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Jan 11, 2017 | 09:15 GMT

9 mins read

A Trade War That Cannot Be Won

A Trade War That Cannot Be Won
(STR/AFP/Getty Images)
Forecast Highlights

  • Protectionist trade policies toward China would do little to achieve the incoming U.S. administration's stated goal of reviving U.S. manufacturing.
  • Beijing would use various means — in particular, harassing U.S. companies that operate in China and depend on the country's growing consumer market — to retaliate against protectionism in the United States.
  • President-elect Donald Trump's administration will likely focus on curbing Chinese steel imports, a policy that could boost U.S. manufacturing without doing much damage to China's economy.

The trade relationship between the United States and China is a cornerstone of the global economy and a linchpin of the economic, social and political order in both countries. But in recent years, and particularly during the runup to the 2016 U.S. presidential election, the partnership has come under fire in the United States. Leaders such as President-elect Donald Trump have criticized Washington's trade ties with Beijing as unfavorable, since China's exports to the United States exceed its imports from it. Trump has decried the negative effects of this trade imbalance and promised to correct it, for instance by imposing a 45 percent tariff on Chinese imports. Despite the backlash that such a drastic measure would invite from Beijing, Trump argues that the United States is better poised to weather a prolonged trade dispute than is China, thanks to their lopsided trade relationship.

A closer look at U.S. trade activities with China casts doubt on this idea, however. Changes in the composition of Chinese exports to the United States, the structure of manufacturing supply chains and the aims of U.S. corporate investment in China have evened the field between Washington and Beijing. As each side tries to achieve increasingly contrary political and economic goals, neither would be immune from the fallout of a trade war. China has just as many options to retaliate against protectionist U.S. policies as the United States has to punish Beijing. The challenge is to understand which tactics the countries' leaders are likely to choose — and to what end.

The Bigger Picture

At first glance, the United States appears to have the upper hand in its trade partnership with China. Beijing ostensibly has more at stake in the relationship than Washington, in part because China's economy relies more heavily on exports. In 2015, exports made up about 22 percent of China's gross domestic product, compared with 12.5 percent of U.S. GDP. Furthermore, exports to the United States — China's largest single-country trade partner — accounted for roughly 3.8 percent of China's GDP that year, while exports to China totaled just 0.65 percent of U.S. GDP. And though the United States imports a larger share of goods from China than China does from the United States, imports play a smaller role in the U.S. economy. This breakdown lends credence to the idea that the U.S. economy has less to lose in the unlikely event that trade with China comes crashing to a halt.

But trade figures alone do not reflect the complexities of the two countries' trade ties or the leverage that they give each side over the other. A look at the kinds — and not the quantities — of goods traded offers a more complete picture. In order of value, electronics and electrical equipment, machinery, furniture, clothing and toys make up China's top five exports to the United States. But even in most of these categories (except toys), exports to the United States account for at most 30 percent of China's total exports. In fact, the United States takes in just 15.9 percent of China's electronics exports, although electronics make up nearly one-quarter of U.S. imports from China. Doubtless, new trade barriers from the United States would hurt China, but Beijing could mitigate the damage by encouraging domestic consumption or increasing its exports to other markets.  

Unintended Consequences

When looking at trade in electronics goods, moreover, official statistics often obscure as much as they reveal. Many electronics registered as Chinese exports, such as the iPhone, are only partly assembled in China, and other points along the supply chain — including the United States, Japan and Taiwan — are responsible for the vast majority of their final cost. But because China is the final point of assembly before export to the United States, the full value of the finished goods is attributed to China. Given the extent of supply chain integration and the share of value that other countries contribute to nominally Chinese electronics exports, an attempt to limit U.S. imports of these goods would disproportionately hurt the United States and its regional allies. On top of that, import controls on items such as electronics, clothing and toys would have tremendous social and political repercussions in the United States, where household consumption is equivalent to 68 percent of GDP. Though Chinese exports account for only a small portion of that consumption — about 4 percent — they are heavily concentrated in everyday consumer goods for which shortages or price spikes would be highly visible, if not economically crippling.

Imposing a steep tariff on Chinese imports would create problems for consumers in the United States — and, by extension, their elected representatives. More important, it would not help the incoming administration fulfill its goal of restoring manufacturing jobs to the United States, or even slowing the flight of existing jobs overseas. High labor costs and a lack of production and assembly capacity in the United States, along with the level of supply chain integration in East Asia, will prevent a renaissance in U.S. manufacturing of high-end consumer goods, much less textiles or toys. A tariff hike on Chinese goods would likely drive the Chinese and Taiwanese companies that dominate electronics assembly to move their operations from China to an even cheaper country to circumvent U.S. restrictions. Although Chinese export businesses would suffer in the process, and employment levels in parts of coastal China could drop, the effects would hardly devastate China's economy, nor would they necessarily invigorate that of the United States.

An Enemy Within

Perhaps the greatest constraint on any Trump administration effort to impose punitive trade measures on China is corporate America's deep interest in the country's burgeoning consumer market. For now, consumption is equivalent to only 37 percent of Chinese GDP, according to official estimates. Nonetheless, by virtue of its size, China is already the world's largest market for a range of consumer goods that are mainstays of U.S. companies, from personal electronics to cars. But because U.S. companies manufacture many of the goods they sell in China there or elsewhere in Asia, export statistics do not reflect those transactions or the extent to which U.S. companies depend on Chinese demand.

This poses another challenge for the Trump administration. In the past, most U.S. foreign direct investment into China was intended for export back to the domestic market. Today, by contrast, most major U.S. corporations sell much of what they manufacture in China to Chinese consumers. That leaves the incoming administration little leeway with which to pressure these companies or, for that matter, Beijing. Tariffs or other import penalties on goods that U.S. companies produce in China will work only if the products make their way back to the United States. Meanwhile, reliance by U.S. companies on Chinese markets gives Beijing significant leverage over them. U.S. companies eager to capitalize on existing and future demand in China would be loath to jeopardize their access to the country's consumers by defying Beijing's wishes.

Trump's Steely Resolve

Considering the limitations and consequences of imposing tariffs and other controls on Chinese exports, the Trump administration will likely pursue targeted protections, for instance on steel. In 2015, the United States sourced just under one-third of its imported steel from China — satisfying about 10 percent of domestic demand for steel that year. Heavy tariffs on Chinese steel could encourage U.S. companies instead to buy domestic steel, for which the United States has retained a sizable production base. Higher import tariffs would probably take a meaningful toll on Chinese steel exporters, too, since about 20 percent of China's total iron and steel exports go to the United States.

But though these measures would go some way toward Trump's goal of rebuilding, or at least stabilizing, one sector of U.S. manufacturing, they would not offer Washington much leverage over Beijing. Under President Barack Obama, the United States has taken action against Chinese steel exporters for allegedly selling steel abroad at artificially low prices (a practice known as "dumping"), and the World Trade Organization has instituted protective measures. Further restrictions on Chinese steel imports would represent merely a continuation of existing policy and not a departure. And because steel makes up only half a percent of China's total exports, redoubling tariffs on Chinese steel — or even instituting an embargo — would do little to rattle the country. Beijing's efforts to consolidate its steel industry may well bring an end to Chinese steel exports to the United States, regardless of Washington's policy decisions. In the meantime, China could probably divert its steel exports to other markets, thereby offsetting the effect of a change in U.S. policy. 

Returning Fire

China, on the other hand, has many economic tools that it could use to damage the United States. Whatever path Trump chooses to take toward China, Beijing will be poised to retaliate. For a start, the Chinese government will continue to use its anti-monopoly law to make life hard for U.S. multinational corporations operating in the country. In doing so, Beijing can count on U.S. manufacturers and technology companies to pressure their government to preserve the status quo with its trade and economic policies. Even if their pleas do not deter the Trump administration from taking action against China, they would likely influence his policies. Beijing will also threaten to procure goods from other countries to compel U.S. companies to lobby Washington on Beijing's behalf.

If trade relations falter, China and the United States would make ample use of more traditional weapons of trade warfare as well. Each side would take trade dispute cases to the World Trade Organization in an effort to gain international support for their policies and delegitimize those of the other. Notwithstanding the imbalances in their trade relationship, neither Washington nor Beijing would escape the fallout of a trade war.

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