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Why China Will Win the Trade War

http://foreignpolicy.com/2018/04/13/why-china-will-win-the-trade-war/

Trump thinks he has a strong hand. In fact, Washington is far more vulnerable than Beijing.

By Philippe Legrain | April 13, 2018, 10:00 AM

Employees build a Boeing 777 airplane cockpit at a plant in Wichita, Kansas, on Aug. 18, 2004. (Larry W. Smith/Getty Images)

“When you’re already $500 Billion DOWN, you can’t lose!” U.S. President Donald Trump tweeted on April 4. He seems to believe that because the United States has a huge trade deficit with China — actually $337 billion in 2017, not $500 billion — he is bound to win the impending trade war between the two countries. But even though China sells more to America than it buys in return, Beijing’s position is actually much stronger, both economically and politically, than that crude calculus suggests.

Economically, both the United States and China would lose from a trade war. Punitive tariffs would push up import prices, dent exports, cost jobs, and crimp economic growth, so both sides would do best to avoid an outbreak of hostilities. But now that the Trump administration is threatening to impose 25 percent tariffs on $46 billion of U.S. imports from China and China has responded in kind, a trade war looms. Trump has since raised the stakes by threatening tariffs on a further $100 billion of imports (so far unspecified), which Beijing promptly said it would match. Trump’s calculation appears to be that China has more to lose and so will back down. He is wrong.

Trump’s calculation appears to be that China has more to lose and so will back down. He is wrong.

Headline statistics greatly overstate China’s economic vulnerability — and understate America’s. Focusing on trade in goods, as most observers do, U.S. imports from China last year totaled $506 billion, nearly four times its exports in the other direction ($131 billion). But the United States also sold $38 billion more in services to China than it bought in return, its biggest bilateral surplus. And whereas U.S. goods exports to China are mostly agricultural produce and finished products consisting of mostly American content and sold by U.S. firms, China’s exports to the United States are typically Chinese-assembled goods that contain many foreign parts and components — and are often American-branded to boot. A further 37 percent of U.S. imports from China consist of parts and components on which U.S.-based manufacturers rely.

Take Apple’s iPhone. When iPhones are shipped from Chinese factories to the United States, the full import cost is attributed to China. Yet these phones include a Samsung display from South Korea, a Toshiba memory chip from Japan, and many other foreign components. According to one estimate, assembly in China accounts for only 3-6 percent of the $370 manufacturing cost of an iPhone X. Since that smartphone retails for $999, the bulk of the value added is American: Apple’s margin and that of U.S. retailers.

Admittedly, that is an extreme example, and Trump isn’t yet targeting iPhone imports. So, consider instead the $46 billion in imports that Trump is threatening, of which $26 billion are electronic goods. Ostensibly designed to stymie the Chinese government’s Made in China 2025 drive to develop its own high-tech products, his tariffs would mainly affect lower-tech products that China actually exports to America right now. And according to estimates by the Organization for Economic Cooperation and Development (OECD), nearly half of the content of Chinese exports of computer, electronic, and optical equipment to United States is foreign. (The latest data is from 2011, so that proportion may have shifted somewhat since.) Even if the proposed tariffs were to slash China’s exports of these products by a quarter, the direct hit to China would be $6.5 billion — roughly 0.05 percent of the country’s GDP. For an economy growing at 6.8 percent per year, that would be a pin prick.

Even a blanket U.S. tariff on all Chinese goods exports — iPhones and all — would be bearable for China. The OECD reckons that around a third of the content of U.S. imports from China is actually of foreign origin. So the Chinese value added of its exports to the United States is perhaps $329 billion — some 2.7 percent of China’s $12 trillion economy. So even if a blanket Trump tariff slashed China’s exports to the United States by 25 percent, the direct hit to GDP would be 0.7 percent. That would hurt. But it would still leave the Chinese economy growing at 6.1 percent a year.

It is very unlikely to come to that, precisely because the United States is much more vulnerable to a trade war than Trump thinks. Imagine the consumer uproar if Trump slapped a tariff on iPhones! Indeed, because so many U.S. firms outsource production to China, they are acutely vulnerable to dirty Chinese tricks

Indeed, because so many U.S. firms outsource production to China, they are acutely vulnerable to dirty Chinese tricks

, such as halting production for a while on spurious regulatory grounds.

The threat isn’t just to American-branded products that American consumers love. A trade war also poses a threat to U.S.-based manufacturers that rely on Chinese parts and components to be globally competitive. Trump’s $46 billion list already targets aircraft propellers, machine tools, and other intermediate goods. Pushing up their costs would threaten manufacturing jobs in America’s heartland. And while those tariffs avoid consumer staples such as clothing and footwear, they will inflate the prices of some consumer goods, such as televisions and dishwashers.

In contrast, China’s potential retaliation is much better targeted. First in line is $16 billion of U.S. civilian aircraft exports. Boeing’s share price slumped when the Chinese move was announced. But Chinese airlines are expanding so fast that Boeing may be willing to slash prices to hang on to sales there, in which case none of the cost of the tariffs would fall on China. And if push comes to shove, the Chinese already have a reliable alternative supplier: Europe’s Airbus.

Second in line is $12.8 billion of U.S. soybean exports. China accounts for more than half of American soybean exports, giving it market power. Indeed, as talk of a trade war heated up, the hit to U.S. farmers was immediate: Soybean prices plunged. Here, too, China has an alternative supplier: Brazil.

In short, the United States’ trade deficit with China — which is actually perhaps only $200 billion in value-added terms — scarcely gives it an advantage.