- Reasons for the commencement of the trade war
- Is the US justified in its actions and how will China respond?
- Impact on the world economy
On 6th of July 2018, the US government led by President Donald Trump executed a notorious plan and imposed 25% tariffs on 818 Chinese goods worth $35 billion, which mainly comprise industrial and agricultural machines like aircraft parts, medical equipment, nuclear reactors, etc. China retaliated by levying taxes of an equivalent amount and size on the US products that include seafood, soybean and automobiles.
This is just the phase 1 of the burgeoning trade war, the US is set to impose more tariffs on an additional 284 products worth $16 billion and it further plans to expand this to $200 billion on the Chinese goods. The battlefield was laid by the US tariffs on steel and aluminium products from China, Canada, Mexico and Europe in early 2018.
Why has Trump administration set the stage for trade war?
Trump has overtly criticised the North American Free Trade Agreement (NAFTA) for stealing manufacturing jobs from the US and diverting these to Mexico. It is one of the major reasons for renegotiation on the NAFTA. Trump does not want the US economy to suffer more with the free trade agreements and this was a prime reason why the nation opted out of the Trans-Pacific Partnership as well.
The imposition of taxes on imports of steel and aluminium was justified in the name of national security and for the protection of the domestic producers who were in a way challenged by a worldwide oversupply of these commodities, led by China. Over and above, the US government considers China responsible for poaching on its technology; related trade secrets and resorting to unfair trade practices. The situation worsened by the rising trade deficit with China, this was $375.6 billion for 2017 (Source: U.S. Census Bureau), although the figures are considered to be overstated. Thus, Trump expects China to contribute to the reduction of glaring trade deficit or face import tariffs without a retaliation (when the US imposes restrictions on the Chinese investment for its key industries).
Is Trump justified in doing so?
Trump’s stance to create more jobs and safeguard domestic manufacturers in order to boost its economy is a rational step. It is also true that it has a huge trade imbalance with China. However, President Trump’s pressure on China for cutting down the trade deficit by $200 billion by the year 2020 or face import tariffs is economically unviable.
Hence, for the trade imbalance to recede:
a. The US’s exports to China need to increase, i.e. China’s imports of USA goods need to increase
b. The US need to decrease the consumption of Chinese goods, i.e. China’s exports to USA needs to fall
Further, for option ‘a’ to happen the US would have to increase the production of its own goods, however, it is unattainable in the short-run. According to a certain set of economists, the US is already utilising its resources efficiently to achieve the maximum possible output, that it is very close to achieving its production possibility frontier. Thus, its exports to China are not expected to increase remarkably in a span of only 2 years. Even if it tries to move away its exports to other countries to China, it is going to disturb the trade balance with these nations. If the US resorts to option ‘b’, it would not make much of a difference to the mammoth trade deficit as the goods bought by the US people from China are priced lower, implying any immediate reduction is inconsequential.
Therefore, the only option that was left was an imposition of tariffs on imports from China, in order to stop what the US claims an unfair trade practice. This seemed to be President Trump’s intention from the very beginning, but to expect that China will not reciprocate with identical tariff measures is irrational and unjustifiable. The US has been leading the world economy since the time immemorable and the rise of China is a big threat to the US supremacy. Additionally, China’s ‘Made in China 2025’ mission which aims to transform the country into a tech giant globally could add to the US’s vulnerability. China has already taken away manufacturing due to the cheap labour, land and is now undertaking a leap to be a technological hub, which seems to be daunting to the US government. Let us also not forget that the US has been a consumption economy rather than a production economy, which in the past was more than willing to buy goods from China because of the price difference. This is the major cause for the trade deficit with China, which, in fact, is not new and abrupt. It has had a trade deficit of over $300 billion since 2012.
However, as far as import tariffs of 25% on steel and aluminium are concerned, the US should not face the critics alone as the European Union imposed similar taxes amounting to as much as 73.7% on the Chinese heavy plate steel as an anti-dumping measure in 2016-17. China’s oversupply of steel at modest prices impacted the European countries, which resorted to anti-dumping regulations so that the domestic players could survive. China is the leading producer of steel with companies having installed more capacities than required, out of the total production of 1,689 million tonnes (2017), 831.7 million tonnes were produced by China. But in order to defend itself, it is now working on reducing its over-capacity by 150 million tonnes in 2018 instead of 2020 as planned earlier.
What are the alternatives available to China?
China has already resorted to the levy of tariffs on the US goods and is preparing to extend this to a plethora of other goods if the US does not vow to end its trade tactics as stated above. China has and will reciprocate accordingly, contrary to President Trump’s demand of the nation being a mute spectator to the American imposition of tariffs. China will not allow the US to thwart its expanding supremacy in the world economy.
Furthermore, another detrimental option that China can exercise is to begin offloading $1.2 trillion of the US debt it holds. China has a reservoir of the US treasuries that it keeps buying due to its large foreign reserves, this stood at $3.2 trillion as of June 2018.
Let us try to understand if this option is economically viable?
Chinese exporters receive their payments in US dollars for their enormous exports to the US, however, they need the Chinese Yuan to pay for their costs incurred in the domestic market. Chinese government buy USD from exporters in exchange for the Yuan and thus, has accumulated a massive amount of the USD as foreign reserves. These foreign reserves are in turn used to buy the US treasuries, which are the safest bet rather than other high-risk securities.
China is actually providing a loan to the US so that it can keep purchasing Chinese goods. If the Chinese government does not intervene to buy USD from its exporters, it could cause an oversupply of the currency in the market and lead to depreciation in its value against Yuan. This would sequentially lead to the US’s exports being cheaper and imports being expensive. China would not want to lose its export competitiveness in the international market. The US needs the loan to keep buying Chinese goods that are economically-priced and China gets the continuous access to the huge US market. However, if China still decides to sell the US debt, it would cause the yields to rise for bonds in the world’s biggest bond market. This would, in turn, make borrowings expensive for both the corporates and consumers, thus slowing down the US economy. This is going to send ripples across international markets and trigger a financial catastrophe.
What lies ahead? Would world economy get affected?
The growing strain in the US-China economic ties is expected to interrupt the global supply chain phenomenon as imports and exports get diverted to other nations. There are big US players like Apple, Nike and Walmart that either invest, outsource or import materials from China. When these processes become expensive, the prices are going to be passed on to final consumers. Further, as Apple, Nike and Walmart are global companies with their products sold world over, the prices of goods supplied to other nations would also rise. President Trump’s actions are thus going to diminish the trade volumes, increase inflation and bring down the GDP. According to Mark Carney, the governor of the Bank of England, ‘American economy would suffer a 2.5% drop in GDP as a result of falling trade volumes alone over three years, should the White House increase US import tariffs by about 10 percentage points on all of its trading partners. The world economy would take a hit to GDP of just over 1%, while there would be a smaller impact on the EU and the UK’.
Moreover, another interesting aspect is that President Trump’s focus is to get the production back into the US economy, in order to protect the interests of the domestic manufacturers and generate more jobs. Nevertheless, with automation and artificial intelligence creeping the markets, the jobs are going to be lost any which ways. President Trump is not oblivious to this fact, thus creating/safeguarding manufacturing jobs shall not form a pretext for a trade war.
Additionally, it seems a far-fetched idea that multinational companies are going to relocate their factories from China just to avoid taxes imposed by the US. Their operations are deeply rooted and these would incur huge costs on a relocation. But if this happens, China would no longer remain the manufacturing giant and would be greatly distressed. On the other hand, China’s tariffs on the US’s agricultural goods and automobiles are going to take a toll on the US economy. The tariffs on soybean would affect the farmers’ interest, which serves as a vote bank to Trump and he is dependent on their political support. In addition, the US’s automobile manufacturers’ sales volume are higher in China, for example, General Motors sold over a million more vehicles in China than in the domestic market in 2017. Thus, the key players in the US are dependent on China for their source of revenues.
It seems that both the countries will suffer due to the tariffs, China, however, has an advantage over the US, in terms of large foreign exchange reserves and the US treasuries or be it the limitations of the US to be self-sufficient to meet its local demand in the foreseeable future. If two of the world’s biggest economies are involved in a trade war, the shock waves are bound to proliferate to the rest of the world. Thus, the need of the hour for both the countries is to get back to negotiations and lay out a compromise plan, best suited for both the economies and the world in conjunction.