The US–China Trade War — Tariffs, Terms of Trade and Policy Responses
Case
Table 1: Trade Data between United States and China
| Total Trade (Billion USD) | US Imports from China (Billion USD) | |
|---|---|---|
| 2015 | 620.10 | 504.03 |
| 2016 | 597.12 | 481.52 |
| 2017 | 655.91 | 526.02 |
Source: wits.worldbank.org, 8 January 2018
Extract 5: U.S.–China trade war is brewing
It seems globalisation forces are weakening, given slow trade growth, tighter immigration policies and the increased risk of protectionist measures. President Trump has repeatedly voiced concerns about US trade deficits, including with China, and his administration is attempting to open up China’s economy to US companies. There are fears a trade war may begin between the two countries, involving tariffs and quotas on imports. Trump’s Commerce Secretary said the president will take “bold action” to address Chinese steel imports entering the market. China is the focus of trade-deficit concerns because it is the US’s largest trading partner. However, the administration may be limited by US commitments under the WTO and by “the high likelihood of effective retaliation by China”.
Source: Cnbc.com, accessed 8 August 2017
Extract 6: Trump’s tariffs will make food and clothes pricier for Americans
Trump’s decision to impose tariffs on an additional US$200 billion of imports from China drags the biggest part of the US economy into the trade war. The 10 per cent tariffs — rising to 25 per cent — affect everyday items including food, furniture and clothing, making shopping pricier. Higher prices will deter household spending and weigh on confidence, and companies may encounter increased prices on more inputs. US retailers counting on cheaper China-made merchandise could be forced to lift prices or take a hit on profits.
Source: Bloomberg.com, accessed 18 September 2018
Extract 7: Trade war damage to China’s economy is already done
The tariff war is underlining China’s rising cost of labour at a time when the job market is under pressure. The trade war could cut China’s export growth by almost half next year, putting around 4.4 million jobs at risk. “China is losing some of its cost competitiveness, especially in labour-intensive and low-value-added sectors.” More than half of China’s exports to the US could be replaced by goods from other countries.
Source: Bloomberg.com, accessed 12 December 2018
Extract 8: China hits retaliation button
A trade war between the world’s two largest economies is on. China imposed countermeasures “immediately after the implementation of the U.S. tariffs”. China would fight back and report to the WTO. “China will not fire the first shot, but is inevitably forced to strike back to defend the core interest of the nation.” The Chinese government is trying to minimise imports of US soybeans, having imposed quotas the month before.
Source: Scmp.com, accessed 6 July 2018
Extract 9: China’s transitioning economy
For decades China focused on aggressive expansion of manufacturing, becoming “the world’s factory” and achieving double-digit growth for close to three decades. But the strategy was unsustainable — the world cannot keep absorbing more Chinese imports at past rates. China recently reconfirmed its commitment to transition to a consumption-driven growth model over the next 10 years; final consumption expenditure contributed 76.2 per cent to economic growth in 2018, up from 45.3 per cent in 2007. Over 140 countries have signed Belt and Road agreements, expected to boost global trade.
Source: Worldfinance.com, accessed 23 April 2018
Questions
(a)(i) With reference to Table 1, calculate the value of exports from the U.S. to China in 2017. [1]
(a)(ii) Using economic analysis, explain possible reasons for the changes in trade balance between the U.S. and China between 2015 and 2017. [4]
(b)(i) With the aid of a diagram, explain how the U.S. president’s “bold action” leads to inefficiency in the U.S. market for steel. [3]
(b)(ii) Discuss whether the U.S. economy will have more to gain than lose from this “bold action”. [8]
(c) Explain whether the impact of the U.S.–China trade war on China’s export and import prices will necessarily lead to a deterioration in its terms of trade. [4]
(d) In the light of China’s denting export growth, assess how, other than tariffs, the Chinese government could reduce the trade war damage to its economy. [10]
[Total: 30]
Answers
(a)(i) [1]
US exports to China in 2017 = Total trade − US imports from China = 655.91 − 526.02 = US$129.89 billion.
(a)(ii) [4]
Between 2015 and 2017 the US trade balance with China worsened — US imports from China rose, increasing the US trade deficit. Two possible reasons:
First, currency depreciation. China may have deliberately depreciated the RMB, making Chinese exports cheaper in USD. US consumers switch from domestic goods to cheaper Chinese imports, while US exports become dearer for Chinese consumers — US export revenue (X) falls and import expenditure (M) rises, worsening the deficit.
Second, loss of comparative advantage. The US loses comparative advantage to China, whose abundant cheap labour lets its firms produce at lower opportunity cost. More price-competitive Chinese exports draw consumers in both countries away from US goods, again lowering X and raising M and worsening the US deficit.
(b)(i) [3]
The president’s “bold action” is a tariff on imported Chinese steel.
The tariff raises the price of steel from the world price. Consumer surplus falls by areas A + B + C + D; domestic producer surplus rises by area A; the government gains tariff revenue of area C. Areas B and D are lost to consumers but captured by no one — the deadweight welfare loss from the inefficiency the tariff introduces.
(b)(ii) [8]
The “bold action” — a tariff on Chinese imports — brings the US both gains and losses. The stand of this answer is that the US has more to lose than to gain.
Gain — improved balance of trade. The tariff shifts the supply of Chinese steel up, raising the US price. Steel is fairly homogeneous with many world producers, so imported Chinese steel has close substitutes and price-elastic demand. The higher price therefore causes a more than proportionate fall in the quantity of Chinese steel imported, reducing US import expenditure and improving the US balance of trade.
Loss — cost-push inflation. As the price of steel rises, the cost of production rises for US producers that use steel as an input — for instance, the motor industry. Higher input costs shift aggregate supply up, raising the general price level — cost-push inflation.
Judgement. The US has more to lose than to gain. First, retaliation: China is among the world’s largest economies with many trade partners (Extract 8 confirms it imposed immediate countermeasures), so it will retaliate with tariffs or quotas that worsen the US balance of trade, negating the initial gain and risking a wider trade war that harms both. Second, steel is a key input across major US industries — aviation, defence, manufacturing — so a tariff on it spreads cost-push inflation widely, eroding the purchasing power and material standard of living of US consumers. The losses outweigh the gain.
(c) [4]
Terms of trade (TOT) is the ratio of a country’s export prices to its import prices. The trade war does not necessarily deteriorate China’s TOT — it could move either way.
China’s TOT might deteriorate: Extract 7 says the war will “cut China’s export growth by half”, so weaker export demand lowers China’s export prices, worsening its TOT.
But China’s TOT might improve: Extract 6 reports rising prices of everyday items. If input prices rise, the cost of producing Chinese exports rises and producers raise export prices to protect margins — higher export prices improve China’s TOT. The outcome is therefore not necessarily a deterioration.
(d) [10]
China’s export growth is slowing and its balance of trade deteriorating, threatening lower actual growth and higher demand-deficient unemployment. Other than tariffs, China can depreciate its currency or restructure towards a consumption-driven economy. The stand of this answer is that restructuring is the better strategy.
Depreciate the currency. China can sell RMB in the foreign-exchange market, raising its supply and lowering its value.
A weaker RMB makes Chinese exports cheaper and imports dearer; provided the Marshall–Lerner condition holds, the balance of trade improves.
Evaluation. Depreciation can cause cost-push inflation, since dearer imported inputs raise the general price level.
Restructure the economy. Per Extract 9, China is transitioning to a “consumption-driven growth model”, reducing reliance on exports and so its exposure to tariffs and protectionism. Using supply-side policy — grants and subsidies to firms serving domestic consumers — domestic consumption (C) grows as a share of GDP, letting China grow without rising export revenue and reversing the trade-war damage to growth and employment.
Evaluation. Restructuring spans “10 years” and supply-side policies act slowly, depending on the economy’s receptiveness; in the short run China remains export-dependent and exposed.
Judgement. Restructuring is the better strategy. Depreciation is a beggar-thy-neighbour policy that invites retaliation, which can worsen China’s trade balance over time; it is also symptomatic, leaving China’s underlying export dependence intact. Restructuring addresses that root cause by reducing reliance on external demand, and is sustainable — China’s 1.4-billion population offers a vast potential domestic consumption base to drive growth. Depreciation may help in the short run, but restructuring is the more appropriate long-run response.