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What a China-U.S. Trade War Might Look Like

June 29, 2018

What a China-U.S. Trade War Might Look LikeAn emerging trade war between China and the United States has prompted predictions of severe disruption – both economic and geopolitical. But analysts say it’s hard to tell how a trade war might actually play out. “Nobody can honestly claim high confidence that they understand what the overall impact will be,” Daniel Rosen, founding partner at economic research firm Rhodium Group, said to The Straits Times

Rosen has 26 years of professional experience analyzing China’s economy, commercial sector, and external interactions and even he is saying, “You might as well project the weather on a Tuesday afternoon a year from now.” But just as a rainstorm on Tuesday afternoon begins with colliding water droplets up in the clouds, a trade war starts with tariffs.

So let’s explore the current state of trade between these two economic superpowers.

Battle between the world’s two largest economies

China and the United States traded goods and services worth over $636 billion in 2017. It's the world's largest bilateral trading relationship. And at $19 trillion and $12 trillion, respectively, the U.S. and China are the world’s largest economies, by far. (Though China is not the only country the U.S. is targeting. President Trump has also imposed tariffs on Canada, Mexico, and the European Union.)

A trade war is exactly what it sounds like: Countries attacking each other’s trade with tariffs, quotas, and other kinds of restrictions. One country will impose restrictions, causing the other to respond in a tit-for-tat escalation. This can hurt both economies and lead to rising political tensions. And when the warring factions are the world’s economic superpowers, their battles affect other economies as well.

A trade war is exactly what it sounds like: Countries engaged in a tit-for-tat escalation of restrictions on the other’s trade.”– Click to tweet

What’s this trade war all about?

For the United States, the imposition of trade restrictions on China has an economic goal and a national security goal. President Trump has invoked both economic and national security rationales for two key strategies. His aim is to close the large trade gap between the U.S. and China and to address what he characterizes as China’s theft of American intellectual property. 

“For the United States, there is both an economic aim and a national security aim to trade restrictions on China.” – Click to tweet

President Trump wants to use tariffs as a way to close the trade gap. The U.S. trade deficit with China was just over $375 billion in 2017– the U.S. buys far more goods from China than it sells to China. As a tax on products made abroad, tariffs raise the cost of imported goods, making consumers less likely to buy the imports and, in theory, boosting local production of those goods. If Chinese goods increase in price, the plan is Americans will turn to locally produced goods.

Another issue is Beijing’s 'Made in China 2025' policy, a strategy designed to increase China’s profile as an innovator of high-tech products rather than just a manufacturer of low-end goods. Along with this strategy, China has been buying foreign technology firms in key industries like semiconductors and robotics. U.S. officials, led by President Trump, believe these practices constitute “unfair transfers of American technology and intellectual property to China.”

As U.S. Trade Representative Robert Lighthizer put it in a statement: “China’s government is aggressively working to undermine America’s high-tech industries and our economic leadership through unfair trade practices and industrial policies like ‘Made in China 2025.’”

Thunderbird Professor Robert Grosse describes those unfair trade practices as state-supported cheating. Typically, joint venture agreements between U.S. and Chinese companies, he says, include technology transfer requirements, meaning the American company has to give its know-how to the Chinese partner.

At the heart of talks of a U.S.-China trade war is Beijing’s ‘Made in China 2025’ policy, designed to increase China’s profile as an innovator of high-tech products.” – Click to tweet

Bloomberg News reports that the Trump administration, including Lighthizer and White House trade adviser Peter Navarro, are pushing for structural changes to China’s policies. That response may extend beyond tariffs. On June 24, the Wall Street Journal reported that the U.S. is planning to introduce new restrictions on Chinese ownership of U.S. technology firms.

Are such measures likely to make a difference? Most analysts say it is unlikely significant changes will be made to the Made in China 2025 policy because it is potentially so powerful for China. If successful, the policy will give China opportunities for sustainable economic growth – even, economic dominance – for decades to come.

It’s complicated

Trade deficits are not necessarily bad. But it’s complicated. As countries have shifted from manufacturing economies to service economies, you have to look a little more closely at what exactly countries trade. 

Discussions of the trade imbalance usually focus on goods. China shipped far more goods to the United States ($505.6 billion last year, according to U.S. figures) than the U.S. shipped to China ($130.4 billion) – that’s where the approximately $375 billion trade deficit figure comes from.

When one trading partner thinks about putting tariffs or quotas on the other country, it’s limited to the dollar value of its imports from that partner. So while the U.S. could restrict as much as $506 billion worth of China’s exports, China has only $130 billion worth of U.S. goods exports that it could restrict. But restrictions on goods trade isn’t the only weapon in the trade fighter’s arsenal. 

The Chinese government could begin targeting trade in services – like tourism, travel, and banking – according to analysts quoted in CNN Money. 

Even more potentially damaging than that could be restrictions on goods and services sold to Chinese citizens by American multinationals with a presence in China – the likes of Apple, Nike, GM, Starbucks, Boeing, and Ford, among others. Those sales are not accounted for in discussions about a trade deficit. Yet, they “far exceed the value of U.S. exports to China,” Alex Wolf, a Hong Kong-based economist at Aberdeen Standard Investments, told the Financial Times.

China could retaliate against U.S. services exports, or against American multinationals selling to Chinese consumers in China.”– Click to tweet

Abroad and at home, for any given industry or business, the impact of trade restrictions depends on a variety of factors: How much does demand change when prices rise? Are substitutes readily available? How much extra productive capacity is there around the world, and how long would it take to get new manufacturing facilities up and running? Tariffs could hurt American companies by imposing costs not faced by their competitors.

Trade wars – they’re complicated. 

What happens next? 

Economists are concerned because neither China nor the U.S. is showing signs of backing down. And the consequences could be severe. According to a model by the Tax Foundation, if the tariffs move ahead, it could lower GDP growth by 0.1 percent (about $20 billion) and cost nearly 80,000 American jobs. 

Tariffs will likely create supply and demand imbalances, while boosting prices for consumers, increasing costs for manufacturers, and potentially exacerbating trade tensions with other countries. S&P Global urged “companies, as well as individuals, should be especially alert as the negotiations play out.”

In the meantime, U.S. tariffs aimed at Chinese goods are scheduled to take effect on July 6. 

Additional Insights

China-U.S. trade war: A recent timeline

Having a hard time keeping up with the details of the looming trade war? That’s understandable. Even before the tariffs take effect, the United States and China seem to be locked into responding to each other’s moves as they up the ante.  

How a trade war could affect U.S. companies

U.S. Automakers: The impact of tariffs on American-made cars is small, but “duties on Chinese imports would disrupt recent moves by Ford and GM to use their Chinese factories to supply limited numbers of cars to the U.S.,” according to Wall Street Journal reports. GM dealers last year sold about 40,000 China-made Buick Envision SUVs.

U.S. Farmers: According to the Wall Street Journal, “Agribusiness firms may need to find alternative markets for U.S. grown oilseeds,” which include soybeans, a huge cash crop for American farmers. U.S. Department of Agriculture data shows that the U.S. is the second largest soybean producer, behind Brazil.  

U.S. Energy: A look at economic subsectors by S&P Global Credit Analysis shows that proposed tariffs would probably deal a significant blow to the U.S. energy sector, which relies heavily on steel and aluminum for various projects.

U.S. Chipmakers: The Semiconductor Industry Association (SIA), which represents major American chipmakers, has two significant concerns about the proposed tariffs. For one, they say the proposed tariffs are “fails to address the serious IP (intellectual property) and industrial policy issues in China.” And, they feel the tariffs actually threaten more harm than good. American chipmakers primarily send finished chips to China where they are assembled, tested, and packaged. Under the announced tariffs, American semiconductor companies argue they will be forced to pay tariffs on their own products.

Recommended resources

White House
Statement on Steps to Protect Domestic Technology and Intellectual Property from China’s Discriminatory and Burdensome Trade Practices

Office of the United States Trade Representative (USTR)
Press Release: USTR Issues Tariffs on Chinese Products in Response to Unfair Trade Practices

Reuters
Envoy says China is ready for proportionate response to U.S. tariffs

Financial Times 
Trump targets China investments as trade war heats up

Embassy of the People’s Republic of China in the U.S. 
U.S. China Trade is a Win-Win Game

U.S. Census Bureau
Trade in Goods with China  

S&P Global
Credit Analysis: Companies And Sectors Most Impacted By U.S.-Chinese Tariffs

Bloomberg
Here’s How Fast China’s Economy Is Catching Up to the U.S.

ASU Now
Tariffs: The blunt tools of trade disputes
Thunderbird Professor Mary Teagarden weighs in on proposed China tariffs

ASU Now
Thunderbird professor Mary Teagarden says factors at play in U.S. and Western Europe also could shape policy in China

Thunderbird Knowledge Network
Economic Forces Push Us Outward, But Social Forces Call Us Home

Thunderbird Knowledge Network
It’s Time for the U.S. to Revoke China’s Free Pass on Trade

SkyNews
Trump's Global Trade War: A Timeline

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