Analysis

A US China trade war

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A US China trade war


 

Since assuming office, it is increasingly clear that US President Donald Trump intends to govern as he campaigned: America First, prioritising economic growth. The administration’s ‘fair deal’ trade agenda seeks to raise the nominal US growth rate, reduce and ultimately eliminate the nominal trade deficit, and increase manufacturing employment.

China is the US’s largest trade partner (just surpassing Canada at 16% of total trade in 2016) and accounts for around half the US trade deficit (or around USD 350bn in 2016). Consequently, the administration’s trade policy revolves around substantially increasing diplomatic and economic pressure on China to force a more favourable trade balance.

As the administration continues to formulate policies – in tandem with the US Congress – to ‘get tough on China’, we update our outlook for the critical US-China bilateral relationship, for trade friction and for US businesses operating in China.

Bilateral frictions to intensify existing trade, regulatory pressures on US business in China
  • The administration will eventually – perhaps imminently – introduce executive and legislative measures targeting trade with China. The stated objective of revising terms of trade with China must be taken very seriously. So far, the administration has closely followed its pre-election script, with Trump using his first week in office to issue a series of proclamations fulfilling – at least symbolically – several campaign pledges. The administration has appointed and nominated advisers and ministers with the intent and capability to target trade with China, as well as other export manufacturing countries, under the rubric of America First. So, while it has retreated from threats to impose a blanket 45% tariff on Chinese imports, and not yet designated China as a ‘currency manipulator’, some moves are likely

  • Limited, targeted and contained actions by both sides are more likely than a rapid or dramatic descent into ‘trade war’ over the next six months. Trump’s options for inflicting severe and widespread economic pain on China are inhibited by legal, regulatory and legislative practicalities, including US commitments under the World Trade Organisation (WTO). They are further constrained by the high likelihood of effective retaliation by China, particularly if he pursues more unilateral and unconventional options. Partly for this reason, the US business community is divided over a more protectionist trade policy, and influential constituencies will lobby both Congress and the administration to avoid major trade disruption.

  • Based on the known positions of the administration and its advisers, the US is likely to rely on a combination of existing executive authorities, legislative initiatives to reform trade relations, and aggressive rhetoric and symbolic escalations. Specifically, the Trump administration – like previous administrations – is likely to increase the use of anti-dumping and countervailing duties (AD and CVD) targeting specific sectors, such as steel and aluminium. It has also signalled its interest in a general tax on imports (distinct from tariffs targeting China), potentially as part of a broader tax reform package. Finally, the administration may yet seek to declare China to be a ‘currency manipulator’ to gain leverage in trade negotiations, which would enjoy bipartisan support in Congress.

  • China is used to many of these tactics and would respond in a targeted, proportional manner. Beijing will continue its ‘wait and see’ approach to Trump, believing the situation can be contained by simultaneously seeking to accommodate with limited concessions and deter with focused displays of retaliatory capacity. Beijing will use legal processes – including at the WTO – to vigorously defend against trade complaints or punitive actions. Meanwhile, it will use any apparent US non-compliance with WTO commitments to further its industrial policy, for example by strengthening domestic players in priority technologies and advanced manufacturing.

  • China’s response is very likely to increase regulatory risks for US companies in China. Beijing’s past behaviour strongly indicates that it will use selective ‘regulatory harassment’ of US multinationals as an effective, low risk demonstration of its ability to retaliate, and leverage US corporate influence to urge restraint on the White House. Increased regulatory activity since 2013 on commercial bribery, antitrust and pricing, product safety and environment is mostly genuine enforcement, but trade or diplomatic conflict can be a trigger for more politically motivated scrutiny. For example, atypical safety and tax inspections, and customs and approvals problems have featured in recent bilateral disputes. Companies may also face pressure not to support trade complaints. Regulatory harassment can take a very wide range of forms and the risk is not restricted to highly trade-contentious sectors.

On the US side, belligerent rhetoric on China is a given, but Beijing will, as stated, react mainly to ‘actions not words’. In the next six months, actions that would indicate a more serious deterioration than we have forecast above would include:

  • Attempts to use trade remedies known or likely to be WTO non-compliant, including under Section 301 of the Trade Act of 1974 (which authorises expansive tariff retaliation, but which has been deemed to be generally WTO non-compliant) or by imposing countervailing duties on the grounds of ‘currency manipulation’ (which has yet to be tested at the WTO).

  • Attempts to invoke rarely used authorities to regulate normal trade relations, such as Section 338 of the Tariff Act of 1930 (which authorises broad retaliation against discriminatory trade practices), the Trading with the Enemy Act (TWEA, which authorises trade restrictions against belligerent countries and is currently used to impose the economic embargo on Cuba), or the International Economic Emergency Powers Act (IEEPA, which authorises trade restrictions to address a ‘national emergency’, and which is used mainly to impose trade and financial sanctions). This would be seen in China as a significant escalation and provoke retaliation, even if legal challenges might ultimately stop such actions.

  • Legislative action granting additional power or discretion to the administration to impose tariffs on China, similar to legislation previously introduced in relation to currency manipulation.

  • Deliberate US conflation of trade issues with other aspects of bilateral relations, such as Taiwan or the South China Sea. In these areas, Beijing has less leeway for ‘tolerance’ than on trade.

  • Indications that the administration would refuse to abide by an adverse WTO Dispute Settlement Mechanism (DSM) ruling. For example, China in mid-December 2016 filed a dispute at the WTO against the US (and the EU), after it declined to grant so-called ‘market economy status’ in line with a commitment made under China’s WTO accession agreement in 2001. Several of Trump’s advisers, including his nominee for US trade representative, believe that the DSM handicaps US trade policy.

  • Indications that US policy intends to go beyond simply reducing the bilateral trade deficit, in pursuit of fundamental – and improbable – changes in China’s economic model, trade and industrial practices.

In China, we will be monitoring for signs of increased or more politically motivated scrutiny and harassment of foreign companies, beyond the current heightened levels of regulatory enforcement. Blatant, widespread resort to such measures, disproportionate trade retaliation or provocations in disputed maritime areas (beyond those already occurring) would suggest China is taking a more negative view of Trump’s intentions, and abandoning its ‘wait and see’ mode to push back more aggressively.

While our most likely scenario for US-China ties in the coming year is not alarming, Trump’s arrival in office has brought far greater uncertainty, and increases the likelihood of scenarios that would entail significant disruption to trade and investment relations. Several factors underline the risk of misjudgements.

Trump and Chinese President Xi Jinping have projected ‘strongman’ personas and narratives of national revival. Trump faces pressure to show that his campaign pledges were not all talk; Xi cannot look weak ahead of his ruling party’s national congress late this year. Each may be inclined to show the other that they are unpredictable and should not be provoked.

Many influential Chinese observers seem to underestimate how different Trump could be from past US presidents who talked ‘tough on China’ on the campaign trail, but ultimately pursued more pragmatic and accommodating policies in pursuit of stable relations and economic integration. Trump’s administration probably underestimates China’s will and capacity to defy and return economic pressure.

However, for now, businesses and investors should think of the new US leadership as a major catalyst for mostly negative trends and pressures, rather than a trigger for a short-term descent into major conflict. This is true of the geopolitical sphere, where tension over regional flashpoints and gradual acceptance of China’s centrality have long been growing. It is particularly true of the business environment for foreign companies in China, for which political, policy and regulatory risks should already be central to strategy.

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