The two largest economies in the world – China and the United States of America – have locked horns in what seems to be the start of a long and ugly trade war, one that could have serious implications for the global economy.
It all started with a tweet from President Trump in March (composed in his signature style where opinions pose as facts) in which he proudly stated that “trade wars are easy to win” for a country like the US. Five months and many tweets later, 25 percent tariffs have been imposed by the US on Chinese imports worth $50 billion, with a threat of 10 percent tariffs on an additional $200 billion worth of Chinese goods. The Chinese have duly returned the favour by imposing duties of 15-25 percent on US goods worth $50 billion.
Both countries have hit the other where it stings the most: US tariffs have been imposed on sectors that Beijing aims to develop as part of its Made in China 2025 plan, while retaliatory tariffs have mainly targeted US agriculture products that make up a hefty share of American exports to China.
To provide context, US is China’s biggest export market, and has imported Chinese goods worth $450 to $500 billion each year in the past decade. The US also faces a large trade deficit with China, worth about $350 billion each year. This trade deficit has irked President Trump since his campaign days, and is one of the primary reasons behind the American drive to protectionism.
Former White House policy adviser Steve Bannon recently said, 'Trump may be flexible on so much stuff, but the hill he’s willing to die on is China'
Put into effect in late July, the additional duties have already started to hurt China’s export sector. The new export order sub index, which is the primary index to gauge the health of China’s exports, fell by 0.4 points to 49.4 in August. A value of below 50 for the sub index is interpreted as a contraction of export orders for the month.
In addition to hurting China’s exports, US tariffs have also caused damage to China’s reputation as an investment destination. Foreign manufacturing businesses stationed in China are now becoming uneasy, and there are talks of the possibility of shifting production to other countries. This is especially true for Japanese firms in China, since many of the “Chinese” exports targeted by the Trump administration are produced in China but by Japanese firms.
The situation complicates things for the Chinese central bank too. The aim of the People’s Bank of China since last year has been to fix its debt situation by tightening monetary policy. The decline in exports will now put pressure on the bank to cut interest rates to boost domestic demand, contrary to its plan. Furthermore, declining foreign reserves will put additional downward pressure on the Yuan. If the trade war persists, it could also reduce Beijing’s ability to generate sufficient foreign exchange to finance President Xi Jinping’s Belt and Road Initiative. This could possibly undermine China’s growing geopolitical and economic outreach in Asia.
The US economy is not safe from the impact of these tariffs either. US steel and aluminum prices have soared since the start of the trade war, and the price of US Midwest hot-rolled coil steel (the US steel price benchmark) has increased by a whopping 36 percent. This may fare well for the US steel industry (since rising prices mean rising profits), but will lead to a consequent rise in prices of goods made with metal. Sectors such as real estate and homebuilding could experience a slump.
On the other hand, Chinese tariffs on soybeans – the largest US agricultural export to China worth about $14 billion annually – have caused soybeans prices in the US to crater. This could very well cause a loss in income (and even unemployment) for American farmers.
Thus, these tariffs may provide a boost to American industries such as steel production and electronics, but losses in other sectors (such as agriculture, construction, transportation and trade services) will far outstrip the gains. According to analyses conducted by the Trade Partnership – an industry group that examines trade issues – steel and aluminum tariffs could create up to 30,000 jobs, but cause losses of about 400,000 jobs due to spill-over effects in other sectors. In such a scenario, the ultimate result would be a slowdown of US GDP growth.
If the trade war persists in the long-term, US manufacturing firms in China could be forced to reorganize their supply chains and locate low-cost production in countries like Vietnam, Malaysia and Mexico. There will be little likelihood of these firms moving production to the US, due to higher production costs. This would defeat one of Trump administration’s main objectives behind increased protectionism: to shift manufacturing jobs back to the US.
Increased protectionism will not have a significant impact on the US trade deficit either. High import volumes are essentially an inevitable by-product of a robust US economy, a strong US dollar, and a large fiscal deficit. Evidence shows that protectionist measures (such as tariffs) do not reduce trade deficits, although they do increase economic costs and inefficiencies.
It remains to be seen how long this trade war lasts, but one thing is for sure: it will not fare well for the global economy (nor for both US and China) in the medium to long term. The reason is not just the disruption of trade but more importantly the erosion of business confidence.
In a typical trade war scenario, uncertainty leads to postponement of investment and consumption decisions. And when two of the world’s largest economies clash, no one knows what might happen to global supply chains and more importantly, to the international economic order. Such unprecedented uncertainty is bound to cause only suffering for the global economy.
The author is an economist at an Islamabad-based think tank.
