China’s imposition this week of tariffs on 128 US export products could be just the beginning of a prolonged and destructive trade war between the world’s two largest economies. Despite President Trump’s boast that “Trade wars are good and easy to win,” this one could impose heavy casualties on both nations and the global economy.
A trade war is a tit-for-tat escalation of tariffs, aimed more at punishing the other country than protecting domestic producers. The Chinese tariffs announced so far are a direct retaliation for tariffs on imported steel that the Trump administration imposed last month on dubious “national security” grounds. If the Trump administration follows through on a threat to impose tariffs on $50 billion in Chinese imports based on a dispute over intellectual property, the Chinese retaliation could be exponentially greater.
Nobody wins from a trade war. When a nation seeks to punish another country with tariffs on its goods, exporters in the target country suffer, but so do consumers and import-consuming industries in the country imposing the tariffs. In fact, they may suffer more economic damage than the targeted country. If the targeted country retaliates, the damage is compounded further in both countries.
This is exactly what is unfolding with the Trump administration’s aggressive trade actions against China, and the stakes are high. China is America’s third largest export market for goods. The Chinese tariffs announced this week hit $3 billion worth of U.S. exports, from nuts, fruits, and wine, to steel pipe. The next round could take aim at the $12 billion in soybeans, $16 billion in civilian aircraft, and $30 billion in industrial supplies that U.S. producers exported to China in 2017.
US tariffs aimed at punishing China for its IP policies will cause collateral damage across the US economic landscape. Almost half of the $505 billion Americans imported from China last year were household goods that are staples of a working family’s budget, such as cell phones, toys, furniture, apparel and footwear. Tariffs on those items will hit tens of millions of Americans right in their pocketbooks.
Tariffs on other major categories of imports from China, such as computers, machinery, and industrial supplies, will hit the bottom line of American companies, raising their costs and reducing their competitiveness in the global marketplace. Hundreds of thousands of American workers could be displaced from their jobs.
US tariffs will do nothing to reduce the U.S. bilateral trade deficit with China. If those tariffs succeed in reducing imports from China, the Chinese will have fewer dollars to buy US exports or to invest in US Treasury bills or US affiliate companies. Both imports from China and exports to China will decline, leaving the trade balance unaffected but reducing overall trade flows and the lower prices and gains from specialization that trade delivers.
The bilateral deficit with China has always been a misleading measure of the trade relationship. The deficit is not driven by differing trade policies, but by such underlying factors as national rates of saving and investment, and the normal demand of consumers. In China, national savings exceed total investment, so its surplus savings flow across the Pacific to invest in the United States. When the Chinese purchase US Treasury bonds, it helps our federal government fund its military and other operations with lower borrowing costs. It also prevents the federal government’s insatiable appetite for debt from crowding out private domestic investment.
The bilateral deficit is also misleading because a large share of the value of goods we import from China actually originate in places other than China. High-tech items such as the iPhone are assembled in China, but much of its total value is represented by components made in Japan, South Korea, and the United States. Yet under the US government’s trade accounting system, the full value of the iPhone is classified as an “import” from China. When the components of imports from China are assigned to the country where the value was actually added, the bilateral trade deficit drops by an estimated 40 percent.
One other way the goods deficit is misleading is that it ignores trade in services. In 2016, the United States ran a bilateral surplus with China in services trade of almost $40 billion. US companies also sell their branded goods and services in China through their affiliate companies. According to the most recent figures from the US Commerce Department, US-owned affiliates in China sold $294 billion in goods and $59 billion in services in 2015. When combined with the lower goods deficit in value-added, the total bilateral deficit with China shrinks considerably.
The right way to approach trade with China is not to provoke an unwinnable trade war, but to seek international cooperation to address issues of mutual interest. In cooperation with other advanced economies, the United States should seek to encourage reform in China to address issues of intellectual property and steel overcapacity. Such cooperation can yield beneficial results without the mutually destructive effects of a trade war.