espite numerous warnings against the possible damage to the world economy, the US has imposed additional tariffs on its major trading partners, particularly China, and is preparing even more ammunition. In past China-US trade frictions, attention was focused on the US demand for appreciation of the Chinese currency. This time, possible disturbances to the global supply chain caused by the US’s actions have attracted more concern.
Professor Yu Miaojie, vice dean of the National School of Development of Peking University, talks about how the China-US trade conflict will affect stakeholders in the global supply chain. He stresses that a proper response from China will largely mitigate the negative impact on its economy.
NewsChina: Why has the trade friction between China and the US caused major concern over the knock-on effects to the global supply chain?
Yu Miaojie: It’s because it does have a big impact on the global supply chain. Of China’s annual exports, with an average annual value of around US$2 trillion in recent years, at least one-third comes from the processing industry – about US$600-700 billion annually. The share of the processing trade contributed more than half of China’s annual exports between 2000 and 2007. It is a business model in which China imports raw materials from the 10 countries of the Association of Southeast Asian Nations (ASEAN) and key parts and components from Japan and South Korea. These are processed on China’s assembly lines and then sold to the European Union and the US, the largest markets for Chinese exports. Electronic and mechanical products and textiles are the two main exports to the US, worth about US$170 billion and US$42 billion in 2016. The 10 or 25 percent in additional tariffs on more than US$200 billion worth of Chinese products, if the US decides to impose them next month, will definitely cover these two sectors. However, neither sector reached 10 or 25 percent profitability. These products will be shut out of the US market. Chinese producers will have to suspend some of their assembly lines. As a result, China will have to reduce imports of raw materials from ASEAN countries, as well as parts and components from Japan, South Korea and even the US. This is how the global supply chain will be affected as a result of the US tariff actions against China.
China’s Ministry of Commerce said about 59 percent of the US$34 billion Chinese products subject to the US tariffs are actually made by foreign-invested enterprises in China. Indeed, about 66 percent of Chinese exports were made by them in 2007 when China’s foreign trade growth peaked. Most foreign-invested enterprises in China were engaged in processing trade at that time.
This is also why the Trump administration declared on July 7, the day after its 25 percent additional tariffs on the US$34 billion worth of Chinese products took effect, that imports from China which contain US exports to China can apply for exemptions from the additional tariffs. The typical example is Apple’s iPhone, with all core components coming from the US. High tariffs on the iPhone will hit US suppliers.
NC: If the global supply chain is susceptible to China-US trade friction, is it true that both China and the US will face much higher costs from substituting their sources of imports and export destinations?
YM: This is true for the US. If a shirt sold in the US costs US$10 from China, US$12 from Vietnam and US$15 from domestic producers, the best choice is certainly to import it from China. But the 25 percent additional tariffs will increase the price of the shirt from China to US$12.5. Then the US has to buy it from Vietnam at higher prices.
By contrast, China is better positioned than the US in preventing fast-rising costs. About 13 to 14 percent of Chinese exports go to the EU or the US annually. If China can expand its market share in the EU, then the supply chain in China would not need much adjustment. However, EU economies remain weaker than the US and are also sensitive to imports from China, so potential gains from the EU market are not very likely to fully make up for China’s losses on the US market.
But China can expand its imports to control the cost rise, which is what China is trying to do now. EU products are the best substitute for US ones. So the EU should be the main source of China’s increase in imports in the future.
NC: China has developed the world’s largest industrial supply chain with more sub-sectors than any other economy. Does this supply chain in China also serve the global supply chain?
YM: A popular book called A Year Without “Made in China” in 2007 [by Sara Bongiorni] shows how US consumers face either higher prices or even no substitutes without Chinese-made goods. The manufacturing sector in China has two main features which explain why it has risen to become the factory of the world. One is size. Manufacturing still accounts for 40 percent of China’s GDP, higher than any other of the top 10 economies. It is below 20 percent in a developed country normally. The second is concentration. Producers in a certain sub-sector prefer to gather in the same city or region to cooperate on controlling costs and risks for market expansion domestically and overseas.
However, the world factory that China has built remains in the mid-to-low end of the global value chain in terms of value added. This is also a well-known fact.
NC: Have you done any research on which economies in the world would be affected by the China-US trade friction and how?
YM: My colleagues and I have looked into the impact on China and the US in particular, and we published our findings in Asian Economic Papers [The Day after tomorrow: evaluating the burden of Trump’s trade war, volume 17, issue 1, 2018], a journal published by the
Massachusetts Institute of Technology. We tested whether an economy would benefit, stay intact or be damaged by the following three scenarios in the case of trade friction started by the US.
First, China does not retaliate. Second, China retaliates with equal strength and scale against US products. Third, besides retaliating with equal strength and scale against US products, China further opens its own markets at the same time. Any of these three scenarios will damage the US – to the tune of about 0.7 percent of its GDP. In our modeling, we included 61 economies and regarded all the others as one economy. The US ranks at 59 or 60 among the 62, meaning it would be the hardest-hit single economy. The 0.7 percent looks tiny. But given the size of the US economy, which is US$18.5 trillion, the absolute value reaches nearly US$130 billion – [that’s] huge damage. The US will not feel much pinch from price hikes due to the tariffs on the US$34 billion worth of Chinese products, but it will if its tariff action extends to another US$200 billion of Chinese products.
The US will also restrict Chinese investment in the US. We think this will cost the US about 260,000 potential jobs.
For China, again the impact of the trade friction depends on how the country responds. China has already taken retaliatory measures, so the first scenario is not possible. Then it’s a question of whether China should expand its opening-up while retaliating with equal strength and scale. If not, China would perform worst of the economies in our test, even worse than the US. If China increases imports from the EU, Japan and South Korea, which can largely
substitute for US products, then trade friction with the US will have a very limited impact on market prices in China. People in China’s export businesses would suffer from income cuts as their companies are hit. But the loss would be about 0.1 percent of China’s GDP, much better than the 0.7 percent of GDP lost by the US, as long as the falls in income are milder than the rise in prices in China. Our research also shows that some small economies, including Singapore and Switzerland, could benefit from the trade friction. Some Chinese products will have to be transferred via these places to other destinations to avoid US tariffs. This is an opportunity to provide services for such trade, including port services and trade financing.
NC: Will the China-US trade friction result in a decline in global direct investment, given the impacts on the global supply chain you mentioned?
YM: Generally it will. But some places may even attract more investment. Take China for example – China’s outbound direct investment (ODI) accounts for 9.9 percent of the world’s total, second only to the US. I have no doubt that the US will restrict Chinese investment. The trade friction between the US and Japan ended up with Japan yielding to US pressure by limiting Japanese car exports to the US. However, Japanese auto makers, including Toyota and Honda, built plants in the US to circumvent export restrictions. The US is just too familiar with this lesson to let it happen again with China. So China’s investment in the US, whether green-field or mergers and acquisitions, will drop drastically due to the US’s imminent restrictions.
Meanwhile, China may invest more in other places, including the EU, Africa and ASEAN. I predict that Africa, in particular, will see a rapid rise in Chinese investment. China already has a big presence in Africa. China does not have much competitive advantage in terms of labor costs compared with places with rich human resources in labor intensive sectors, so there are several benefits if Chinese enterprises build facilities in Africa. First, Africa is closer than China to Europe and the US, the main destinations for Chinese exports. Second, there are a lot of free trade arrangements between Africa and the EU or the US, with even zero tariffs on many products made in Africa. By the same token, ASEAN countries may also see a rise in Chinese investment, though not as fast as Africa. The EU is much friendlier than the US to Chinese investors. If the US closes its doors, then more Chinese investment may go to the EU than otherwise.
It is hard to say whether China’s ODI will rise or fall, as it depends on whether the EU can fully make up for the gap left by the US. I think this is not very likely. China’s ODI will probably go down in the short term, despite an increase in the EU, Africa and ASEAN.