Shortly after the U.S. trade war with China began in early 2018, I spoke at a conference in Shanghai about how long it would last. My assessment was that it was the opening salvo of a conflict that would persist for a long time.
The trade war was launched shortly after Special Trade Representative Robert Lighthizer produced a report in March of 2018 that found China was conducting unfair trade practices. The backdrop is that China ran large trade surpluses with the U.S. since it became a member of the World Trade Organization (WTO) at the end of 2001. Meanwhile the U.S. experienced significant job losses in manufacturing, the U.S. government accused China of pillaging U.S. intellectual property, and national security became a growing concern.
Over the next year and a half, the U.S. phased in tariffs on imports from China that eventually accounted for about one-half of the goods it shipped to the U.S. The highest tariff rate was set at 25 percent, and the average tariff rate is estimated to be about 20 percent.
Some observers at the time concluded the conflict would have a detrimental effect on China’s economy, but it was not readily apparent. However, several considerations suggest the impact could be greater this time.
One reason is that President-elect Donald Trump is contemplating tariffs that are substantially larger and more comprehensive than in the initial round. During the presidential campaign, he pledged to boost tariffs on all Chinese goods to 60 percent, and he has since announced he will begin raising duties on imports from China by 10 percent on Inaugural Day.
Financial markets have not reacted thus far, because many investors view the threats as a bargaining ploy on Trump’s part.
The median expectation of 50 economists in a recent Reuter’s survey, however, was that duties of 40 percent would be in place by early next year. In that event, respondents estimated that China’s economic growth rate would be cut by 0.5-1.0 percentage point in 2025.
Another consideration is that China has been able to circumvent some of the existing tariffs by rerouting goods shipped to the U.S. through facilities in Mexico and Vietnam. Thus, while U.S. imports of Chinese goods fell by about $110 billion from 2018 to 2023, imports from Mexico and Vietnam increased by about $130 billion and $70 billion, respectively. (See chart below).
Chinese exporters may still shift to new markets and establish offshore factories, but Trump has pledged to stop this end run. He has threatened to increase tariffs on goods from Mexico by 25 percent and to impose duties of 100 to 200 percent on EVs produced by Chinese companies in Mexico that are exported to the U.S.
Another important difference is that China’s economy is considerably weaker today than it was when the trade war was launched owing to a series of adverse developments. They include a property bust that has resulted in substantial wealth destruction, the dampening effect of its former one child policy and a tepid response to the lifting of restrictions that were imposed during the Covid-19 pandemic.
The Chinese government has announced fiscal measures to bolster the economy recently, but the impact has been limited thus far. Some observers believe this may weaken China’s hand in negotiations.
However, several developments suggest China’s government is unlikely to take the prospective trade hits without retaliating against the U.S.
The Financial Times reports that China has enacted sweeping laws since Trump’s first term that allows it to counter measures taken by other countries. They include new laws that allow it to blacklist foreign companies, impose its own sanctions and cut American access to crucial supply chains.
An expanded export control law means that the Chinese government can also utilize its global dominance of resources such as rare earths and lithium that are crucial to modern technology to limit other countries’ access to them. China announced this week that it was banning the export of some rare minerals to the U.S. one day after the Biden administration tightened Chinese access to advanced U.S. technology.
This raises the possibility there could be yet a further escalation of the trade war. For example, Chairman John Moolenaar (R-MI) of the House Select Committee on the Chinese Communist Party introduced a bill last month that would revoke China’s most favored nation status (now called Permanent Normal Trade Relations or PNTR) that was granted when it joined the WTO.
A recent study by the Peterson Institute for Internal Economics found that ending China’s PNTR status would cause higher U.S. inflation and a short-term decline in US gross domestic product relative to baseline from which the economy never fully recovers. The study concluded: “Stock market prices would fall, with agricultural, durable manufacturing, and mining firms absorbing the biggest declines.”
Weighing these considerations, the risk is that the next phase of the U.S.-China trade conflict could be more detrimental to both China and the U.S. than the initial round. If so, global markets could turn volatile as investors realize there are no winners from a trade war between the world’s two largest economies that is more disruptive than before.