Donald Trump won round one of the trade war. In round two, China has the upper hand

South China Morning Post Dipublikasikan 00.09, 20/09/2019
Donald Trump won round one of the trade war. In round two, China has the upper hand

Since the US-China trade war started in March 2018, the two countries have been slinging tariffs at each other in between the 12 rounds of negotiations. With the next talks scheduled for early October, it is natural to wonder whether one side or the other has won the epic battle's first phase.

President Donald Trump had two primary goals: to cut the US trade deficit with the world, with China in particular, and to force the relocation of supply chains and production out of China to weaken its long-term economic power.

For their part, the Chinese have been mostly playing defence, with their main objective to minimise damage to supply chains that have taken decades to build, while maintaining access to the US market. Because of this difference in aims, it has been in the interest of the US to delay the signing of an agreement, while China showed a strong desire to do an early deal, but to no avail.

Based on the results so far, Trump has largely won Trade War 1.0. There has been substantial relocation of production out of China, damaging its supply chains, though the American trade deficit with the world has continued to grow.

As we enter Trade War 2.0, it is now the Trump administration that is more eager to make a deal; China is no longer in a hurry.

In the first seven months of 2019, US imports from China shrank to US$260.5 billion, a decline of US$36.6 billion, or 12.3 per cent, over the same period in 2018.

With lower imports from China, the US trade deficit with China declined from US$222.9 billion for the seven months of 2018 to US$200 billion over the same period of 2019, a reduction of US$22.9 billion, or 10.3 per cent, much in line with Trump's intentions.

But that conclusion holds only if one looks at the effects on and with China. During the same seven months of 2019, imports to the US from Mexico rose by 6.3 per cent, from Vietnam by 33.3 per cent, from Japan by 4.6 per cent, from South Korea by 9.8 per cent, and from Taiwan by 20.3 per cent.

Without taking other countries into account, the total increase in US imports from these five economies alone is about US$35 billion, almost identical to the import reduction from China over this period.

From 2018 to 2019, total US imports from all countries for the first seven months increased by more than US$6 billion, with the overall US trade deficit rising from US$494.5 billion to US$506 billion. The trade war has made the US trade deficit bigger, not smaller.

Against this metric, Trump's tariff strategy has not worked. However, the real goal behind the trade war was arguably not to reduce the overall US deficit, but to force relocation of production from China to other countries and to weaken the Chinese economy.

Imports to the US are no longer coming from the cheapest sources - in many cases, China - but from the cheapest sources after tariffs are included.

Since the Trump administration has applied tariffs selectively against China, the cross-country composition of US imports has been altered significantly and is continuing to change.

In the textiles sector, for example, there is a growing belief that US trade policy will not be reversed. Michael Casey, chief executive of Carter's, a children's clothing chain, recently stated: "We're … assuming these tariffs will stay in place indefinitely."

The trade data demonstrates that there has been a significant relocation of production out of China and into Vietnam, Mexico, Taiwan, South Korea and Japan.

Even though actual tariffs on Chinese imports were not imposed until July 6, 2018, trade war talks and threats had been going on from the very beginning of the Trump administration, adding much uncertainty to the future trade framework between the US and China.

Confronted by the heightened risks, American and other multinational businesses have had more than two years to decide whether to stay or move.

It bears remembering, too, that the trend to diversify production locations beyond China (referred to as a "China-plus-one" strategy) has been playing out for years, with even Chinese companies shifting some operations, typically to Southeast Asia. The trade war appears to be confirming, if not accelerating, this tendency.

Trade War 1.0 is prompting the relocation of production to a range of other economies. For easy-to-move manufacturing, Vietnam, Thailand and Bangladesh are benefiting. For more advanced products, relocation tends to favour South Korea, Japan and Taiwan, though the process of leaving China may take longer, as finding alternatives is more complicated.

Since much of the disruption to China's supply chains has already been done, as the two sides enter the next phase of their dispute - Trade War 2.0 - their relative negotiating positions have switched: China is not as eager to reach an agreement since it is difficult for any such deal to reverse the damage.

Trump, meanwhile, is now under pressure to get a deal to help his re-election bid, amid early signs of an economic slowdown and complaints from the American business community.

Under these circumstances, we would not expect China to make extraordinary concessions but would anticipate a much watered-down agreement that is light on the structural reforms and compliance monitoring mechanisms Washington had been demanding. Could China emerge as the winner of this second round?

Zhiwu Chen is director of the Asia Global Institute and William and Victor Fung Professor in Economics at the University of Hong Kong. Heribert Dieter is the institute's director of policy research

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