disputes over the South China Sea did not make him optimistic.