US-China: Likely a Truce, Not an End to the Trade War

First published 13th January 2020 as part of Forecast2020
by Alexander Gale
Asia | Fostering Growth & Opportunity| Understanding Your World

With the announcement of a ‘phase one’ trade deal in December, economists have questioned whether this is the beginning of the end for the US-China trade war, which has raged since July 2018. Most of the international business community would welcome an end to the tariffs. Indeed, the World Trade Organisation warned in November that global trade has become increasingly sluggish. Likewise, the International Monetary Fund made a dismal forecast in October for global growth at just 3% in 2019, the weakest since the 2008–09 period of the Great Recession. However, the deal will likely represent a fragile truce and not the full blown end to financial hostilities many economists were hoping for.

The intricacies of the deal have yet to be fully fleshed out, but a reduction in tariffs will likely be the first major step. In addition, Beijing is expected to implement better protection for American intellectual property and purchase more goods from the US. However, it is extremely unlikely that Chinese reform will satisfy the Trump Administration’s aspirations for future trade with China. Ultimately, Xi Jinping will not abandon China’s unique model of communist capitalism, at the behest of Washington, nor will he abandon several trade practices the US deem ‘unfair’.

Election is looming

The deal comes at a crucial time for President Donald Trump, as he looks to retain power in the 2020 election. The President will likely flaunt any concessions made by Beijing as evidence of an American victory. More crucially, Trump will need to ease the pressures of the trade war on his voter base. Many of those hit hardest by retaliatory Chinese tariffs are in the Great Plains area where Trump enjoyed a high degree of support in the last election. Many of these voters who supported Trump in 2016 are farmers, but agriculture has taken hits during the trade war. For example, China ceased importing American agricultural goods such as corn and soybeans, forcing some farming companies to lower their production outputs. More broadly the Trump Administration will want to further avoid alienating disgruntled middle-class consumers, who have had to pay more for various products because of the tariffs.

Washington has another motivation to press pause on the trade war, namely avoiding a recession. Economic growth has been mostly slow and steady during Trump’s tenure as President, with unemployment at its lowest level for about 50 years and an overall growth in GDP. But this slow and steady growth is built on shaky foundations. A survey by the National Association for Business Economics found that 72% of the economists it questioned are expecting a recession in the US by 2021. Easing the tariff war with China might help stimulate demand, at least enough to offset a recession during the 2020 election period. For growth to endure, US consumers must keep spending.

If Washington was motivated purely by financial balancing, the trade war would be less likely to continue over a longer-term period. Yes, China’s practices, which do not adhere strictly to the free market model pose uncomfortable questions of foul play; and yes, there is an argument to be made for reducing the trade deficit. However, China’s retaliatory tariffs may prove more hurtful than its alleged ‘unfair practices’ and the US has had an increasing trade deficit since the mid-1970s, offset by Wall Street’s ability to attract foreign capital and investment.

Does America still lead the free-world?

The greater consideration motivating Washington is therefore the US’s geo-strategic place in the world. After an unparalleled era of American power as the world’s leading hegemon; policy makers in Washington are waking up to a future where the US will no longer be the globally unquestioned superpower.

Increasingly there are fears that Beijing will overtake Washington if the Chinese economy surpasses the US. Consequently, the trade war is more about limiting Chinese economic growth and power than it is about safeguarding American finances and it is for this reason that it will be difficult to bring to a conclusive end.

A great deal of uncertainly will remain even if a comprehensive deal is reached. Will such a deal last and for how long? The most prudent approach for those with a vested interest is to make preparations on the basis that some kind of financial conflict will endure between the US and China for the foreseeable future. The pivotal question, for now is, how will the US and China fare if the trade war continues?

Panic in the east

The US-imposed tariffs initially generated significant panic in the Chinese economy; however, China has so far weathered the storm remarkably well. Despite exports to the US dropping by close to 15% in 2019, demand for Chinese goods in Europe and South-East Asia have largely mitigated losses. This is partially due to the depreciation of the yuan to the dollar by 6%, which has prevented Chinese exports from becoming too expensive.

Similarly, fears that a trade war would lead to a mass exodus of US firms with operations in China have not materialised. A US-China Business Council Member Survey conducted in 2019 found that 87% of US companies intended to remain in China. Even for those who want to leave, relocating to the US will not be easy. Many firms have deeply entrenched supply chains and would struggle to quickly reacquire certain key resources if they moved.

Beijing has also been adept in its application of tariffs, only imposing them on US imports, which can be replaced by goods from other countries. Meanwhile tariffs on alternative trading partners have been reduced from 8% to about 6.7% on average, stimulating domestic Chinese demand for imports that do not originate from the US. This has actually lowered prices for Chinese consumers on several goods despite US tariffs.

The Chinese economy has demonstrated its resilience to the trade war, thus far, but there are risks to be aware of. If the trade war continues indefinitely and escalates to the point where serious attempts are made at decoupling the US and Chinese economies, the consequences would be dire. However, the world’s two largest economies are so closely linked that decoupling would be equally disastrous, if not more, for the US and the global economy as a whole, so this worst-case scenario is unlikely to materialise.

Analysts are split as to whether the Chinese economy will remain robust if the trade war continues. Projections for growth are expected to slow and there is a greater risk that American buyers will cease purchasing Chinese goods if tariffs resume after a brief truce. Writing for Foreign Affairs, Weijan Shan has noted that the Chinese economy is shifting from export-dependency to a consumption driven model. Therefore, economic growth may slow down, but as China’s growing middle class continues to consume at a greater rate, the economy may stabilise. This may offset the most severe degree of risk posed by tariffs, although it will depend on exactly how far and how fast China transitions.

Our take on the risks

Despite the risks, China will remain an attractive place for foreign businesses and opportunities will remain. The question is not so much, ‘will companies remain in China’ but is instead, ‘how will they adapt’? For Western firms, China’s unique way of doing business has always posed challenges. Issues with corruption, politics and infrastructure were problematic but addressable before the trade war and firms will continue to operate despite additional challenges that have arisen since economic conflict broke out in 2018.

While our recommendations on working in China and doing business there haven’t changed, we recommend thorough planning and research to ensure you’re not accidentally placing yourself, your project or your business at risk. With China’s ever changing landscape as well as the US-China trade war, compliance will be key in 2020.

We’re watching this closely at ComplexGlobal to keep abreast of regional analysis and what this means for our clients in the region. For more insight and analysis on this event as well as a global understanding of the issues that affect you, explore our wide range of analysis, intelligence and commentary at www.complexglobal.co