Trade tensions between the U.S and China have been rising since the U.S. imposed a 25% tariff on approximately $34 billion of Chinese goods July 6 and on an additional $16 billion of Chinese imports August 23. China retaliated each time with tariffs on approximately the same value of imports from the U.S. Subsequently the U.S. announced a plan to impose 10% tariffs on an additional $267 billion of Chinese imports. These new proposed tariffs are to be implemented in several stages depending the response by China with the ultimate expected tariff of 25%.
On September 18, China announced that it will retaliate with additional tariffs on $60 billion worth of U.S. goods with tariff rates from 5% to 10%. Note that this time China did not propose an equivalent amount of imports from the U.S. to be subject to the retaliation for two reasons. First, there are goods that China wishes to acquire from the U.S. that it does not want to tax, and second China only imported $130 billion of U.S. goods in 2017. China did indicate that there is a possibility of expanding their response in this tit-for-tat trade dispute with other non-tariff restrictions on U.S. companies doing business in China and potentially restricting exports of intermediate goods to U.S. manufacturers. China has also filed a grievance with the WTO against the U.S. claiming that the tariffs are a violation of WTO international trading agreements.
Were the additional tariffs to be imposed and the trade dispute escalated, the end-game would not be obvious. The most optimistic scenario is that the escalation stops, both sides declare a win, and both sides pull back through negotiations. There is a pathway to this result. China has been moving towards increased IP protection, and this is an issue for the U.S. In response to a deal on IP, both sides could declare victory and begin to remove the tariffs.
The most pessimistic scenario is that the rhetoric from both Beijing and Washington translates into further escalation. This narrative is fed by news organization in each country which report that the other side is feeling the pain more than they are. This end-game could well be autarky—the cessation of most trade between the two countries. There is much room between the most optimistic and the most pessimistic scenarios for a settlement. However, the political landscapes in the two countries may dictate a solution that does not correspond to the most advantageous economic solution.
In other recent trade disputes involving the U.S., there has been a more rapid movement to the negotiating table. Why have China/U.S. economic relations not taken the same path as yet? The fact is that the issues between the U.S. and Mexico; the U.S. and South Korea, and the U.S. and Europe are quite different than that of the U.S. and China. In the former, small revisions in trading arrangements, revisions that reflect changes in the world economy over the past few years, have been acceptable to both sides. As explained in our annual essay1, the issues between China and the U.S. are about fundamental domestic economic policy and about relative economic power.
In recent days, the U.S. requested a return to the negotiating table. This is encouraging news in that it follows a pattern similar to the negotiations between Mexico and the United States. Those began with strong rhetoric, met with internal opposition, and ended with the outlines of a yet to be ratified, modified agreement. The reports from Washington on the dispute with China indicate there are two camps with the hardliner camp less influential at the moment. Similar reports of controversy over strategy are coming out of Beijing. Thus, the assumption we at The UCLA Anderson Forecast have been making with respect to U.S. trade for our forecast exercise, that no major changes will take place, may well prove prescient. In this regard it is instructive to briefly review the recent outcome of those U.S./Mexico talks.
On August 27, the U.S. and Mexico reached an agreement to modernize the 24-year-old NAFTA. According to Office of the United States Trade Representative2, the agreement provides more comprehensive enforcement provisions on intellectual property, stronger standards on trade secrets, and new protections for innovators. The agreement also modernizes some of the digital products trading arrangements, products that were not contemplated in the 1980’s and 90’s when NAFTA was originally negotiated. This agreement has mutual benefits for both countries and does not disrupt the most important aspect of U.S./Mexico trade, that of automobiles and auto parts.
Can a similar kind of agreement be reached between the U.S. and China? The sticking points thus far have been the insistence by the U.S. that China change its fundamental economic policy on the one hand and the insistence by China that the U.S. cease spending more than it earns if it wants lower trade deficits on the other. Since neither are likely to happen, domestic pressures in the two countries could well make them fade away as in the U.S./Mexico negotiations with that check that Mexico will never write for a border wall.