The Impact of A US - China Trade Friction
• US tariffs on USD 60bn of Chinese imports could cause 5% fall in China’s exports to US, 0.15% drop in GDP • We maintain our China GDP growth forecast of 6.5% given strong Q1 growth, uncertainty on US remedies • China’s economic dependency on the US fell from 6.3% of GDP in 2006 to about 3.0% in 2017 • US economic dependency on China rose steadily from 0.1% of GDP to 0.7% during 2000-2014 • US GDP could fall 0.2% if China retaliates, banning US food, transport imports; 0.9% if all imports banned
Announcements from both the US and China have triggered fresh concerns about a potential trade war. On 22 March, US President Trump signed a memo that could impose a 25% tariff on up to USD 60bn of imports from China (but only after a 60-day consultation period). In response, China’s Commerce Ministry said “China will take all necessary measures to defend its legitimate rights and interests”. The development is in line with our long-held argument that Us-china trade frictions will intensify this year, though a full-blown trade war remains a tail risk.
In this report, we answer the five most frequently asked questions.
(1) How dependent are the US and China economies on each other?
(2) How much will China’s exports fall as a result of the higher US duties?
(3) How big will the impact on China’s economy be if the US bans (a) only imports of hi-tech goods from China; (b) all direct imports from China; (c) all direct and indirect imports from China?
(4) How will the US economy be affected if China retaliates?
(5) Which industries/countries will be affected most by a Us-china trade war?
In short, we estimate that the 25% tariffs on USD 60bn of Chinese imports could result in a 5% fall in China’s total exports to the US. Given that US demand accounts for about 3.0% of China’s GDP, higher US tariffs, if implemented, could lead to a 0.15% drop in China’s GDP. We maintain our 2018 China GDP growth forecast of 6.5% in light of the economy’s strong Q1 performance and given uncertainty about the eventual trade remedies by the US.
We have analysed all anti-dumping ( AD) and countervailing duty ( CVD) orders that the US issued against imports from China from 201016. The findings suggest that every 1ppt increase in US duties will likely result in a 1.6ppt decline in China’s exports to the US in the next 12 months. It also raises questions about the effectiveness of targeted import duties against China
in protecting US industries from import competition and narrowing the US trade deficit.
Our study, based on the Leontief model and the latest World Input-output Database ( WIOD), also suggests that China’s economic dependency on US and foreign demand has been falling (Figure 1). Almost 6.3% of China’s economy was driven by US demand in 2006. The ratio fell to 3.1% in 2014 (latest WIOD data). We estimate that China’s dependency on the US fell further to c.3.0% in 2017.
US economic dependency on China, however, rose from 0.17% of US GDP in 2000 to 0.7% in 2014 (Figure 1). US economic dependency on all foreign demand also increased from 6.2% in 2002 to 9.0% in 2014.
A trade war would be in no one’s interest. Our World Economic Dependency Table suggests that c.20% of the world economy is created by foreign demand via global trade. Figure 2 shows how much key economies under our coverage are driven by foreign demand.
However, if a broader trade war between the US and China did happen, the estimated decline for China’s economy is about 1.3% of GDP if the US banned all hitech manufactured product imports from China. The projected economic losses for the two more severe scenarios outlined in Question 3 on page 1 are 2.6% and 3.2%, respectively.
If China retaliated, the expected decline for the US economy would be 0.2% of GDP if China banned all agricultural and transport equipment imports from the US. The losses would rise to 0.9% if China banned all direct and indirect imports from the US.
We discuss each of the above-mentioned five questions in more detail below.
How much do US and China economies rely on each other?
One cannot accurately gauge two countries’ economic inter-dependency or trade relationship by only looking at their direct trade. This is because goods and services are often exported and imported several times before they reach end-consumers. Regarding US exports to China, for example, of total goods and services the US exported to fulfil China’s final demand in 2014, our model suggests that only 68% was shipped directly to China; the other 32% was exported to other countries first, and then re- exported to China. In this case, direct exports understate the true scale of US exports to China (the true US- China trade imbalance could be much smaller). There is another problem with direct trade. Of total US direct exports to China in 2014, 14% was not for China’s final demand, and therefore was re-exported by China (after processing) to other countries. From this perspective, direct exports could also overstate true US exports to China.
To overcome the problems associated with looking at only direct trade, we have tapped into the WIOD, a project of the European Commission, led by the University of Groningen. The WIOD presents global trade among 44 economies and 2,464 industries, which can be regrouped according to their final demand using the Leontief model. This way, we are able to calculate an economy’s true dependency on domestic and foreign demand.
Our study shows that China’s economic dependency on US and foreign demand has been falling steadily since 2007, while China’s contribution to the world economy has been rising over the same period (Figure 1). The story was different between 2001 and 2006, though. During this period, access to the WTO and a booming US economy saw China’s dependency on US demand rise from 3.9% of GDP to 6.3%, while China’s dependency on total foreign demand rose from 17.4% to 27.8%. Only 72.2% of China’s economy was generated by its domestic demand in 2006, down from 82.6% in 2001.
The onset of the 2008-2009 global financial crisis (GFC) forced China to change its growth model. China has been prioritising domestic consumption over exports since then. Consumption now contributes about 65% of China’s total economic growth, up from under 40% pre- GFC. As a result, China’s reliance on US and foreign demand fell from 6.3% and 27.8% in 2006, respectively, to 3.1% and 18.8% in 2014. The share of China’s economy driven by domestic demand was up from 72.2% to 81.2% over the same period. We estimate that China’s dependency on US demand further declined to 3.0% at the end of 2017, as the share of domestic demand increased from 81.2% of GDP in 2014 to 81.6% in 2017.
US economic dependency on China demand rose steadily, from 0.17% of its GDP in 2000, to 0.7% in 2014 (Figure 1). By the type of China demand, about 0.32% of the US economy was driven by consumption, versus 0.38% by investment. US economic dependency on China should have increased further from 2015-2017, as a result of China’s steady, domestically-orientated growth
over this period. The rise of China’s middle-class means that the US, as well as the world economy, should continue to see an increasing portion of their economies driven by China demand in the coming years (Figure 2).
A trade war is in no one’s interest. According to the latest WIOD, a serious disruption to global trade could see up to 20% declines in the world economy. US dependency on total foreign demand has been rising since 2004, from 6.2% of its GDP to 8.9% in 2014. While China’s economy is increasingly dependent on its domestic demand, external demand still drives some 18% of its total GDP. Our World Economic Dependency Table shows each economy’s reliance on foreign demand.
How big an impact will higher US tariffs have?
As the odds of the US increasing import duties on select goods from China are rising, a better understanding of the impact of higher US duties on China’s exports to the US is required.
We list our key observations from the case studies.
1. In 19 of the 22 cases, China’s exports to the US (in volume terms) fell after AD/CVD orders were issued. On average, every 1ppt increase in US AD/ CVD tariffs on imports from China resulted in a 0.8ppt drop in China’s exports to the US in the first year following the AD/CVD orders.
2. In 15 cases, US imports from non- China economies increased following the orders to levy higher duties on Chinese imports. On average, every 1ppt increase in US AD/CVD tariffs on imports from China resulted in a 0.5ppt increase in US imports from non-china economies in the first year following the AD/CVD orders.
3. There is no clear relationship between China’s market share (the share of total US imports from China for that particular product) and the extent of fall in China’s exports after the AD/CVD orders are issued. For example, although China accounted for 88% of US imports of high-pressure steel cylinders and 49% of utility scale wind towers, the drop in China’s exports of these products to the US as a result of a 1ppt increase in AD/ CVD duties was much bigger than for some other products, where China had a lower market share.
4. In 10 of the 22 cases (or 45%), US imports from non-china economies increased by more than the fall in China’s exports to the US after AD/CVD orders were issued against China imports. This raises questions about the effectiveness of targeted import duties in protecting US industries from import competition (and in narrowing the US trade deficit).
We think the impact of higher punitive tariffs that the US is currently considering will be twice as large as suggested by historical AD/CVD cases. This is because AD/CVD orders are designed only to bring prices to fair market levels, and not to make them more expensive like a punitive tariff does. As a result, we estimate every 1ppt increase in US tariffs on imports from China to result in a 1.6ppt fall in China’s exports to the US in the next 12 months.
In such settings, a 25ppt increase in US tariffs on USD 60bn of Chinese goods (about 12% of China’s total exports to the US) could see China’s total exports to the US fall by 5% in the next 12 months. Given that China’s economic dependency on the US is about 3.0% of GDP, a 5% decline in China’s exports to the US would result in a c.0.15% decline in China’s GDP. However, in light of China’s better-than expected growth in Q1, and uncertainty regarding the final trade remedies the US may take against China, we maintain our 2018 China GDP growth forecast at 6.5%.
How much would a trade war hurt China’s economy?
While we think a full-blown trade war is still unlikely, we propose three increasingly severe scenarios to estimate the potential economic losses for China if a trade war between the US and China did happen:
1. In the least severe, but most likely scenario, we assume that the US only bans, as a result of its Section 301 investigation, imports of hi-tech manufactured products from China. In this case, China’s exports of computer, electronic and optical products, electrical equipment, machinery, vehicles and other transport equipment to the US would most likely be affected. Such hitech products account for about 50% of total China’s total direct exports to the US, with a weighted average value-added ratio of 76% according to our model. In the worst case under this scenario, assuming the US stopped imports of hitech products from China completely, the total economic losses for China, from all economic activity associated with the production and exports of hitech products to the US, should be about 1.3% of China GDP.
2. In the second scenario, we assume that US- China trade frictions escalate, with the US limiting all direct imports from China (note that 20% of China exports for US consumers arrive in the US indirectly through our other countries). In this case, our model suggests the total economic losses for China could rise up to 2.6% of China’s GDP, from 1.3% in Scenario 1.
3. In the worst case, we assume that the US is capable of banning all imports from China for its own consumption, including those being imported indirectly from other countries with China components. Our model suggests the total economic losses for China could rise further to 3.2% of China’s GDP, up from 2.6% in Scenario 2.
How hard would China’s retaliation hit the US economy?
If China reacted to US trade sanctions by limiting imports from the US, how much would such measures hurt the US economy? Again, we have proposed three scenarios based on their severity and likelihood:
1. In the first scenario, we assume that China reacts to US sanctions on imports of China hi-tech products by banning imports of US agricultural products and transport equipment. Such products account for about 30% of US total direct exports to China. Earlier this year, China’s Ministry of Commerce said it launched an AD/CVD investigation into imports of sorghum grown in the US. In this scenario, we estimate that total economic losses for the US could be c.0.2% of US GDP.
2. In the second scenario, we assume that China bans all direct imports from the US (note that around 32% of US exports due to China demand arrive in China indirectly via other countries). In this case, our model suggests an eco-
nomic loss for the US equivalent to 0.6% of its GDP.
3. In the worst scenario, assuming China bans all direct and indirect imports from the US, economic losses for the US could amount to 0.9% of its GDP, according to our model.
Which industries are likely to suffer most in a trade friction?
Our analysis suggests no real winner in a trade war. But we attempt to identify the industries and countries (other than the US and China) that are likely to be worst affected, assuming a complete cessation of trade between the US and China.
If the US bans all imports from China
Our model suggests that the loss of the US market could depress China’s manufacture of furniture (FU) by c.16% and production of computer, electronic and optical products (CEOP) by 14%. The projected decline in China’s air transport (AT), textiles (TX), rubber and plastic products ( RP), electrical equipment (EE) and chemical industries (CI) ranges from 6% to 10%. The decline in production of paper products (PP), fabricated metal products (FM) and certain machinery equipment (CME) could be around 5%.
From a broad GDP perspective, the slowdown in China’s computer, electronic and optical industry as a result of a Us-china trade war is likely to have the largest impact on China’s economy, subtracting c.0.4% of GDP. The impact of a slowdown in wholesale trade, textiles and mining industries is next, at c.0.24% of GDP.
A ban of China imports by the US would not only negatively affect China, but there would likely also be collateral damage. In Figure 5, we list the top 10 economies that could see the highest impact from a slowdown in China’s exports to the US. In particular, economic losses for Taiwan, Korea, Australia and Japan would likely amount to 0.8%, 0.4%, 0.2% and 0.1% of their respective GDP.
If China bans all imports from the US
Figure 4 shows the top five US industries that are likely to suffer the most from China’s ban of imports from the US. For the air transport (AT), non-vehicle transport equipment ( NVTE), computer, electronic and optical products (CEOP), agricultural products (AP) and machinery equipment (ME) industries, production could slow between 3% and 6% according to our model. From a value-added perspective, the slowdown in the accounting and management consultancy, computer, electronic and optical, wholesales, chemical and non-vehicle industries would have the highest impact on US GDP.
Figure 5 shows the economies that are likely to be affected most by a slowdown in US exports to China. The top five economies worst affected are Canada, Mexico, Ireland, Taiwan and Korea (note that Taiwan and Korea appear to be most vulnerable to collateral damage as they are closely linked to both China and US exports).