Date
17 October 2018
It’s possible that US President Donald Trump will seek a deal when he meets Chinese President Xi Jinping at the G20 summit in late November. Photo: Reuters
It’s possible that US President Donald Trump will seek a deal when he meets Chinese President Xi Jinping at the G20 summit in late November. Photo: Reuters

Why US tariffs may only disrupt China economy in the short term

As we went to press, we heard US President Donald Trump’s announcement imposing a 10 percent import tariff on US$200 billion of Chinese imports from Sept. 24.

Relations between the United States and China have suffered a setback that will not be quickly or easily repaired. As such, the US-China trade conflict may get worse before it gets better.

Before long, we will start to see more of the negative economic impacts materialize, e.g., significant price increases for US consumers and job losses among some of the low margin, low-value-added Chinese private sector exporters (many of whom exist perilously on razor-thin profit margins).

It’s still difficult to know what Trump’s ultimate objectives are in all this. It seems his administration wants to start unwinding some of the close economic ties that have built up between the US and China.

To some extent, the current China policy is being driven more by the US Department of Defense than by the Commerce Department and economic interests. We believe there is little or nothing that China can offer that will appease the US defense establishment.

Against this, the US business sector overall still sees China as the one market they simply must be in for the long haul. China remains a top three investment destination for most US multinational corporations. Overall, there is a long battle to be fought in America between US business interests and the Trump administration.

It’s still possible that Trump will seek a deal when he meets Chinese President Xi Jinping at the G20 summit in late November. That is probably the earliest we could expect good news.

Any deal will have to be sanctioned by President Trump in person. One obvious problem is that even if China makes major concessions on all the key points of contention (allowing Trump to declare a quick victory), running the economy hot guarantees that the US-China bilateral trade deficit may not shrink by as much as the deal implies, and the overall US trade deficit can only increase.

Trade war: current implications for emerging markets

Emerging markets (EM), for now, will remain susceptible to further bad news on US-China trade and so will stay very much in focus. External deficit countries like Indonesia, the Philippines, or India may see further currency pressure, requiring further monetary tightening measures that would otherwise have been unnecessary.

But while EM equities will stay challenged in the short term and continue to flirt with bear-market territory, the decline has been relatively orderly rather than panic stations. Valuations for EM equities in relative terms are now just 5 percent above the cycle low reached in January 2016, which Goldman Sachs has called a “significant” floor.

We believe that the negative sentiment on trade that has been depressing EM stock markets may be greater than the inherent risks present.

How will China be affected?

While 25 percent US tariffs may disrupt China’s economy in the short term and may cause it to slow over the next year (possibly two), in the longer run we believe there is unlikely to be a big lasting impact, for the following reasons:

1. China’s technology upgrading and productivity growth don’t depend to any significant degree on US imports or technology. China has all the tools it needs to continue with its rapid economic development.

2. Over the longer term, the impact of US tariffs (a one-time shock) on China’s secular growth path is likely to be small, perhaps even negligible.

3. Most vulnerable now to the Trump tariffs will be the low-margin, low-value-added private sector Chinese exporters (textiles, furniture, etc.). China is already gradually losing this business to Vietnam, Malaysia, and other countries. If US tariffs accelerate this process, it may not be totally unwelcomed by Beijing. It fits with the “Made in China 2025″ plan to upgrade to higher-value-added industries.

It is also possible that broker estimates of the economic costs of US tariffs to China based on an import price elasticity taken from previous empirical research on trade are too high, since:

1. An assumed high price elasticity of -3.0 may be sensible for some price-sensitive consumer items where there are close substitutes from other countries. But in some cases, Chinese consumer goods will still be cheaper than or as cheap as competitors, even after a 10 percent price hike, notably because of the huge economies of scale of the Chinese manufacturing supply chain.

2. The cost of many imported smaller components/ intermediate inputs is fairly price-inelastic (at least in the short term).

3. Chinese manufacturers can do what they did in the case of solar panels – move final assembly plus some manufacturing operations to Malaysia. This only took 18 months to complete.

4. There is scope for “tariff-hopping” – China diverts sales of some goods to third markets, whose exporters replace China in the US market at a higher price than before. China and the third party benefit, the US consumer loses.

Regarding the solar panels and Malaysia, Chinese companies retain much of the benefits today. Solar panel exports from Malaysia to the US are outside the scope of the original tariffs (even if they possess a high China content). Thus, Malaysia’s solar panel exports to the US have soared in recent years. The combined China/Malaysia share today is quite close to the Chinese share before the introduction of tariffs.

This exercise could probably be repeated without too much difficulty for several other export products. It would have the advantage also of creating regional supply chains linking the economy of China with those of other Asian countries.

– Contact us at [email protected]

RT/CG

Senior Strategist (Asia), Capital Markets & Strategy Team, Manulife Asset Management

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