Sunday, September 30, 2018

Who will win the Sino-US trade battle?

By CEIBS Professor of Economics & Finance Xu Bin

“Who will be the winner in the ongoing trade battle between the US and China? To get an estimate of how both countries’ economic growth would be affected, one must consider both the direct effect of the trade war and all the potential adjustments in government policy and company strategy. This is not a simple matter. Without a comprehensive analysis, any estimates from ‘experts’ are likely to be off the mark. In the short run, a trade war will likely lead to lower economic growth. But how it affects economic growth beyond the short run depends on many factors.

For example, some have suggested that the ongoing trade conflict and tariffs from the United States will likely encourage Chinese companies to move up the value chain and improve their goods. But this is only a hypothesis. Without research, no one knows if the hypothesis will be accepted or rejected, and, if accepted, the extent of the impact it will have on specific industries. Based on my understanding of economics and the Chinese economy, I would say that Chinese private companies are very responsive to changing environments. Even without the US tariffs, China’s fast transition towards an upper-middle income country has pushed Chinese private companies to move away from production of low-end goods to the production of middle/high-end goods. This is also evident from the fact that Chinese private companies have been eager to acquire middle/high-end companies, especially in Europe. I think US tariffs would have the same effect. Indeed, it is not about US tariffs per se. It is more about the transition of the Chinese economy. US tariffs simply add an additional force to push Chinese private companies to upgrade their production structure.

In terms of the role the government will play in this transition, I believe it will be less than that imagined by many beyond China’s borders. The outside world overestimates the power of the Chinese government in generating new/improved goods and services. As far as I can tell, the upgrading of China’s production structure is mainly a result of Chinese private companies responding to the new business environment in China. China is no longer a cheap place to produce low-end goods. A large number of Chinese consumers no longer want low-price low-quality goods and services. China’s gigantic companies like Alibaba and Tencent all emerged from the market, not from any government project. 

Chinese companies will be successful in producing goods and services that utilize the country’s “3S” advantage: Scale, Scope, and Speed. In traditional manufacturing sectors, Chinese companies will have an advantage in industries that require large production scale and/or complex supply chain (i.e. wide production scope). In the Internet-based new economy, Chinese companies will have an advantage in speed-sensitive sectors which require repeated trial and big data. In the coming years, China will export more goods and services of this nature, and they are likely different from those exported by advanced countries. For example, China will produce and export electronic automobiles, and artificial intelligence goods. Advanced countries will maintain their advantage in high-quality goods, brand goods, luxury goods, etc., which requires little scale and scope, not to mention speed. German and Japanese companies will polish their goods to perfection and sell these goods to high-end consumers. Chinese companies will produce quick versions and sell at lower price to middle-range consumers. And Vietnam and the like will produce labor-intensive goods (e.g. shoes) for low-income price-sensitive consumers. 

Who will win?

I would call the current situation ‘trade conflicts’ rather than a trade war because China and the US are still engaging in exporting and importing activities despite the tariff exchanges. Admittedly the amount of extra tariffs exchanged by the two countries is on a large scale. But one cannot gauge the effects of such tariffs by assuming that the parties involved will not change their behavior. For example, Chinese exporting firms may adjust the price of their exports, the Chinese government may adjust the exchange rate and export tax rebate rate, and there may be an adjustment of export destination, etc. Given the fact that both China and the US have large domestic markets, it would be a mistake to overestimate the negative impact of the tariff exchanges on their economies.

It is generally true that no country wins in a trade war, but this refers to a permanent trade war. One may argue however that a temporary trade war may result in long-term gains. For example, the US has the strongest position in the global economy. It is possible for the US to use its strong position to push for more long-term gains for itself despite the short-term loss from trade protectionism. On the China side, it is possible that the increased difficulty to export to the US may force Chinese companies to more strenuously explore both the domestic and the non-US market. Better yet, it may force Chinese companies to improve the quality of their products and upgrade their export structure. Thus a temporary trade war may benefit both the US and China in the long run.

Of course this is only one possibility.

It is also possible that the tariff exchanges between the two countries escalates to a full-fledged and long-lasting trade war. In this case, both countries will lose, and given the relative strength of the two economies China will probably lose more.

Questions have been raised about whether China will use its currency as a weapon in this skirmish. RMB may depreciate against USD by a small percentage (say 5%) when the US dollar index is rising (i.e. appreciating against all other currencies combined), but I don’t think the Chinese central bank will use RMB depreciation as the main tool to offset the effect of US tariffs. In my view, the probability is zero for China to use US Treasury bonds as a tool against the US, which is like the Japanese attacking Pearl Harbor in the Second World War. If China sold US Treasury Bills on a large scale, American people and American allies would buy the bills China sells, and the only result would be China selling these bills at a cheap price and losing all its hard-earned reserves. Allow me to be rude: I think only stupid ‘experts’ would propose this course of action but the Chinese government is much more clever than these ‘experts’.”

Professor Xu Bin is Wu Jinglian Chair in Economics & Associate Dean (Research) at CEIBS. His current research focuses on the global and Chinese economy, multinational enterprises in China, and trade and finance issues of emerging markets. This article was compiled from his replies to interviews with CNN and the Spanish Daily ABC on September 27.

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