The China–US trade war: impacts and implications
What benefits the enemy, harms you; and what benefits you, harms the enemy.
- Niccolo Machiavelli
With unprecedented scope and scale, the China-US trade war has become a major factor affecting the Chinese and American economies, as well as an important risk for the world economy. Based on an original analytical framework and existing data up to the end of 2019, this chapter aims to make a comprehensive assessment of economic consequences of this historical trade conflict. It examines relevant economic variables at various levels -macro, meso and micro levels - and from different perspectives - trade and investment diversion, macroeconomic performance and firm behaviour. Due to the diverging economic and trade structures of China and the United States, ramifications of the trade war differ. For China, the impact of “export direction” is primary, as manifested in the reduced exports, industrial output and economic growth. For the United States, by contrast, the impact of “import direction" dominates, reflected in how tariffs affect import prices and consumer welfare, while the “export direction" shock affects a rather limited number of areas, such as agriculture. As the two parties are the world’s largest economies and major powers, this chapter also pays attention to some issues with long-term significance, exploring what the trade war means for China-US relations, world economy and the global system as a whole.
Trade and investment diversion: impacts at the international level
As a cross-border economic phenomenon, trade war affects a country’s economy first at the international level. This is mainly reflected in the
Impacts and implications 65 diversion effect of trade and investment, that is, the shift of trade and investment flows due to special tariffs. The extent of trade and investment diversion depends on many factors - in the case of trade, for instance, the tariff pass-through rate and the prices elasticity of demand (Chapter 1, Section 1.3). By comparing changes before and after the trade war, this section analyzes the extent of diversion effects for international trade, FDI and cross-border portfolio investment, respectively. The coverage of tariffs and the sensitivity of enterprises’ decision-making lead to differences among products and industries. The trade war directly affects the specific products on the tariff list and the related industries. However, there have been spillover effects on other products and industries. Therefore, we first look at the aggregate measurement of trade and investment, and then examine the situation of specific products and industries. This is helpful to study the connection between the impact of trade war at international and macro levels.
The Cliina-US trade war has led to a surge in bilateral tariffs between China and the United States (Chapter 3, Figure 3.2). This has been translated to a considerable degree of trade diversion. The concept "trade diversion” refers to changes in the trade volume of a country triggered by a change in specific policies (trade policies, trade remedies, tariffs, etc.).1 To be more concrete, under the background of trade war, a specific tariff that Country A imposes on Country B will increase the prices of goods exported from the latter, which will possibly reduce the exports to Country A, and a third party (Country C) will export more to Country A accordingly. In this case, for Country A, part of its imports are diverted from Country B to Country C. As for a specific kind of product, whether trade diversion will happen depends on the real effect of tariffs on prices (the degree of tariff pass-through as discussed in Chapter 1, Section 1.3), the price elasticity of both supply and demand, the existence of import substitution country (Country C) and the comparison in production costs between Country B and Country C. In the short term. Country C needs to expand its product capacities. For specific products, the country may need to build new production facilities in a relatively longer term. Therefore, the capital and time needed for building or expanding productive capacities in an alternative production location is also an influencing factor.
The aggregate trade diversion effect is well reflected by the changes in China and the United States' exports to each other and then- proportions in their counterpart’s total imports. These data show that both China and the United States have experienced a significant degree of trade diversion since the onset of the trade war. With regard to the timing of these effects, the decline of exports from the United States was earlier, mainly in the second half of 2018, while that for China appeared later, mainly in the first half of 2019. In terms of the specific goods on the tariff lists during the first two phases of the trade war, there has been a downward trend in the export volume of both China and the United States (Cerutti et al., 2019).2 A similar study finds that US tariffs against China resulted in a reduction in imports of the tariffed Chinese products by more than 25% during the first half of 2019, and China’s export losses increased over time (Nicita, 2019).
During the second half of 2018, there was no obvious trade diversion for China at the aggregate level. In fact, total US imports from China went up after the beginning of the trade war, and China accounted for 22% of the United States' overall imports in the second half of 2018, rising from 20% in the first half (Figure 4.1). By contrast. Chinese data show that the import volume from the United States declined right after the onset of the trade war, particularly in the fourth quarter of 2018. Meanwhile, the share of imports from the United States in China’s total imports dropped from more than 8% to approximately 6%, indicating a significant trade diversion for the United States due to the trade war. The tune lag of the trade diversion for China can be explained by two factors. On the one hand, at the beginning of the trade war, some US importers adopted a wait and see attitude. In other words, they tended to not to change their sourcing patterns as they were not sure how long the tariffs would last. On the other hand, some US importers
Figure 4.1 Bilateral imports of China and the United States. 2018 and 2019 Source: General Administration of Customs of China; US Census Bureau.
Impacts and implications 61 took “pre-emptive actions" by undertaking advance purchases in order to avoid the negative impact of tariffs. Indeed, there was an increase in imports in advance of the effective dates of tariff (Cerutti et al., 2019).
However, the situation has changed since the beginning of 2019: while US exports to China remained stable, the negative impact of the trade war on China's exports to the United States started to unfold (Figure 4.1). Chinese data demonstrate that, in the fust quarter of 2019. imports from the United States chopped slightly, but the US share in total Chinese imports remained at 6%. This was partly because China had suspended tariffs on automobiles and auto parts from the United States and agreed to resume soybean imports from the United States. However, the US data show that both the amount of imports from China and its share in total imports of the United States dropped significantly. Imports from China chopped from USS 145 billion in the last quarter of 2018 to USS 106 billion in the first quarter of 2019, with China's share declining from 22% to 18%. Monthly data also demonstrate a downward trend: US imports from China in March 2019 diopped to USS 31 billion, or 15% of the total, stupassed by Mexico for the first tune. This took place as US importers started to change their sourcing strategy: as inventories were digested, alternative purchasers were made, hi addition, some exporters have started to relocate their production bases away from China.
Statistics from commercial institutions show that containerized cargo shipped from China to the United States declined by 6.4% in the first quarter of 2019, in which some specific kinds of goods are seriously affected. For example, refrigerators imported from China to the United States dropped by 24% in the first quarter, while those imported from Korea and Mexico increased by 32%; tires imported from China dropped by 29% while those imported from Vietnam surged by 142%.3 Generally, it can be concluded that some Asian countries like Vietnam and some Latin American countries like Mexico whose importing industries are substitutions for those of China are main beneficiary countries of the trade diversion. By comparing US imports of tariffed products during the fir st two quarters of 2018 and 2019, respectively, an analysis demonstrates that Taiwan Province of China, Mexico, the European Union and Vietnam benefited the most from trade diversion effects of the China-US trade war (Nicita, 2019). With regard to the USS 50 billion worth of Chinese products as the target of US tariffs during the first phase of the trade war, the share of China in US imports declined from 8.6% in 2018 to 5.5% in the first half of 2019, and Mexico gamed most from the trade diversion.
Throughout 2019. exports from China and the United States to each other remain stagnated. In the second quarter, the total imports of China and the United States both increased, but imports between their counterparts remained flat. In the third quarter, both US imports from China and
Chinese imports from the United States increased, but were still lower than the quarterly amount in 2018. In the fourth quarter of 2019, as the performance of US exports to China remined stable, that of China declined. Overall, trade diversion exists for both countries: China's share in total US imports chopped from 21.2% in 2018 to 18.0% in 2019; the US share in total Chinese imports declined from 7.3% to 6.7% during the same period.
As long as the United States keeps importing goods instead of producing domestically, the amount of the US trade deficit will remain the same despite the existence of trade diversion. Therefore, the real impact of the China-US trade war on the US trade deficit depends on whether films decide to invest and produce locally in the United States. The trade data illustrate a mixed picture. Total deficit in trade in goods of the United States reached USS 891 billion in 2018, the year when the trade war started, 10.4% more than that in 2017. In 2019, however, the US goods deficit dropped slightly to USS 866 billion. In the same year, the deficit with China decreased USS 74 billion to USS 346 billion.4 China did suffer from the trade war, but if third party countries take most of China's market share, the overall impact of the trade war on the US trade deficit is rather limited.
Foreign direct investment
In the era of globalization, the increase of international investment and the expansion of global value chains have reshaped the landscape of world tr ade. The China-US trade war is the first major trade conflict that has taken place against the background of strong globalization (Chapter 1, Section 1.2). Thus, it will not only impact on trade, but will also have strong effects on the patterns of international investment and global production networks. Impact on FDI is manifested in two aspects - both reduced FDI inflows from new investors and shrinking inward FDI stock due to divestments.
Conceptually, FDI flows can suffer from a similar diversion effect like trade flows. MNEs may relocate their production facilities from home to host countries or move their manufacturing and export bases from countries with high tariffs to those with low tariffs, as motivated by "tariff jumping/ hopping" motivations (see e.g. Blonigen, 2002). In the context of a trade war, specific tariffs can affect both supply chain management and international production location of MNEs. A specific tariff that Country A imposes on Country В will raise the price of goods which are produced in Country' В and exported to Country A, making Country В less appealing as a manufacturing or export base. Thus, some potential investments will possibly divert from Country В to a third party (Country C), and even some existing production facilities in Country В may be relocated to other countries.
Official FDI data come from the balance of payments (BOP) statistics, covering both cross-border mergers and acquisitions and greenfield investments. To analyze the investment diversion due to trade war, greenfield investment is the mam research target. Therefore, we pay attention to the amount of investment of greenfield projects, rather than the total amount of FDI, and examine the quarterly data on gr eenfield investment in China and the United States during 2018 and the first half of 2019 (Figure 4.2). The ratio between the United States and China’s amounts of greenfield investment is used to measure the relative strength of the two countries in attracting international capital.
Tire picture of greenfield investment also points to a muring point at the beginning of 2019: foreign investment in China was strong in the second half of 2018 but dropped sharply in the fir st half of 2019 (Figure 4.2). This illustrates that foreign investment was significantly affected by the trade war. As for the United States, the quarterly amount of greenfield investment experienced obvious fluctuations in 2018 with a reduction in the second half of the year. Meanwhile, the number of the US greenfield projects in the second half of the year went up. The investment volume in the United States also dropped considerably in the fir st half of 2019, especially in the fir st quarter. It seems that foreign investment in both China and the United States has been negatively affected, owing to the uncertainty arising from the trade war. However, China seems to suffer more, as the quarterly average of foreign gr eenfield investment declined from USS 27 billion in 2018
Figure 4.2 Greenfield foreign investment in China and the United States, 2018 and the first half of 2019
Source: EDi Markets.
to USS 11 billion in 2019. As a result, the ratio between the United States and China jumped to a level above 100% in the first half of 2019. This demonstrates an increased attractiveness of the United States vis-à-vis China to international investment in the short term.
Data on projects in specific industries show that the increase in greenfield investment in China in the second half of 2018 was primarily driven by manufacturing industries, especially automobiles, chemicals and electronic components. In the industries of highly internationalized production networks, such as electronics, decisions on production location and supply chain configuration are relatively easily affected by the trade war. Nevertheless, what happened in the second half of 2018 did not show such influence, partly due to the time lag of the tariff impact on firms’ long-term investment decision. Additionally, major enterprises and large-scale projects played an important role in the steady growth of foreign capital in the second half of 2018, despite the ongoing trade war. Indeed, when the negative effects of tariffs started to unfold, foreign investment in China has been significantly affected since the beginning of 2019.
China’s official data show that FDI inflows to the country have remained stable since the outbreak of the trade war. However, there is a significant difference between China’s ciment FDI statistics system and the common international practices, and. as a result, divestment is not reflected in the official numbers. Judging from the specific conditions of various regions and industries, some divestments were the result of the combined effect of higher production costs caused by rising wages and land prices and higher tariffs caused by the trade war. There has been some evidence of divestments in China due specifically to the China-US trade war. For instance, Japanese video game giant Nintendo has shifted production of its Switch console from China to Vietnam; Google has moved its manufacturing business of cloud motherboards and some Nest smart home products to Taiwan Province of China and Malaysia; both HP and Dell plan to relocate most of then- PC manufacturing operations to Southeast Asia.5
Cross-border portfolio investment
Diversion effects also exist in international portfolio investment, due to investors’ changing valuation of specific securities from related countries. Though both FDI and international portfolio investment are in the financial and capital account of the BOP, they show different reactions to the trade war. While the impacts on the FDI have a longer time lag, portfolio investment is more sensitive to the shock from specific events related to the trade war.
After the United States and China announced tariff measures in early April 2018. Chinese stocks experienced two consecutive months of declining net inflows in the global market.6 Most economies, including China and the United States, experienced significant net outflows in June before the tariffs were formally imposed in July. Since July 2018, capital inflows to Chinese stocks had started to recover in global financial markets. Different from the newly industrialized Asian economies and major emerging economies, Chinese stocks had shown a unique appeal for international capital. In November 2018, capital inflows in Chinese stocks began to decline because of the earlier escalation of the trade war (Chapter 3, Section 3.1). During this period, capital inflows to the Asian and emerging economies began to pick up. while the United States was still dominated by capital outflows.
Dining the second and thud quarters of 2019, foreign investors expressed concerns about further trade war escalations and worries about the deadlock in trade talks between China and the United States. Consequently, more than USS 13 billion flowed out of Chinese stocks from April to August 2019. At the same time, the escalation of the trade war has negatively affected the stock market performance in many other countries.