US and China Lose, Third Countries Win in the Trade War

US and China Lose, Third Countries Win in the Trade War

Puja Tayal - Author

Jul. 15 2019, Published 1:09 p.m. ET

  • The US-China trade war is hurting both countries’ economies.
  • The trade war is benefiting third counties, like Taiwan, where chip companies are shifting their manufacturing operations.
  • China’s economic growth is at the lowest level since 1992. Another escalation in the trade war could slow the growth more.
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Tariffs impact the countries that levy them 

The US-China trade war started in April 2018. So far, there have been three rounds of tariffs. Currently, the US levies a 25% tariff on $250 billion worth of Chinese imports. China levies up to a 25% tariff on $110 billion worth of US imports. Investors question whether or not tariffs are effective. History has shown that tariffs don’t help the counties that levy them. Tariffs have a negative impact on the GDP and both economies’ trade at the macro level. Higher tariffs impact the countries’ industries and value chains at the micro level.

Tariffs make goods expensive and reduce trade. Some companies absorb the cost, while some pass the cost to consumers, which increases the prices. Higher prices reduce consumer demand. In a weak demand environment, companies delay their orders due to fears of not being able to sell their output. Reduced orders slow the manufacturing activity, which creates job losses. All of these factors slow a country’s economic growth. At the G20 summit, the International Monetary Fund’s managing director, Christine Lagarde, stated that export and import growth rates have hit the lowest levels since the 2009 financial crisis. US-based consumer companies like Costco and Walmart will pass on the tariff costs to consumers.

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Slower manufacturing activity in the US and China

The trade war has depressed the manufacturing activity in China and the US. The Caixin China General Manufacturing PMI fell to 49.4 in June from 50.2 in May due to a contraction in the manufacturing output and new orders. The iShares FTSE/Xinhua China 25 Index (FXI) has fallen 5.3% since May 1.

In the last two months, the IHS Markit US Manufacturing PMI was at the lowest level since the 2009 financial crisis. Large companies moved to absorb excess inventory amid a sharp slowdown in new orders. The June PMI of 50.6 was slightly above the May PMI of 50.5—the slowest growth in three years. The PMI showed a contraction in manufacturing output and a reduction in factory payrolls. One major reason for the slower manufacturing activity was reduced trade activity between the US and China due to tariffs. The US imposed tariffs to reduce its trade deficit with China, but that isn’t how tariffs work.

Do tariffs resolve bilateral trade imbalances?

The IMF’s (International Monetary Fund) April 2019 World Economic Outlook report conducted a regression analysis of historical trade data. The report found that all trading partners contribute to a country’s trade deficit adjustments. Reducing bilateral trade imbalances will likely lead to trade diversion. The reduction will have a minimal impact on the country’s overall trade balance.

According to US Census Bureau data, the US trade deficit rose 15.1% YoY (year-over-year) to $21.17 billion between January and May. While the US trade deficit with China fell, the trade deficit with other countries rose, which indicates trade diversion. The pattern shows that countries like Vietnam and Taiwan are benefiting from the US-China trade war.

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The US tariffs on Chinese imports encouraged US companies to switch to other South Asian suppliers instead of manufacturing in the US. The American Chamber of Commerce’s China and Shanghai unit surveyed companies operating in China in May. The survey showed that ~40% of the companies are considering or have moved their manufacturing outside of China. Less than 6% of these companies are considering moving to the US.

Taiwan benefits from the trade war

The tariffs and Huawei ban helped the US reduce its imports from China 12.4% and exports to China 19.2% on a YoY basis between January and May. The trade was channeled elsewhere. The US trade deficit with Taiwan increased 36.5% YoY. The imports rose 22.4%, while the exports rose 14.2%. Technology firms are shifting their manufacturing activity to Tawain.

Before we discuss the manufacturing shift from China to Taiwan, it’s important to understand the concept of a global supply chain. The global supply chain boosted world trade. The supply chain evolved because some countries offered significant cost advantages over other countries in producing certain goods. The cost advantage made China the global manufacturing hub for electronics. However, the US increased tariffs on some Chinese imports to 25% in May, which removed the cost advantage. As a result, companies shifted their manufacturing operations to the next best alternative.

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Several Taiwanese firms have manufacturing operations in China. Goods manufactured by Taiwanese firms operating in China are falling prey to the 25% tariff imposed on Chinese imports. The increasing tariffs are encouraging Taiwanese firms to move their supply chain out of China. Citibank analysts noted that the Chinese government is giving Taiwanese firms incentives like favorable tax policies and permission to participate in national research and development projects. The incentives are meant to encourage the companies to stay in China. However, the efforts aren’t enough.

Tech companies eye Taiwan

In mid-June, Foxconn’s founder, Terry Gou, stated that the company could move iPhone production to Taiwan on short notice. Foxconn is Apple’s largest iPhone assembly partner. Taiwan is attracting large investments from the technology sector. Several companies, including Microsoft, are looking at Taiwan for their AI operations. The production shift is reducing China’s manufacturing and increasing unemployment. Just like Taiwan, Vietnam, South Korea, India, and Bangladesh are benefiting from the supply chain adjustment outside China. However, we’ll have to see if the shift in the global supply chain outside China is permanent. Manufacturers might just be re-routing their goods.

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Is the global supply chain adjustment permanent?

Companies have a hard time permanently shifting an entire well-established supply chain to other countries that have lower wages and offer the same quality as China. Shifting production requires time and incurs a cost. Factories need to be built and supplies need to be redirected. Instead of going through all of this trouble, an importer would rather pay the tariff and pass the cost to consumers. Importers hope that the trade war ends soon.

An easier, quicker, and illegal alternative to avoid tariffs is repackaging goods in other countries. A Reuters report stated that Vietnam’s customs agency is tracking China-made goods that are imported to Vietnam, relabeled with “Made in Vietnam,” and shipped to the US to avoid US tariffs.

Trade war slows China’s economic growth

The trade war is benefiting third countries. China’s GDP rose 6.4% in the first quarter. US firms front-loaded shipments due to the anticipation of higher tariffs in the coming months. China’s GDP growth rate slowed to 6.2% in the second quarter—the lowest level since 1992. China’s National Bureau of Statistics stated that the economy will continue to face “downward pressure” in the second half of this year.

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Manufacturing investment is a key contributor to China’s GDP. Many analysts and economists stated that the second half of the year would be tougher for China. Many manufacturers are thinking about moving their operations outside China to avoid the tariffs. Nomura economists expect China’s GDP growth rate to slow to 6.0% over the second half of the year.

If the trade war continues, analysts think that the Chinese government will unveil more stimulus measures like interest rates cuts to boost the economy. However, the rising debt, low investment returns, and falling current account surplus due to lower exports left little room to expand the stimulus. Any major stimulus measures would significantly increase the nation’s debt and have a negative impact the yuan’s exchange rate.

Nomura economists expect that China’s GDP growth could stabilize to 6.3% in 2019 if a trade agreement is reached with the US. However, China’s GDP growth could slow to 6.1% in 2019 and 5.8% in 2020 if the trade war escalates more.

Trade war hurts global economic growth 

The trade war between the two largest economies in the world is weighing heavily on the global economy. The IMF’s April report expects global economic growth to slow from 3.6% in 2018 to 3.3% for 2019. The IMF expects the growth to improve in the second half of 2019 and beyond. The growth would result in the global economic growth of 3.6% in 2020. However, global growth will slow more if the US-China trade war escalates.

Trade’s foundation consists of demand and supply. The US-China trade war is disrupting the global demand and supply. For the US and China, the economic growth will be subdued unless they reach a trade deal or there are permanent supply chain adjustments.


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