[SCMP Column] Cost of Trade War

December 19, 2016


So let us imagine that it is May 2017 and Wilbur Ross, Donald Trump’s trade policy warrior, has unleashed the dogs of trade war on China. What then?
From the trade policy war room deep in a bunker in downtown Beijing, perhaps the first thing China’s trade policy planners and strategists should do is exactly what the British do: Stay calm.

After all, unless Trump decides to abandon all commitments – and ride roughshod over Chinese protections – under the WTO, then there are clear limits on the trade policy harm he and his Commerce Secretary can inflict. And remember his business reputation is to demand the outrageous before retreating to a workable compromise. It remains comparatively easy to contrive anti-dumping cases and impose some publicity-grabbing tariff “punishments”. But the real impact of such selective action on China’s overall trade with the US would be negligible.

China’s response could likely be measured: official protests here, cancelled diplomatic exchanges there. Retribution could be low profile and inflicted with a scalpel: maybe some Boeing orders cancelled (Boeing says China plans to spend US$670bn buying over 5000 passenger aircraft over the next 20 years – so easy for these to slip over to Airbus). Maybe some soya or grain imports cancelled – perhaps targeting Trump supporters in Iowa. Maybe Ivanka Trump’s clothing line, which is apparently sourced mainly from China and Vietnam.

But here you quickly see a trade asymmetry that makes it much easier for China to inflict pain on US exporters than the other way round. The lion’s share of US exports are farm products, aircraft or motor vehicles. It is clear that most US exports are localized, like soya in Illinois and Iowa, or aircraft in Washington State, or vehicles in Alabama, Michigan or South Carolina. Most of these are strong Trump-supporting states, and finely targeted Chinese retribution would quickly hit exactly the people Trump is claiming to fight for.

By contrast, most of the value in China’s exports sits in other countries. Behind China’s US$350bn exports to the US so far this year, at least half is imported components and other inputs that have been imported from other countries linked by long, complex manufacturing supply chains. Hurt China, and Trump hurts others – often much more, and often in the US.

Remember out of the US$179 export value attributed to each iPhone exported to the US from China, the total value-added in China is just US$7. At least one US electronics company that supplies components for the iPhone earns over $40 in exports to China for each iPhone. Hit iPhone exports from China, and you inflict more harm on that US company than you do on Foxconn in China where iPhones are assembled.

Beyond selective targeting of specific US exports, a linked Chinese step would be to make it tougher for US companies to invest or operate inside China. Large numbers of US companies have invested a total of around US$228bn on the ground across China, many with the explicit aim of selling products to increasingly affluent Mainlanders. That is one of the reasons why the Bilateral Investment Treaty is such a big deal for so many US companies. Behind-the-border obstacles to such investment remain problematic for many US companies, and a trade war that made them even more so would gift massive competitive advantage to European and Japanese companies that are also fighting for domestic market share.

A trade spat would also prompt China to accelerate efforts to de-link trade from the US$, instead using other currencies, including the RMB, to settle trade balances. At present, only a small share of China’s trade is settled in local currencies, but this could build quickly, undermining the pivotal role the US$ plays underpinning world trade.

One driver of this de-linkage would undoubtedly be the “One Belt, One Road” initiative, which embraces a total of at least 64 economies worldwide, but excludes the US. Linked with this would likely be the work of the China-led Asian Infrastructure Investment Bank (where the US is also not a member), putting China at the heart of much of the key infrastructure-building across Asia, as far west as Central Asia, Turkey, and in most significant African economies. We could expect the work of these institutions to become much more politicized.

Whether the spat becomes serious or not, we can expect Beijing to put increasing emphasis on building consumer demand within China, to reduce reliance on trade. Trade today accounts for 41% of China’s GDP – a low level of trade reliance compared to Europe’s economies where the average is 83%, but very high compared to the US’s 28%. In a trade war the US’s low reliance on international trade has always been seen as an advantage – one that China would doubtless like to narrow.

This suggests that China will accelerate the process of pulling onshore the more high-value-added segments of the production chains of which it has become an integral part. The “disappearance” of long – and high value adding – segments of existing production chains inside China will have the effect of reducing international trade, reducing opportunities for high value adding exporters worldwide, and increasing the need for international companies to operate within China itself.

Other potential responses in a trade war would be to sell US treasuries (these holdings have already been trimmed by 20% to US$1.12tr), and to stop supporting the RMB, allowing it to weaken in the 30-40% range as we have seen in Japan, Indonesia and Australia, for example. This would undoubtedly give a shot in the arm to Chinese exporters, but would hurt its efforts to build middle class affluence within the Mainland, and would compound the problems it already has with capital flight.

Review all of these factors, and it seems that China has not a lot to fear from a conventional trade war – and that the self-inflicted harm on the US might be considerably greater than any harm China might suffer. But this raises another and much more alarming prospect: if Trump’s team shares this view, then the temptation to escalate conflict beyond trade, into more dangerous areas, could be great. That is why Trump’s mischievous telephone chat with Taiwan’s Tsai Ing-wen, and his unseemly flirtation with Putin may raise wider concerns. Flash points in North Korea and the South China Sea also become less predictable. From January 20, our world becomes a more dangerous place.
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