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Apr 6, 2018 | 22:41 GMT

8 mins read

Trump Tosses Out The Trade Rulebook With Latest Tariffs

A cargo ship carrying containers stops at Qingdao Port on April 6, 2018 in Qingdao, China.
(VCG/VCG/Getty Images)
Highlights
  • The United States has proposed additional tariffs on China after Beijing responded to Washington's first moves, risking a full-out trade war.
  • China will be forced to respond in kind to some extent, but its strategy is likely to evolve toward a more nuanced approach.
  • Any tariffs won't be implemented for weeks, and both sides will try to increase their leverage in negotiations. Still, the United States' main demands shake the Chinese state structure to its foundation, making compromise a challenge.
  • The dispute between the world's two largest economies will have major secondary impacts, forcing many countries to either back the United States and risk a full-blown trade war, or back China and possibly destroy the global trading order they rely on.

U.S. President Donald Trump keeps nudging China toward a trade war. After markets closed on April 5, the White House announced in a press statement that Trump had directed U.S. Trade Representative Robert Lighthizer to consider increasing the amount of Chinese goods subject to new U.S. tariffs by another $100 billion in value. This move triples the severity of the $50 billion in tariffs that Washington announced on March 22, which Beijing responded to in kind earlier this week. If implemented, the new tariffs could mark the beginning of an all-out trade war between the world's two largest economies.

Typically during trade disputes, one country retaliates against another's first moves, then both countries call a de-facto ceasefire to prevent further escalation. But neither the United States nor China appears to be backing down. China's Ministry of Commerce said that China was already in the process of adopting "comprehensive countermeasures" to the latest tariff increase, and declared that it was "not afraid to fight a trade war." The two countries still have plenty of room to engage in negotiations before any tariffs go into effect, but as long as the United States and China continue their tango, the global trade environment will be on shaky ground. 

The Big Picture

By threatening another round of sweeping tariffs in retaliation against China, the United States is wielding the threat of a global trade war. While there is some space for negotiation, U.S. demands are clashing with China's fundamental imperative to rebalance and advance its economy with a state-driven approach. That gap and the willingness of the United States to escalate its threats beyond the bounds of the World Trade Organization raise the specter of a trade war with deep ramifications for the global economy.

The United States' Sedulity

To the Trump administration, the results of the investigation into China's technology transfer practices are a sign that something extreme needs to be done to counteract what it views as China's unfair behavior. Cooler heads could certainly prevail, but China hawks such as Lighthizer and Peter Navarro believe that even if the tariffs end up damaging the U.S. economy or threatening the very existence of the World Trade Organization (WTO), forcing China to change its behavior is worth the risk. For them, the $100 billion increase is a strategic move; to respond in kind, China would be forced to increase tariffs on all of its imports from the United States, which totaled just $135 billion in 2016 — and then some. The White House could then use that move as justification for implementing a blanket tariff against all Chinese imports.

But there is still time for both parties to slow things down or turn around. This week, several hesitant U.S. officials, such as Treasury Secretary Steven Mnuchin and new National Economic Council Director Larry Kudlow, sought to shift the narrative away from a trade war. They emphasized that there was a two-month period before even the initial $50 billion tariffs come into effect, leaving time for Beijing and Washington to talk out their differences and decide against implementation. Their statements could be wishful thinking or an attempt to calm markets, but negotiations will inevitably take place, and the United States wants to make sure it has the upper hand. The new tariffs will be subject to the same review period as the first round, leaving months of negotiation time. Rather than an off-the-cuff trade policy statement or tweet, Trump's decision to up the ante is a clear and calculated decision.

Indeed, the United States has already issued several demands to China, including a reduction of Chinese tariffs on U.S. automobiles, more Chinese imports of U.S. semiconductors, greater investment access to China's financial sector and a reduction of the U.S. trade deficit with China by $100 billion. These are all measurable targets, though the United States is also demanding less quantifiable action, such as China restructuring its economy so that it reduces subsidies to state-owned enterprises, providing more regulatory transparency and ending the requirement for foreign firms to enter joint ventures for their Chinese investments.

The Vigilance of China

The ball is now in Beijing's court. China has already stated that it will continue to match Washington's trade moves, but it may shift strategies to more nuanced approaches. Beijing will still keep tariffs in its back pocket, but they won't be the first tool it reaches for, especially since it already used its most powerful points of leverage over Washington with its last retaliation. It added tariffs to four of its top six imports from the United States, while tactfully choosing sectors that would prompt the least self-harm while targeting Trump's Republican base. (Beijing declined to place tariffs on its imports of aircraft over 45,000 kg, which includes most passenger airliners, semiconductors and integrated circuits).

The Cascading Economic Effects of Import Reductions
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China is more than likely going to take a wait-and-see approach on tariffs, opting instead to pressure the United States in other ways. These could include harassing U.S companies with investments in China or canceling orders that it has made for Boeing planes. During Trump's visit to Beijing in November 2017, the United States and China signed more than $250 billion in deals that included a $43 billion investment deal by CNPC into Alaskan LNG and natural gas, promises by three of China's four largest smartphone makers to increase their business with semiconductor giant Qualcomm, and a $5 billion investment fund launched with Goldman Sachs. All of those deals are now in jeopardy, as China and the United States establish their positions in negotiations.

If the United States and China can't settle on common ground during negotiations, the stability of the entire global economy will remain at risk.

During the Boao Forum on April 10, Chinese President Xi Jinping will give a critical speech that likely sets the tone for China's response in negotiations. But it will be hard to avoid the fact that many of the United States' demands — such as limiting support to state-owned enterprises, changing its tech strategy and becoming more of a market economy — hit at the foundation of the current Chinese geopolitical strategy. And there will likely be a gap between what the United States demands and what China is willing to concede on.

Risks Heard 'Round the World

As much as the United States would like for its spat with China to remain a bilateral issue, the reality is that a trade war between the world's two largest economies poses significant risks to every country. Both China and the United States have arguably violated WTO precedents multiple times with little in the way of consequences, which sets the stage for the WTO to eventually sink into irrelevance. China will use this argument to try to shift the discussion away from its own economic behavior and toward the United States' decision to go above and beyond the established WTO norms to pressure China. In doing so, Beijing hopes that it can attract allies that do not want to see the WTO blown onto its side, such as Europe and Asian trading partners, both of whom are dependent on global trade. Of course, this puts countries that have sided with China — including South Korea, Japan, Taiwan and Germany — in the United States' crosshairs.

Deeply interlinked supply chains across Asia will face additional consequences. Any reduction in imports from China to the United States will incur second-order effects throughout the region. And though Japan and Europe have already joined the United States' push against China's technology transfer practices at the World Trade Organization, they remain nervous about what impact U.S. action will have on their economies. South Korea and Taiwan, in particular, are extremely dependent on certain sectors of China's trade with the United States. In 2017, Stratfor estimated that any reduction in U.S. imports of Chinese electronics resulting in a decline in Chinese exports of those products overall would have a greater proportional impact on Taiwan's gross domestic product and overall output than on China's. It would have nearly the same impact on South Korea as China. Thus, the two countries are likely to, at least on some level, side with Beijing in order to diffuse trade tension.

The European Union might be in an even more difficult position. President Trump has also instructed Agriculture Secretary Sonny Perdue to implement plans to protect the U.S. farmers who faced the brunt of China's first round of retaliation, which hit strategic exports like soybeans and sorghum. And any aid to farmers would likely come in the form of subsidies, tax breaks and other activities that could almost certainly run afoul of the United States' WTO commitments. Since those measures would not necessarily be directed at China, it will have consequences for the countries that typically moan and groan about U.S. agricultural subsidies: European countries such as France (and also Canada). They may well issue their own responses.

The United States has shown little fear of the consequences of escalating trade tensions with China far beyond what would be considered a typical dispute, and Beijing has so far stood up to those escalations. If the pair can't settle on common ground during negotiations, the stability of not only their countries, but the entire global economy will remain at risk.

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