The Trade War between China and the United States

The US elections in 2016 had already revealed the intentions of Donald Trump on China. He campaigned on the premise that the decline in US manufacturing as well as the ballooning trade deficit were attributed to China’s unfair trade practices. As he became president, the writing was on the wall. In 2017, he raised import tariffs on Chinese exports to the US estimated at 250 billion. Tariff rates ranged from 10-25%. In response, China retaliated by imposing tariffs on US exports estimated at over 100 billion. Many US exporting firms have been adversely affected by these measures. Dollar Tree the Virginia based retail firm imports about 42% of its products from China. As the tariff rate goes up, it eats into its profits.  In order to maintain profitability, retailers may be forced to increase prices or put products into smaller packages. Target and Walmart are expected to increase prices due to the high tariffs. Retailers are also stocking up inventory by importing more Chinese merchandise before the new round of tariff hikes thus pushing up transportation and warehousing costs.

Despite all this, the US trade deficit has gone down. The US Census reported that the U.S. goods trade deficit reached a record of $891.3 billion in 2018, an increase of $83.8 billion (10.4 percent). The broader goods and services deficit reached $621.0 billion in 2018, an increase of $68.8 billion (12.5 percent). The rapid growth of U.S. trade deficits reflect the failure of Trump administration trade policies, as well as the negative impacts of tax cuts and spending increases, which have sharply increased the federal budget deficit, and tightening of U.S. monetary policy, resulting in upward pressure on interest rates and the real value of the dollar. The U.S. goods trade deficit with China reached a new record of $419.2 billion in 2018, up from $375.6 billion in 2017, an increase of $43.6 billion (11.6 percent). United States trade with China is dominated by the deficit in manufactured products.

The impact of the trade friction between the two countries is not just limited to US retailers and consumers. It is beginning to adversely affect American companies exporting to China. The electric automaker company, TESLA, had to raise the price of its Model X cars and Model S by $20, 000 in July last year after the new round trade tariffs. The increase came after Beijing placed an addition of 25% on imported American cars. Tesla independently sells its cars as imports, unlike the way most of the foreign companies use joint-venture partnership. China also raised its tariff on America’s biggest export to China: soybeans. Before the imposition of the tariffs, the US exported soybeans amounting to $12 billion to China. The tariffs led to a reduction of soybean imports by 63%. The prices of US soybeans declined by 20% after China imposed its retaliatory tariffs. Research has shown that even a slight increase in tariff generates large adverse economic effects.

The two countries experienced GDP losses. China experienced a decline in its GDP by 1.2% while the US experienced a GDP decline of 0.3%. This asymmetric loss was because the US has market power in the international market. It was also due to the trade deficit between China and the US. On average, the amounts of Chinese exports to the US are $500 billion while that of US exports to China is $150 billion. This means that the US exports to China account for a smaller percentage of its GDP. On the other hand, the exports to the US make a large share of China’s GDP. Other countries in the OECD enjoyed slight benefits from the decrease in exports from China to the US. The benefits are due to trade diversion where other countries have to be brought into the equation to fill in the lost trade. This means that a decline in trade between the two large economies indirectly benefits other economies.

The US and Chinese presidents agreed to remove the tariffs that had been imposed to increase trade between the two countries. The two countries selected a team that would lead the negotiation process to solve the economic standstill between them. We do not know whether this will happen anytime soon. The most important cause of large and growing U.S. trade deficits is persistent currency undervaluation by countries such as China, Japan, and Korea, which have run large, persistent trade surpluses, as well as large structural surpluses accumulated by the European Union, including especially Germany and the Netherlands.