Intensifying trade war could quadruple economic damage

18-May-2019 Intellasia | TheHill | 6:00 AM Print This Post

Financial markets have recoiled at the recent deterioration of US-China trade negotiations.

Of course, protectionism itself is hardly a new thing; it has been a central economic theme over the past year and was a key element of President Trump’s campaign platform before that.

Some of the American motivation to rewrite trade deals is based on a shaky foundation: The woes of US manufacturing workers have more to do with automation than outsourcing, and the Chinese yuan is not especially undervalued.

But part of the grievance is entirely legitimate: American companies do pay higher tariffs on average than their foreign counterparts, and China enjoys particularly asymmetric advantages over the US

China is the most critical of the various battlefields that the US has opened on the trade file and also the most challenging to navigate. This is because China is responsible for the great bulk of the US trade deficit and yet is less susceptible to US pressure tactics due to its own economic heft and centralised power structure.

For nearly two decades, China has enjoyed the privilege of low tariff rates as per World Trade Organisation rules while simultaneously maintaining an economic system that tilts the playing field to its own advantage via a unique mix of capital controls, state-owned enterprises and joint venture requirements.

Responding to this, the US imposed several rounds of tariffs on China in 2018, punctuated by a 10-percent tax on $200 billion of Chinese products in October. China largely responded proportionately to these actions, hitting US exporters with tariffs of a similar magnitude, though strategically targeted at different sectors.

The US had originally imposed a deadline of December 31, 2018 for China to comply with US demands, after which time the tariff rate on China would increase from 10 percent to 25 percent. However, the deadline was delayed to allow for negotiations between the two countries.

A month ago, these negotiations were beginning to look quite promising as per reports from both sides of the table, with success thought to be a matter of weeks away.

However, all of the positive talk has now vanished, and the two countries are at loggerheads again. The US says that China had initially agreed to legislate a wide range of economic reforms, but its latest edits to the proposed agreement have backtracked on several fronts. China, for its part, feels that it is making many concessions in exchange for very little on the US side.

It has been believed by many that any deal would be fairly superficial and fail to fully address the underlying frictions between the world’s two economic superpowers. China, for instance, is unlikely to abandon its reliance on state-owned enterprises given their centrality to the country’s economy and power structure. But even a half-victory on the trade file now seems elusive.

The US has now delivered on its long-delayed threat, raising its tariff rate on the $200 billion of Chinese products from 10 percent to 25 percent. These mostly affect imported industrial goods.

The White House has also threatened a further set of tariffs on another $300 billion of imports from China. If delivered, this would shift the burden toward more consumer-oriented products.

China has retaliated, with higher tariffs of its own on $60 billion of imports from the US, spanning an eclectic mix of agricultural, industrial and consumer goods.

Loosely speaking, the tariffs exchanged between the US and China in 2018 subtracted around 0.3 percent from US economic output, and a bit more from China.

The latest actions roughly double that damage. Should the $300 billion threat be delivered, that could double the damage again. Even this falls somewhat short of a recessionary shock, but it is nevertheless significant.

Markets are naturally unhappy with this dispute. The rebound in risk assets since the beginning of 2019 was the product of three things: more dovish central banks, stabilising economic growth and fading protectionism worries. The last of these supports is now reversing, making the market recalibration unsurprising.

Fortunately, there is still a glimmer of hope. The US is not immediately levying the new, higher tariff but is instead waiting to apply it until after goods already in transit have been processed.

China has done even more. Not only was its response to US tariffs fairly restrained in magnitude, but its new tariffs don’t apply until June 1, leaving additional room to resolve the dispute.

The US must surely be anxious to avoid needless damage to its economy with a 2020 election approaching and China equally so given its recent fiscal stimulus package. This could yet motivate a patchwork of a deal, though not a genuinely final resolution for two countries that seem destined to tango repeatedly over the coming years.


Category: China

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