Tit-for-tat-for-tit-for-tat

The US is moving quickly to follow through on Trump’s threats to further escalate his trade war with China (now is as good a time as any to say that the trade war has officially started).

Last week the US imposed tariffs on US$34 billion worth of Chinese imports, with another US$16 billion to be hit shortly, and China is responding in kind. Now the administration has released a list of a further US$200 billion worth of Chinese goods that it proposes to hit with higher tariffs, as part of Trump’s threat to double-down in response to Chinese retaliation.

If Beijing continues to fight back, Trump has indicated he is willing to cover all Chinese imports, worth roughly US$500 billion in additional tariffs.

Trump’s escalations would quickly turn a needless but miniscule negative shock into a much more significant macroeconomic one. His actions provide an unfortunately vivid example of precisely why tit-for-tat protectionism is such a dangerous route to go down (although Trump is on the verge of escalating things far more rapidly than most probably imagined).

The initial set of tariffs on US$50 billion worth of goods in both directions will do unnecessary but very little damage in the scheme of things. The gross value of those exports equates to only 0.4% of China’s GDP and about 0.25% of America’s respectively. If things stopped there, the overall macroeconomic effects would perhaps be perceptible but ultimately of not much significance.

The effect of tariffs on US$500 billion worth of Chinese imports will obviously be much bigger. How big is difficult to say.

For one, Trump hasn’t specified the tariff increase. If we assume it would be the 10% he is proposing for the next US$200 billion, together with 25% on the initial US$50 billion, that would make the weighted average tariff increase about 11.5%. Sizeable, but much less than the 45% across-the-board tariffs he originally threatened on the campaign trail.

Much harder to gauge is how China would retaliate. US exports to China only amount to about US$130 billion, so China won’t be able to mirror Trump even on his next US$200 billion batch. But they have other options to make up the difference, including simply applying a higher tariff rate and aggressively deploying regulatory levers to arbitrarily harass US firms exporting to China (for example, delaying customs approvals) or those operating in China (for example, increased audits and inspections).

Devaluing the renminbi is a theoretical option, but would be far too risky given the danger of prompting renewed capital outflows (although the RMB would indeed need to weaken on the fundamentals).

In the short-term, the costs will be magnified by the disruption to global supply chains, the incredible uncertainty being generated, and the fear that things will only get worse. Firms would significantly delay or even curtail important investment decisions, as are already starting to do so.

Overall, the impact would be a significant negative shock for both economies (with flow-on effects for the global economy). Though not likely to be recession-inducing, the costs would be large, needless, and could easily escalate further, including with mounting risks of a more globalised trade war.

There is still some scope to make a deal before all this comes to pass (perhaps a face-saving or time-buying deal). But the space to manoeuvre is rapidly shrinking.

As my colleague John Edwards has pointed out (US–China trade: joke’s over), it is not clear what the Trump administration wants that China would realistically give. China might be willing to sweeten the deal it offered earlier, by agreeing to further increase the forced purchase of US goods, and maybe by moving faster on certain liberalising measures.

But Trump’s maximum pressure tactics look more likely to prove highly counterproductive. Xi Jinping presents himself as a strong leader and cannot be seen to be giving in to such blatant foreign bullying (especially given China’s historical sensitivities).

Nor will China budge on core US demands to dismantle its industrial policies. In fact, there is instead real concern Trump’s bullying tactics are only strengthening the hand of those in China who want greater national self-reliance and believe in a more statist approach – to the detriment of those pro-market reformers the US should instead be trying to bolster.

Roland Rajah