Since the 2016 presidential election campaign, President Trump has stayed true to his “America First” approach towards economic and foreign policy. After ticking the boxes on the tax reform and infrastructure bill, Trump’s focus has turned to trade, with China being his primary target. Trump’s motivation is more political than economic, as protectionist measures are unlikely to fix the structural drivers of the US’ massive trade deficit, including the long-term decline in the savings rate, low productivity and excessive consumption.
Since the enactment of the steel and aluminium tariff, Trump has broadened the list of Chinese imports that are subject to a 25% tariff, mainly high-end electronic products. The Chinese response was swift and direct, suggesting any retaliation will be equal in value and intensity. The Chinese seemingly reciprocal approach has an asymmetric impact. For instance, $50 billion worth of goods represents 30% of US exports to China, but only 10% of Chinese exports to the US.
Taking into account flows of goods within the global production chains, the direct impact on China is even less. According to the Organisation for Economic Co-operation and Development (OECD) estimates, the domestic value-added content of Chinese exports to the US is 65%, and that of electronic products is even lower at just 46%. On the contrary, the domestic value-added of US exports to China stands at 85% and near 90% for agriculture products. This suggests the US will lose more from a value-added perspective if trade retaliations are of an equal value.
Strategically, China has targeted soybeans, aircrafts and autos which are politically sensitive sectors within the US. With the mid-term election approaching, Trump risks losing his support base if these damaging trade tariffs go ahead. On the contrary, Xi has all the political capital to defend national interest. With a centrally-directed economy, China can flex fiscal and monetary policy to ease any negative economic impact in a timely manner.
With a trade war being a lose-lose, perhaps more so for Trump, there is an incentive to negotiate. The willingness is there, as evident from the 60-day consultation period, a targeted list of products and the pragmatic tone from officials. The desire to reach a deal is clear from China. For instance, China has shown increased appetite for US imports, such as beef and natural gas, following a trade deal agreed last year. As China already has plans to gradually open up its financial sector, negotiations present an opportunity to address US concerns about market access and intellectual property. Finally, the scope for further trade escalation is limited without broadening to consumer goods. That would hurt US consumers directly through higher prices and lower earnings, so would seek to be avoided at all costs. Overall, we expect the scale of final measures to be smaller, with China agreeing to increase imports from the US and further opening up their services sector in exchange for a resolution.