On March 2, 2018, US President Donald Trump tweeted: “When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win. Example, when we are down $100 billion with a certain country, and they get cute, don’t trade anymore — we win big. It’s easy!” There are arguments for and against Trump’s statement, and the trade disputes between the US and many of its trading partners — in particular, China — are some of the hottest issues around the world.
The US imposed a tariff hike of 25 percent on USD 34 billion of Chinese imports on July 6 and USD 16 billion of Chinese imports on August 23; it is going to impose a 10 percent tariff on an additional USD 200 billion of Chinese import on September 24 and automatically hike the tax to 25 percent by January 1, 2019, if no trade agreement is reached with China before then. President Trump has announced that he might consider an additional tariff on USD 267 billion of Chinese imports if the Chinese government fails to engage in meaningful talks with the US.
The US government has announced that the list of items under the first batch of the 25 percent tariff was chosen under several criteria. The first criterion was to minimize the impact on inflation. Thus most of the goods are intermediate products. The second was to create a maximum impact on the Chinese economy to force China to come to the negotiating table. The third was to target Chinese high-tech products under the “Made in China” program, as the Americans feel that Chinese advances under the plan come from the theft of American technology. The decrease in imports in the affected categories can be used as a proxy to gauge the worst initial impacts on Chinese exports.
US import trade data on a disaggregated basis is released after a time lag of around two months. Hence analyzing how an import category is affected by a tariff measure can only be analyzed the month after the importation takes place. Many analysts are looking at the disaggregated July US imports from China with particular interest because changes in the July importation figure of the affected items are the first tangible data points of how the Chinese exports to the US have been affected and how any subsequent impositions of tariffs will affect Chinese exports to the US.
Many banks and research institutions had estimated the potential impact of the tariff hikes on US-China trade, and their models of trade elasticity were based mostly on static assumptions and not dynamic conditions reflecting many real-life moving factors such as the availability of alternative suppliers, currency effects, and quality factors affecting substitution. The July import figures of the affected products provide the first real-life data point to gauge the substitutability of Chinese imports under the 25 percent tariff scenario to validate their earlier models.
A significant decline in the July importation of USD 34 billion worth of goods under the new 25 percent tariff hike would have meant the high substitutability of these products from either domestic production or alternative suppliers elsewhere. On the other hand, a slight decrease would indicate that these products are so intertwined in the global supply chains that short-term replacements are impractical. The announced importation drops of 9.6 percent on a year-to-year basis in the USD 34 billion worth of products under the 25 percent tariff hike was much less than expected and the latter interpretation appears to be the case. Consider an annual natural market growth of 2-3 percent; one can surmise that the worst impact of the 25 percent tariff hike on Chinese imports to the US would be around 10-12 percent. The impact on the US will likely be much higher prices for the products under the increased tariff as the tariff will likely result in a simple pass-through in the absence of alternative suppliers.
The analysis of the 2017 trade items between the US and China shows that the extent of integration of both countries in the global supply chain is more in-depth than is commonly acknowledged, and that the spat over trade is a “lose-lose” situation.
The figure also supports the earlier view of some economists who had analyzed the potential effects of duties on US-China trade based on an analysis of 2017 US importation from China. Several salient features emerged from the 2017 US importation analysis. The first is the high China market share in the particular import category; four categories have market share more than 50 percent, five groups have a market share between 20 percent and 50 percent, with only the tenth group (road vehicles) at an insignificant 5 percent. High market shares in overall importation means the country enjoys comparative production cost advantage in the international trade arena on these products. Trying to replace these products by substituting with alternative import sources are not realistic in the short run. The second is the massive trade deficit sustained by the US on said importation — it means US domestic production is either not cost competitive against the said Chinese imports or there is no local production of the said products.
The intensifying trade disputes between the US and its key trading allies is widening its trade deficit. The high domestic demand from a buoyant economy and tax cuts has increased import demand, and the appreciating dollar as a result of the rising US interest rate and the deterioating conditions in many emerging markets, such as Turkey and Argentina, has make US exports more expensive in foreign markets and hence a drag on exports. The latest trade figure since trade war started in June shows that US exports have stagnated while imports have surged. The US trade deficit on goods and services is likely to hit USD 600-650 billion this year, a significant increase from USD 566 billion in 2017. Imposing tariffs on Chinese goods in the absence of domestic production and viable foreign substitutes will likely result in the tariffs passing through to the consumers and expanding the trade deficit.
In the top two import items from China that account for more than USD 170 billion or almost 35 percent of Chinese imports to the US, the multinational corporations play an important role in the industries. If these multinationals are forced to relocate outside China either to evade the tariff imposition or succumb to political pressure from the US government to relocate, then China might face an exodus of these industries. There are signs that the US government is trying to swing the global supply chain on its China importation away from the country, although whether that will be successful remains to be seem. China has increased its value participation in the supply chain and it will be a costly decision for multinationals to move their production base away from the country.
Table 1. Top ten imports into the US from China and their market share among imports in 2017
The analysis of the 2017 trade items between the US and China shows that the extent of integration of both countries in the global supply chain is more in-depth than is commonly acknowledged, and that the spat over trade is a “lose-lose” situation. The July trade figures confirm the “stickiness” of Chinese imports and the absence of meaningful substitutions to them. The possible expansion of the US trade deficit on goods next year to over USD 1 trillion and the inflationary impact of tariffs reflect the vulnerability of the US in its trade spat with China and other countries. Likewise, the slow migration of some multinationals out of China also reveals the potential damage to the country. Contrary to Trump’s tweet, the trade war is not only not easy to win, it is more like a fight without a winner.