International Trade CSQ — US–China Trade War, Currency Manipulation and Protectionism
Case
Table 1: Change in Chinese Yuan per US dollar from 2013 to 2016
| 2013 | 2014 | 2015 | 2016 | |
|---|---|---|---|---|
| Exchange Rate (Yuan per USD) | 6.15 | 6.16 | 6.28 | 6.64 |
Source: Focus Economics
Extract 1: US fights for protectionism
Tapping into economic discontent, President Donald Trump has argued for protectionism and asserted that decades of free trade policies were responsible for the collapse of the American manufacturing industry and its ballooning trade deficit. He has been feeding on the perception among many Americans that globalisation has brought more pain than gain. For example, globalisation has brought cheap consumer goods into the country, costing domestic jobs and depressing wages. Outsourcing of jobs to cheaper markets has also been a concern.
President Trump wants to renegotiate the North American Free Trade Agreement (NAFTA) which lowers trade barriers between the US, Canada and Mexico and rejected claims that the deal has helped the US economy create more jobs and reduce trade deficit by opening up export markets. He has also argued that since China joined the World Trade Organisation (WTO), Americans have witnessed the closure of more than 50,000 factories and the loss of tens of millions of jobs. He wants the US government to label China a “currency manipulator” and has lambasted the rapidly growing Asian economy for “unfair subsidy behaviour”.
Source: The Guardian, 9 November 2016
Extract 2: Vietnam, a prime location for investors
In recent years, Vietnam is well on its way to becoming a key destination for electrical and electronic products manufacturing for companies like Samsung and LG Electronics. Exports of smartphones and computer parts now account for more in export earnings than oil and garments. Samsung has turned Vietnam into a global manufacturing base for its products, producing almost a third of the firm’s output. Samsung has invested over US$17 billion into the country.
Compared with other developing markets in the region, Vietnam is emerging as the clear leader in low-cost manufacturing. Currently, labour costs in Vietnam are 50 percent of those in China and around 40 percent of those reported in Thailand and the Philippines. With the country’s workforce growing annually, Vietnamese workers are inexpensive, young, and, increasingly, highly skilled.
In the past few years, a growing number of businesses have relocated their operations from China to Vietnam in an attempt to escape rising costs and an increasingly complex regulatory environment. Given the recent trade war between China and the US, alongside the signing of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and EU-Vietnam FTA, the country is steadily becoming more open to international trade and investment.
In terms of regulatory and financial incentives, Vietnam has become increasingly investor-friendly in recent years — the government has taken actions such as reforming its financial sector, streamlining business regulations, and improving the quality of its workforce. In addition, Vietnam has a zero percent tax on dividends remitted overseas and a low corporate tax rate of only 20 percent.
All these advantages have enabled Vietnam to become a premier “sourcing economy” in the eyes of many companies.
Table 2: Vietnam’s top exports, 2017
| Top Exports | Export Value |
|---|---|
| Phones | US $45.1 billion |
| Textiles | US $25.9 billion |
| Electronic goods/Computers | US $25.9 billion |
Source: Vietnam Briefing, 19 November 2018
Extract 3: Trade war will hurt the US
The US imports machinery, clothing and consumer electronics from China, with a lot of it made by US companies which profit from them. President Donald Trump’s proposed measures of raising tariffs against Chinese products and declaring China a currency manipulator might end up hurting both economic giants and others. All this, without quite achieving Mr Trump’s objectives of bringing back manufacturing jobs to the US or reducing its $552 billion trade deficit with China.
While even Chinese economists admit that China’s economy will suffer if Mr Trump went ahead to slap tariffs on Chinese products and take other punitive trade measures against China, other economies are set to be hurt too. This is because many products exported from China to the US are assembled in China with components made in other countries as part of an international supply chain. In an interconnected world built on a complex web of supply chains and mutual economic interdependencies, China’s trade partners, particularly in east and south-east Asia are likely to be among those hit hardest by the fallout.
On the other hand, the US economy could be hurt by a trade war too. First, more expensive imports as a result of the tariffs would hurt Americans’ pockets, particularly those in the low-income groups. Second, the Chinese are likely to hit back at any US action with their own punitive measures. China is also the US’ third-largest export market, and one that is expanding rapidly. The Communist Party-linked Global Times warned: “A batch of Boeing orders will be replaced by Airbus. US automobile and iPhone sales in China will suffer a setback, and US soybean and maize imports will be halted.” The Trump administration’s moves against China could hurt American firms with investments in China and the burgeoning American exports there.
Yet, for all that trouble, Mr Trump may not see many manufacturing jobs returning to the US. In industries like textiles, where factories were lost decades ago to China, the jobs will simply move to countries where labour is less expensive, such as Bangladesh and Vietnam.
Source: The Straits Times, 28 January 2017 and Financial Times, 3 December 2018
Questions
(a)(i) State what happened to the nominal exchange rate of the Chinese Yuan between 2013 and 2016. [1]
(a)(ii) With a relevant diagram, explain how intervention by the Chinese government could have led to the change identified in (a)(i). [3]
(b) Explain how “currency manipulation” in Extract 1 might widen US’ trade deficit with China. [3]
(c)(i) Using a tariff diagram, explain the impact of China’s tariff on the revenue of US exporters of soybeans to China. [3] (The [ANS] marking scheme allocates this part [2] — see the ingestion discrepancy log.)
(c)(ii) With reference to the concepts of price elasticity of demand and price elasticity of supply, explain why the impact of the tariff on the revenue of US exporters of soybeans to China would likely be small in the short-run. [3]
(d) Discuss whether the concept of comparative advantage can explain why Vietnam is becoming a “key destination for electrical and electronics products manufacturing” for foreign investors. [8]
(e) In light of globalisation, discuss the extent to which the US economy would benefit from a protectionist stance on trade. [10]
[Total: 30]
Answers
(a)(i) — state [1]
The nominal exchange rate of the Chinese Yuan depreciated between 2013 and 2016 (it took more Yuan to buy one US dollar, rising from 6.15 to 6.64). “Devaluation” is accepted; describing the rate as having “increased” would be incorrect phrasing and earns no mark.
(a)(ii) — explain with diagram [3]
To weaken the Yuan, the Chinese government sells Yuan (buying foreign currency) in the foreign-exchange market. This increases the supply of Yuan from S₀ to S₁. With demand unchanged, the price of the Yuan relative to the USD falls from P₀ to P₁ — a managed depreciation, consistent with the move from 6.15 to 6.64 Yuan per USD.
Marks: accurate diagram with reference [1]; correct intervention — government sells Yuan [1]; correct explanation of the effect of selling Yuan on the market [1].
(b) — explain [3]
A depreciation of the Yuan (“currency manipulation”) changes relative trade prices. When the Yuan depreciates against the USD, US exports to China become relatively more expensive for Chinese consumers, so the quantity of US exports demanded falls and US export revenue (X) falls. Symmetrically, Chinese exports to the US become relatively cheaper for US consumers, raising the quantity demanded and increasing US import expenditure (M).
Provided the Marshall-Lerner condition holds (PED_x + PED_m > 1), the depreciation of the Yuan reduces US net exports (X − M), widening the US trade deficit with China.
Marks: impact of depreciation on export revenue (X) [1]; impact on import expenditure (M) [1]; Marshall-Lerner condition with overall impact [1]. (Stating only the Marshall-Lerner condition without the individual X and M changes caps at 2.)
(c)(i) — explain with tariff diagram [2]
A tariff on US soybean imports raises the domestic price in China from P₀ (the world price) to P₁. This contracts the quantity imported from the US — imports fall from Q1–Q2 to Q3–Q4. Consequently the revenue earned by US exporters falls from area ABQ₂Q₁ (price P₀ × the free-trade import quantity) to area CDQ₄Q₃ (price-less-tariff received × the smaller post-tariff import quantity). The full tariff diagram is set out in the tariffs note.
Marks: accurate tariff diagram with reference [1]; description of revenue changes [1].
(c)(ii) — explain [3]
The fall in US exporters’ revenue is muted in the short run because both demand and supply for soybeans in China are price-inelastic.
Demand for soybeans in the Chinese market is price-inelastic because soybeans are a staple of the Chinese diet with few close substitutes — a price rise causes a less-than-proportionate fall in quantity demanded. Supply is also price-inelastic in the short run because the production period is long (crops take time to reach maturity), so Chinese producers cannot quickly raise output when the price rises.
With demand falling less than proportionately and domestic supply rising only slowly, Chinese consumers still purchase a large quantity from US exporters in the short run, so the fall in US export revenue is likely to be small.
Marks: PED factor for the Chinese market [1]; PES factor for the Chinese market [1]; link to the impact on US export revenue [1].
(d) — discuss [8]
Thesis. Comparative advantage — a country producing a good at a lower opportunity cost than another — is one explanation for Vietnam’s rise as an electronics manufacturing hub, but the displacement effect of US–China protectionism is the stronger driver.
Comparative advantage as an explanation. Vietnam plausibly holds comparative advantage in electronics. Extract 2 reports that its workers are “inexpensive, young, and, increasingly, highly skilled”, with labour costs around 50% of China’s. Electronics is labour-intensive, so abundant, relatively cheap skilled labour means Vietnam incurs a lower opportunity cost producing electronics than producing goods that draw on resources it is less suited to. By the theory of comparative advantage, Vietnam therefore specialises in electronics and electrical products and attracts the foreign investment that locates production where unit costs are lowest.
Protectionism as the stronger explanation. The US–China trade war independently makes Vietnam attractive. US tariffs on Chinese electronics raise the price of Chinese output, so US buyers switch to Vietnamese electronics as a viable substitute, and Chinese firms — facing higher costs on US-sourced inputs and on selling into the US — relocate to Vietnam “to escape rising costs” (Extract 2). Rising demand raises Vietnamese producers’ profits and output, lifting the marginal efficiency of investment for foreign investors, who follow the relocating supply chains.
Evaluation and judgement. Protectionism is the better explanation. Vietnam’s comparative advantage may be overstated — its workforce is not as established as economies with deeper education infrastructure (Singapore, Japan), so the depth of its advantage is uncertain. By contrast, because the US and China are two of the largest economies in the world, any diversion of their enormous demand toward Vietnam lifts Vietnamese output substantially. The trade war is also likely to persist or intensify while the US pursues protectionism, so the relocation effect is durable. On balance, protectionism rather than comparative advantage best explains Vietnam’s emergence as a key electronics destination — though the two reinforce each other, since the trade war pushes investment precisely toward a country that already has a cost advantage. (Mentioning opportunity cost in the comparative-advantage explanation is required; omitting it caps that requirement at cursory.)
(e) — discuss [10]
Thesis. Protectionism could improve the US balance of payments and reduce unemployment, but at the cost of higher inflation and — through retaliation — lower economic growth. On balance the US economy is unlikely to benefit.
Benefit 1 — improved balance of payments. Import tariffs raise the price of imports into the US, reducing the quantity of imports demanded. Imports are likely price-elastic (they take up a sizeable share of income, with substitutes available), so the more-than-proportionate fall in quantity reduces US import expenditure (M). Ceteris paribus this narrows the US trade deficit, improving the current account and the balance of payments.
Benefit 2 — lower demand-deficient unemployment. Extract 1 notes the closure of “more than 50,000 factories” since China joined the WTO, as US producers lost demand to imports. Tariffs redirect domestic demand back toward US goods, causing an unplanned fall in inventory that prompts US producers to raise output and hire more factors of production, reducing demand-deficient unemployment.
Cost 1 — cost-push inflation. The US “imports machinery, clothing and consumer electronics from China” (Extract 3), much of it used as inputs. Tariffs raise input costs, raising US firms’ costs of production. This is a cost-push shock: short-run aggregate supply shifts up and to the left, raising the general price level.
(The source [ANS] labels this shift as an upward shift of LRAS; the syllabus-correct construction for cost-push inflation is an SRAS shift, as rendered above and in the cost-push note — see the ingestion discrepancy log.)
Cost 2 — lower economic growth from retaliation. Protectionism is a “beggar-thy-neighbour” strategy and invites retaliation; Extract 3 warns the Chinese “are likely to hit back”. If China tariffs US goods, the price of US exports rises for Chinese buyers; with price-elastic export demand, the quantity demanded falls more than proportionately and US export revenue (X) falls. Aggregate demand shifts left, lowering actual economic growth.
Evaluation and judgement. The US economy is unlikely to benefit. The grievances driving protectionism — alleged “currency manipulation and unfair subsidies” — are not solved by import tariffs; tariffs treat the symptom, not the cause. Because China is a large economy with a large export sector, it is well placed to retaliate, which can negate the BOP and employment gains and leave the US worse off through inflation and slower growth. In light of globalisation, the better response is outward-facing: supply-side measures to raise export competitiveness in areas of comparative advantage, diversifying trade partners through more FTAs, and addressing unfair practices diplomatically through international institutions, rather than turning inward.