Principal and Director of Analysis
The US-China trade war
- Asia Pacific
The US-China trade war is on the brink of a different, more dangerous phase
When the editor-in-chief of one of China’s most prominent newspapers last month described new tariffs as President Donald Trump’s “last card”, he could hardly have been more wrong. With US duties now affecting Chinese imports worth USD 250bn and Trump threatening to double that level, this quantitative tariff escalation will soon be felt more keenly in both countries. However, an equally disruptive qualitative evolution has also begun, with an increasing focus on tactics such as politicised regulation and sanctions.
Having only imported around USD 128bn of US goods last year, China cannot continue simply matching US tariffs as it has done so far. Beijing is now torn between looking weak with continued restraint, or expanding its retaliation to tactics – including tougher treatment of US companies in China – that risk serious self-inflicted damage. Surveys by the US-China Business Council and the American Chamber of Commerce in China last month found that a substantial proportion of US firms in China have already experienced more regulatory difficulties since the trade war began. That is with Beijing still playing nice.
Chinese leaders do not want to exacerbate conflict or scare off US firms. This would undermine their focus on domestic stability, summed up in President Xi Jinping’s call to “stabilise employment, stabilise foreign trade, stabilise foreign capital, stabilise investment and stabilise expectations”. His top economic official told US corporate leaders Beijing “won’t allow retribution against foreign companies”. China’s “Plan A” is still to contain the trade war, cushion its impact, and wait for Trump to be swayed by domestic forces as tariffs bite. Xi is probably right to think he can out-last Washington in this tariff pain game, but the Trump administration is changing the game and raising the stakes.
War by other means
The US Commerce Department brought one of China’s leading companies, ZTE, close to collapse earlier this year. The administration is now beginning a concerted effort to intensify pressure on multiple fronts. In September, the State Department announced sanctions against China’s main military procurement agency, over purchases of Russian military equipment. This month Washington accused China of seeking to influence US mid-term elections, charged a Chinese agent with conspiring to steal trade secrets, and expanded controls on sensitive US exports to China and Chinese investment in the US.
The US will further increase pressure with similarly robust tactics in several areas in the coming weeks. It has been mulling sanctions on Chinese entities over industrial practices, alleged cyber infiltrations, human rights issues, and trade with North Korea and Iran. Additional scrutiny or controls on bilateral trade and investment ties in sensitive sectors are being considered. Beyond trade, the US Navy is reportedly considering a show of force in November with exercises in the South China Sea and Taiwan Strait.
For the US, restricting or punishing specific companies and behaviours is a logical evolution of approach. If Trump tops out on tariffs or wants to ease domestic pain while maintaining pressure on Beijing, he will need these other tools to add leverage. This shift in tactics is also likely to be a long-term feature of US-China competition. Countering China has broad, bipartisan support in Washington, but most observers want to focus beyond tariffs and the trade deficit, to better target systemic issues of market access, intellectual property (IP) protection and state support for favoured local firms.
For its part, China is only beginning to grasp the strength and breadth of resolve in Washington to hold out for substantive concessions. Beijing is therefore struggling to decide on a “Plan B” of retaliation or concessions that are likely to deter or satisfy the Trump administration. Without a clear sense of how to contain this, China will turn to its own non-tariff toolkit more frequently and aggressively as the US ups the ante. It will remain selective, aware of the collateral damage, but US companies can expect more scrutiny in areas such as antitrust, data protection and product safety, and more problems with issues like licensing and approvals, workplace safety and customs inspections.
From semiconductors and software to cups of coffee, top US brands in China have struggled with issues like antitrust and pricing even before the trade war. For Beijing, such regulatory pressure does limited domestic damage and can be passed off as normal regulatory enforcement. Fear of scaring off investors is still a constraint, but if the Trump administration goes hard after Chinese companies, Beijing may even be tempted to seek its own “ZTE moment” – a more shocking demonstration of its capability to hurt a top US company. It could target one of the many that make a large share of their global profits in China.
Another often overlooked risk is that a nastier nationalism is waiting in the wings of this dispute. It has been notably absent in China so far, with nothing like the protests against Japan in 2012 and South Korea last year. This is not because there is no anti-US sentiment in China; it erupted briefly in 1999 and 2001, and remains abundant online. It is because Beijing, despite stoking nationalism with its “patriotic education” and “China Dream” rhetoric, usually suppresses actual organisation and protest.
For now, Beijing’s message is that everything is under control. Making concessions to US demands is already awkward for Xi; stronger outpouring of patriotic passion would further constrain him. Hence the propaganda apparatus has told media and online censors to avoid overly emotive trade war coverage. However, if a slowing economy and socio-economic strain put Xi under more domestic pressure, it will be tempting to unleash the nationalist narrative, directing anger out, not in. The government will not allow widespread unrest and most consumer boycotts in China have been short-lived, but nationalist sentiment remains a concern for US firms as local brands in many sectors are already gaining ground.
In theory there is clear scope for compromise. After the summer standoff, the realities of the tariff war will set in this autumn for both Washington and Beijing; by winter there will be domestic discontent and more motivation to soften positions. Many in China speculate optimistically that US mid-term elections on 6 November, and a planned meeting between Trump and Xi in late November, might help shift the diplomatic trajectory. Trade war fatigue may blunt escalation as tariffs begin to really sting, and help fuel more serious bilateral and multilateral efforts to create more sustainable trade rules.
As well as offering big purchases of US goods and a few market access concessions, Beijing may soften aspects of its economic and industrial policies attracting the strongest criticism. It is already thinking more seriously about which market reforms it is willing to accelerate, and how to package and message these to balance domestic and US-facing priorities. In this context, compromise is arguably a question of time: how long will it take before trade war pain and domestic pressures reach a point where both sides are ready to make bigger concessions. However, the real drivers of conflict are deep and structural:
- China’s leaders see their core political-economic model, including a big state-owned sector and rapid industrial upgrading, as non-negotiable. They are determined to deter what they – and most Chinese – consider to be US efforts to contain China’s development through economic coercion.
- The US sees a more aggressive, authoritarian China seeking to dominate key industries and technologies by exploiting open economies, while directly challenging US security dominance and economic influence in Asia and beyond. The consensus in Washington is that the US cannot continue such open economic ties with China without major changes to China’s model or global trade rules.
Even if a superficial deal is struck in the coming months to contain escalation, reconciling underlying US-China grievances in any sustainable way will require deeper concessions – a renegotiation of the bilateral relationship which neither side seems ready for yet.
Disrupted not decoupled
Long-term readjustment could happen in many ways and poses daunting questions. Will adjustment be mainly negotiated, co-ordinated and managed, or the forced, chaotic result of confrontation and unilateral punitive measures? Will China increase its levels of economic openness and marketisation much closer to global norms, or will other countries adjust to China by increasing protection of their own markets? Will we see divergence, with different trade and investment norms for “strategic” and “non-strategic” industries, and blocs of countries with more compatible systems and policies?
The most likely scenario may see China make a lot of the running: not abandoning its core model, but making just enough concessions to blunt the full force of opposition, with trade rules also adjusting to make issues such as state-owned enterprises (SOEs) and IP more manageable. In this scenario China would speed up and expand market liberalisation, either proactively to avoid being isolated by US-led “coalition-building”, or because it fails to avoid it and is eventually forced into bigger concessions.
Combined with Washington moderating its current confrontational approach sooner or later, this could restore some stability, but tension between fundamentally different political and economic models will persist. Adjustment will be a contested, disruptive, sometimes volatile process playing out over years. A return to a “pre-Trump” status quo, a comprehensive agreement to settle disputes and reset trade rules, some clean “decoupling” of the world’s two largest economies all look unlikely, or at least distant.
If tariffs remain a key part of Washington’s strategy for dealing with China, there will be growing signs of partial decoupling as firms make larger and more lasting changes to global production and supply chains. But for most firms this is not a simple question of staying or going, or of avoiding tariffs. China may still be the “workshop of the world” in some respects, but most of the world’s largest companies are in China primarily to sell to the massive China market, not as a cheap export-manufacturing base. Some figures suggest US firms’ sales within China – which are not captured in US trade deficit data – are now worth roughly the same as US exports to China. In a market this big, growing at around 6%, exit is not an easy option. Most companies will choose to stay and adapt as best they can to a tougher environment.
Stuck in the middle
Foreign multinationals in China have seen difficult times before, and the outlook is not all doom and gloom. Accelerated reforms may prove shallow and selective but still imply opportunities for some. Third-country governments and companies have been quick to see opportunities amid US-China risks. It is no coincidence that European firms seem set to be the first beneficiaries of recent market access concessions in the automotive and financial sectors. As it struggles to find a balance between addressing and deterring foreign pressure, Beijing will be keen to adopt a corporate carrot and stick approach.
Nonetheless, businesses should now view the disruption, costs and uncertainty associated with geopolitical adjustment as part of a base-case scenario, rather than a spike in tensions. Non-US firms should also remember that most countries are vulnerable to bilateral frictions with China at some point. External dynamics will combine with equally important domestic ones to drive continued transformation of the environment for foreign companies in China.
Features of this environment will include:
- The next phase of the trade war, combining extensive tariffs with growing scrutiny and constraints from both Washington and Beijing on bilateral trade, investment and business ties.
- Conflicting political pressures from China and home governments on firms’ business decisions, such as locating production, research and investments, and a premium on insulating supply chains.
- Particular pressure on companies in strategic sectors and advanced technology, including greater scrutiny of links to China as well as tighter regulation and potentially diverging industry standards.
- Increasingly proactive and sophisticated domestic Chinese regulatory enforcement across multiple issues, posing rapidly evolving challenges for multinationals, from compliance to government affairs.
- Intensification of the long-standing squeeze on foreign companies’ margins and market share, both from slowing growth, rising costs and stronger competition, and from government industrial policy.
- Existential questions in multinational boardrooms about their long-term strategy to survive and prosper in China, their role in and value to a changing Chinese marketplace and policy space.
With geopolitical dramas likely to continue dominating headlines, it is crucial to also keep thinking seriously about the domestic trends and developments that will be at least equally important in shaping companies’ future in China. This is the first in a series of articles that will consider various practical aspects and challenges in this evolving business landscape, and how companies can approach them.