Impact of the U.S.-China Trade War and China’s Policy Responses

Photo: Despite growing economic relations and mutual dependence, China and U.S. disputes have grown increasingly tense. https://www.ft.com/content/6124beb8-5724-11ea-abe5-8e03987b7b20

Since China’s accession to the World Trade Organization (WTO), the international organization that deals with global rules of trade, trade between China and the U.S. has been increasing over time. The U.S. provides China with a large exporting market, and the imports of lower-cost goods from China also greatly benefit U.S. consumers. However, despite growing economic relations and mutual dependence, China and U.S. bilateral disputes have become increasingly tense especially since U.S. President Donald Trump came to power in 2017. The Trump administration followed through months of accusations and threats to impose sweeping tariffs on China for its alleged unfair trade practices and intellectual property theft. China denied these allegations and claimed that the U.S. was simply trying to curb China’s rise as a global economic power. Over the three years that followed, the two countries got embroiled in a tit-for-tat tariff war and restrictions of Chinese technology such as WeChat, TikTok and 5G wireless network. Consequently, the trade tensions led China and the U.S. to the brink of a full-blown trade war. The tariff war affected not just the U.S. and Chinese economy but the entire world economy. The U.S. could not even achieve its central objectives of decreasing the overall U.S. trade imbalance and reversing a U.S. decline in manufacturing. Although the trade war caused economic setbacks to China, the country managed a quick recovery with effective policy responses.  

 On January 15, 2020, after a series of WTO cases and back-and-forth negotiations, both countries officially signed the “Phase One” trade agreement. The deal forms part of an effort to resolve trade tensions. It demanded a rollback of tariffs from the U.S. in exchange for China’s expansion of trade purchases, renewed commitments on intellectual property, technology transfer and currency practices. Given that the coronavirus pandemic has ravaged the world, it has become very hard, especially for China, to keep its commitments to purchase a set amount of U.S. products under the agreement. In addition, new conflicts over Chinese applications TikTok and WeChat that emerged earlier this year have created a less-than-favorable environment for more talks. So, it is yet to be seen how effective the Phase One deal would turn out to be for both countries in their efforts to de-escalate the trade war.

With the rise in tariff imposition, President Trump hoped that an economic attack on China would miraculously create economic prosperity for the U.S. However, the tariff escalations of 2018 and 2019 inflicted a slowdown in the GDP growth, a reduction in trade volume, and a downturn in manufacturing sectors of both U.S. and China. The overall exports and imports in the U.S. and China fell in the first 10 months of 2019, compared to a year ago due to the escalation in tariffs between the two countries. The Trump administration argued that the U.S. trade deficit—mostly contributed by a bilateral imbalance with China—would reduce with the increase in its tariffs on Chinese exports. Although the China-U.S. trade imbalance did reduce by 18% from 2018 to 2019, the overall U.S. trade imbalance did not change much that year. It was mainly because the U.S. importers shifted to cheaper sources of goods from Vietnam, Mexico and other countries. In connection with that, the U.S. trade imbalance is soaring this year mainly because the U.S. trade deficit with China has increased again amid the Covid-19 pandemic and is back to where it was at the beginning of the Trump administration. Hence, the U.S. trade war with China cost its economy almost 300,000 jobs, 0.3% of its real GDP. Despite imposing tariffs on hundreds of billions of dollars of Chinese products to discourage imports, the U.S. was not able to achieve the objectives of reversing a U.S. decline in manufacturing and decreasing its overall trade deficit. 

The trade war with the U.S. also affected China’s economic growth, decreased its overall trade volume and contracted its manufacturing industry. While it suffered substantial losses from the trade war, China promptly adopted a series of policy measures that helped it alleviate the negative effects. Such measures included counter-cyclical measures and institutional reforms that the Chinese authorities implemented during the 2018–2019 China-U.S. trade war. In the case of the counter-cyclical measures, the Chinese government adopted a proactive fiscal policy (tax and fee cut to enhance economic growth) and a prudent monetary policy (reserve requirement ratio -RRR- cuts together with the drop of policy rates). With the implementation of the countercyclical measures, along with the sheer size of output, the rapid development of the economy and the abundant reserve assets, China managed to withstand the negative shocks brought about by the trade war, even in the worst-case scenario. The institutional reforms were increasing efforts at encouraging, supporting and guiding private-owned enterprises (POEs), enhancing protection on intellectual property, further opening up its domestic financial service market, reforms on stock markets regional integration and urbanization. Although some of the institutional reforms have yet to be fully realized, China is determined to shift its policy focus on lowering taxes and decreasing regulation. Earlier this year, the Chinese government also unveiled a “dual circulation economy” strategy to reduce its dependence on external circulation and technology in its long-term development. The plan focuses on China’s internal circulation or domestic market—production, consumption, and distribution—along with reliance on indigenous innovation as a strategic approach to spur China’s growth. 

The trade war with the U.S. also took a toll on the world economy, and in particular, China’s largest trading partners such as South Korea, Japan, Chile and Brazil. In the case of South Korea, its exports to China fell by 21.3% in August 2019 in comparison to the same month a year earlier, driving an overall 13.6% decline in exports. In Japan, the capital spending in its manufacturing sector decreased by 9.3% by the end of 2019—the first decline in two years, as the Japanese companies struggled with a nearly double-digit decline in their exports to China. Both in Japan and South Korea, the impact is particularly pronounced in high-tech parts and products purchased by factories in China, such as South Korean semiconductors and Japanese auto parts. The factories in China use those materials to manufacture finished products, some of which are then exported to the U.S. Therefore, the trade war between China and the U.S. affected China’s major neighboring trading partners grappling with a nearly double-digit decline in exports to China and the downfall of their economies.

The unprecedented scale and impact of the outbreak of the U.S.-China trade war in 2018 drew worldwide attention. Despite imposing tariffs on hundreds of billions of dollars of Chinese products to discourage imports, the U.S. was not able to reverse a decline in its own manufacturing, and it experienced a decrease in its overall trade deficit. In fact, both countries suffered a slowdown in their GDP growth, a reduction in trade volume, and a downturn in manufacturing sectors. Uncertainties around the trade war also hurt the economies of other countries that weighed heavily on the global economy. While the U.S. failed to make significant progress in resolving the fundamental structural imbalances of the U.S.-China trade relationship, the tariffs did not deliver a fatal blow to China and destroy its economy. It managed to recover from the shocks to its economy by lowering tariffs with its trading partners and making various policy changes. However, tensions still exist between the two countries and it is yet to be seen if China follows up on its commitments to the agreement. A further escalation of the U.S.-China trade war and the subsequent widespread disruptions to the international financial markets would slow down global growth and may even lead to an economic crisis. The world cannot afford the risk of decoupling and a full-blown trade war between China and the U.S.