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Moderate Chinese Retaliation – But Keeping The Powder Dry

Key points

  • The Trump administration yesterday announced that it plans to impose tariffs on USD60bn of imports from China.
  • China plans retaliatory measures – but the first round is only muted. China is keeping its powder dry, awaiting specific measures from Trump.
  • The US trade actions put at risk 75 years of global trade integration.
  • This has been promoted by a significant reduction in emerging market tariffs, including by China, to levels close to US and European ones.
  • Hence, average tariff rates in China, the EU and US are now roughly the same.

Trump announces new trade measures against China

The Trump administration yesterday announced plans to impose tariffs on up to USD60bn of imports from China. The tariffs will target the ten focus sectors for China identified in the Chinese authorities’ strategy ‘Made in China 2025’ (see table below). The White House has given the US Trade Representative 15 days to identify specific goods that will be subject to tariffs. Following this period, there will be a 30-day period for public comment. Hence, the formal implementation of the tariffs will most likely be in 45 days. Furthermore, President Trump has instructed the US Treasury to come up with a plan to impose new restrictions on Chinese investment in areas such as those below within 60 days. The new measures are designed to penalise China for trade practices that the Trump administration says involve stealing American companies’ intellectual property.

Overnight, China responded strong verbally but soft in actual retaliatory measures. The Chinese Ambassador to the US Cui Tiankai said, ‘If somebody imposes a trade war on us, we’ll fight to the end’. China also outlined plans to put tariffs on 128 products accounting for USD3bn in imports including a 15% tariff on US steel pipes, fresh fruit and wine and a 25% tariff on pork and recycled aluminium. This is a very measured reaction as USD3bn is a drop in the ocean out of the USD131bn the US exports to China every year. Also, the new tariffs do not include soybeans, sorghum and aircrafts, which could hurt Trump more. However, the retaliation was not to the news from Trump yesterday of the tariffs on USD60bn of Chinese goods. Instead, according to the Chinese Commerce Ministry, it is a reaction to the US tariffs on steel and aluminium announced a few weeks ago.

China is thus keeping its powder dry still but is likely to target soybeans and aircrafts in a new round of retaliatory steps when Trump announces his specific measures over the next 15 days. In Research: 10 areas where China could retaliate vs US measures, 15 March 2018, we also point to other areas China could target.

While important on a political level, the direct effect on Chinese or US GDP should not be overestimated. Trump is targeting USD60bn of Chinese goods, which corresponds to 10% of Chinese exports to the US. However, this is only 0.5% of Chinese GDP, which reached USD12trn in 2017.

Assuming the tariffs were to shave off 25% of the targeted Chinese exports, this would correspond to a reduction of 0.1% of Chinese GDP. If we additionally assume that imported contents in exported goods amount to 50% (for many goods it is higher), we end up at an effect of 0.05% of Chinese GDP. For the US, exports of USD3bn correspond to 0.015% of GDP and the actual effect on growth would be less than 0.1 percentage points.

While the direct effects are small, the risk is that it triggers a tit-for-tat trade war between the US and China. It is not our baseline scenario, as neither the US nor China would benefit from a trade war. But it is a risk that needs to be watched closely. Also, for at least the next couple of weeks the fear of an escalation will continue to hang like a heavy cloud over financial markets and the global economy.

Reversal of global trade integration?

he trade actions taken today and over the past weeks by the Trump administration do put at risk the global trade integration that has taken place since the end of the Second World War. Apart from the already announced trade measures, the US administration is likely to seek re-negotiation of NAFTA. Furthermore, President Trump has denounced the World Trade Organisation as a “catastrophe”. The series of tariff reductions in the context of the General Agreement on Tariffs and Trade (GATT) have helped boost global trade from a mere 17% of global GDP in 1960 to almost 50% of global GDP in 2016. While global trade has come under pressure since the financial crisis (due to a fall in investment and waning global outsourcing according to the IMF), the new trade measures and retaliation by the US trading partners risk hitting global trade even further in years to come.

The effects of trade liberalisation have especially led to a reduction in emerging market tariffs. The process accelerated when the WTO was created in 1996. This was particularly true for China, which reduced its average tariffs from almost 30% to 15% in a matter of a few years. The entry of China into the WTO in 2001 led to a further reduction in average tariffs to about 5% currently. Also Latin America and the wider East Asia reduced their tariffs in the 1990s and early 2000s. This has narrowed the difference with developed countries such as the US and EU markedly.

Looking at the (average) tariff rates between the US and the EU/China, it is difficult to see that the US is being unfairly treated on this front. Yes, China has higher tariffs, but only a couple of percentage points. And Europe has lower overall tariffs than the US. Note though that the numbers below are averages, and individual goods may be subject to significantly higher tariffs, while others apply zero rate tariffs.

How much damage would a global trade war do?

A key question is how much damage the trade restrictions could do to the global economy. In our base case of limited retaliation by China and other US trading partners to the US measures and few additional trade restrictions by the US, the impact on US growth and inflation and more broadly the global economy would be limited (for more discussion, see Research US: Symbolic protectionism with limited impact on growth and inflation but risks remain).

In the case of a more severe global trade war, where the trade restrictions are more pervasive, the impact would of course be more significant. The OECD found in 2016 that the global loss in GDP would be about 1.3% in the case of a full blown global trade war. With regard to the impact on countries, such as the US, China and the EU, which impose the tariffs, the loss to their GDP could be closer to 2%.

The impact of US trade restrictions on the global economy may be less damaging than in the past. First, the US share of global trade has declined significantly over the past 15 years, accounting for just 12% in 2016, down from almost a fifth in 2000. This is explained partly by the growing importance of emerging markets, notably China, which now export two-thirds of their exports to other emerging markets.

Secondly, a trade war would most likely be between the US and the rest of the world. As such, it would probably affect the US economy more than other countries. We think it is unlikely that China, Europe and other regions will not engage in trade wars with each other. Quite the contrary, these regions may seek to strengthen ties in response to a more closed US trade regime. For example, the EU and Mercosur countries have recently restarted their free trade negotiations

Danske Bankhttp://www.danskebank.com/danskeresearch
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