Zhiwei Zhang on How China Could Respond to US Tariffs

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Zhiwei Zhang on How China Could Respond to US Tariffs

What starts bitter ends sweet?

Zhiwei Zhang on How China Could Respond to US Tariffs
Credit: Deutsche Bank

American protectionist rhetoric is turning into action this year, with President Donald Trump having announced the intention to impose sweeping tariffs on Chinese imports. It marks the United States’ most confrontational stance toward China since its entry into the WTO and signals both nations need to come to new terms on trade.

‘‘The current dynamics between the two countries make it difficult to sit down and negotiate,’’ says Zhiwei Zhang, chief China economist at Deutsche Bank. In this interview, he shares insight into the fundamentals behind the trade relation and the scenarios that are likely to unfold.

Maurits Elen: Is there a clear strategy behind tariffs on China?

Zhiwei Zhang: The Section 301 investigation by the United States Trade Representative found that China’s intellectual property practices caused $50 billion of harm per year to the U.S. economy. To compensate for this damage, the U.S. intends to impose a 25 percent tariff on certain imports from China, including airplanes, computers, cell phones, and various electronic products and parts. The U.S. will also file a WTO dispute against China’s technology licensing practices, and restrict China’s investment in technology sectors in the States.

It may well be that the saber rattling over tariffs is designed to move negotiations along at a faster pace with results more to the American advantage. But there is also increasing risk of miscalculation and retaliation, resulting in real damage to macroeconomic activity.

Do American and Chinese firms enjoy equal market access?

From an ownership perspective, the business imbalance, including both trade and business investments, between China and the U.S. was large. But it has already corrected in the past 10 years, with U.S. and Chinese firms now benefiting equally from each other’s market.

Some simple examples. General Motors sold more cars in China than in the U.S. last year. There are 310 million active iPhones in China, more than double the number in the States. These cars and phones did not show up as U.S. exports to China, as they were made and sold in China. The U.S. business interests in China are much larger than what the trade data shows. The looming trade war puts these interests at risk.

Is China better off appeasing the U.S. or retaliating?

China and the U.S. are certainly better off without a trade war. But the current dynamics between the two countries make it difficult to sit down and negotiate. The two sides should both refrain from taking further actions to force the others to give in, as this could heighten risk of policy mistakes. We believe China is willing to negotiate and make its market more open.

If the trade war escalates, what options does China have?

As a baseline case, we continue to expect China will demonstrate restraint against aggressive retaliation against higher U.S. tariffs. The trade war will likely not escalate to a full-blown one. The retaliation from China would include putting higher tariffs on selected U.S. exports to China. China would likely be targeting imported products that would have significant impact on the U.S., and that China could afford to import less from the U.S. There could be some warning shots on the U.S. business interests in China. Also a possible [option] is to delay the process to open up the service sector, or provide preferential access to countries other than the States.

If the trade war escalates and the U.S. imposes further tariffs on other products, and the macroeconomic impact becomes more visible, China could have options to impose higher tariffs on all U.S. exports to China, restrict market access for U.S. firms in China, provide preferential treatment to U.S. competitors, and restrict U.S. travel by Chinese nationals.

Selling U.S. treasuries and buying other government bonds could also be an option. But reserve rebalancing away from U.S. treasuries would have a global implication given the role of U.S. interest rates in the global financial markets. A disruptive rise of U.S. interest rates would be damaging for China’s economy as well. In this regard, we think it is less likely than the other options.

Other than trade, how to measure economic exposure?

When discussing U.S.-China business interest, it is misleading to only look at trade imbalances. We think “aggregate sales balance,” which includes both trade and sales generated locally, can show a more comprehensive picture.

We estimate the size of U.S. business interests in China, using data from the U.S. Bureau of Economic Analysis (BEA). The total sales of U.S. firms in China was $372 billion in 2015, including $223 billion by their subsidiaries in China and $150 billion through exports from the U.S. to China. The same set of data from the U.S. shows the Chinese firms sold $402 billion of goods and services to the US in 2015, $10 billion through Chinese subsidiaries in the States and $393 billion through exports.

This suggests a net balance of -$30 billion from the U.S. perspective in 2015. We define it as the ‘‘aggregate sales balance,’’ which includes both trade balance (-$243 billion) and sales generated through subsidiaries’ FDI operations in destination countries ($213 billion).

Interestingly, both the trade balance and the aggregate sales balance widened before 2009, but their trend diverged since then. The trade balance continued to rise while the aggregate sales balance declined from -$110 billion in 2008 to -$30 billion in 2015. This was driven by the surge of sales by U.S. subsidiaries in China: BEA data shows that China accounted for one-third of the incremental sales by U.S. subsidiaries globally between 2010 and 2015. Firm level data shows the sales of U.S. firms in China continue to outpace their global sales in 2016 and 2017.

This interview has been edited for clarity.