Risks of new tariffs go beyond affecting China

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If you think President Trump’s tariffs on steel and aluminium imports are aimed at tackling the imbalance in Sino-US trade, think again. The main products that contribute to the massive USD 375 billion Sino-US trade deficit are electronic and labour-intensive products including data-processing machines and communications equipment, toys, furniture, footwear and plastics.

Both types of products are hard for the US to target because
• electronics are an integral part of US production in the global supply chain, so that higher import tariffs would raise the costs for US companies
• the US has no comparative advantage on making labour-intensive products anymore [1], so that tariffs only act as a tax on US consumers.

US trade in advanced technology products (in millions USD)

Source: United States Census Bureau, US International Trade in Goods and Services, as of January 2018

US exports, imports, and balance of selected goods (in millions USD)

Source: United States Census Bureau, US International Trade in Goods and Services, as of January 2018

The tariffs are likely applied broadly, although some conditional exemptions appear to have been granted, while further exemptions could be negotiated. One country spared the tariffs is US ally Canada, which accounts for 16% of US steel imports and 41% of aluminium. South Korea, Japan and Germany, each of which accounts for 5%-9% of steel imports, are less lucky.

It is worth noting that target China is not even among the top-five steel exporters to the US, so the impact is likely to be small. Its total steel and aluminium exports to the US account for about 0.2% of total exports and 0.03% of GDP. To counter any potential damage, China can raise domestic investment and export more, notably to the 65 countries along its Belt & Road routes.

So is the US is edging towards an all-out economic and technological confrontation with China? At this point, it appears President Trump’s stated goal is cutting the trade deficit by forcing China into abandoning its ‘unfair’ trade practices of state subsidies and financing.

US tariffs: China is calm, for now

From China’s perspective, so long as the US tariffs remain product/sector-specific, the macroeconomic damage should be manageable. The response has been muted so far, but a tit-for-tat exchange looks likely. The country has promised a “justified and necessary” reaction, but provided no details. Meanwhile, China may try to lessen the tension by enforcing intellectual property rules at home more strictly or opening financial or selected internet services areas further.

The renminbi will not be used in the trade war, in my view. China may even allow it to gain on the US dollar to soothe the tension. Nonetheless, further serious US actions against Chinese exports would put pressure on the renminbi’s potential strength. Net, despite escalating Sino-US trade conflicts, and barring a sudden and sustained strengthening of the dollar, we still expect CNY to rise against the USD by about 3.0% by year-end.

Political posturing versus actions

While the desire for a tougher policy stance against China is supported in the US political spectrum, there is no obvious consensus on measures that should inflict serious pains on China without causing equal or greater harm to US companies.

A lack of coordination between trade and national security hawks has created inconsistency in the US strategy. Security hardliners would like to ensure that key US allies are on board with their efforts to contain China’s threat. Trade hawks have backed unilateral action such as the tariffs that have undermined any coalition-building efforts.

US trade in goods by selected countries and areas (balance of payments basis, in millions of USD)

Source: United States Census Bureau, US International Trade in Goods and Services, as of January 2018

Many US businesses are ambivalent on the issue. They are unhappy with China’s discriminatory policy, but the country is also a huge market and source of growth as well as a top investment and trade target. However, unless the globalists can gather stronger support from those companies whose fortunes are tied to the Chinese market, the odds are that the nationalist trade and security hawks’ strategies will gain further momentum.

The risks of US tariffs go beyond affecting China

If national security thinking begins to drive US international economic policy, protectionism can rise beyond short-term considerations such as buying votes for the November mid-term elections.

For China, this can mean that more sectors will be affected, with collateral damage on other Asian economies due to their role in the global supply chain.

For the global system, an escalating (Sino-US) trade war would harm growth and investment. The disruption of the global supply chain would boost inflation and geopolitical risk. As shared economic interests are dismantled, the risk of armed conflict could rise.

Under these circumstances, the premium for risk assets (and potentially dollar assets) will rise.

[1] Market research shows that the average wage in the Chinese urban sector is still less than 20% that in the US. Labour costs are lower in other developing countries and they could replace China’s cheap exports to the US.

Chi Lo

Senior Economist for China

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