US and China: On the brink of a trade war

When one country initiates action intended to hurt another, and the other country responds to inflict a similar hurt, then a trade war happens. Such is the nature of the relationship between the United States and China as of yesterday.

China’s immediate response. Some two weeks after the US raised tariffs by 25 percent on steel and 10 percent on aluminium imports, and subsequently exempted six large countries from the imposts, it became clear the tariffs were directed at China.

In response, China singled out 128 goods from the US comprising $3 billion of imports. Specifically, China imposed 15 percent tariffs on 120 products that include fruits, nuts, and such products as steel pipes, and 25 percent tariffs on eight products such as pork and recycled aluminium.

Thus, China’s response affects a wide range of industries and products, that are produced across the United States. It hits targeted agricultural sectors and also industrial products including steel products.

The nature of the response of China is actually quite small compared to the immensity of its actual trade relations with the United States. In 2017 (according to the US census and statistics), China exported a total $505 billion of goods to the US compared to the US exports to China of $130 billion. (This, of course, shows an actual direct trade deficit of $375 billion with China!)

By showing defiance and a willingness to take measure for measure, China’s response to American trade actions against it indicates the start of a trade war.

Simply, the two countries are on the brink of a serious trade war that could escalate.

With the Trump government planning additional measures aimed at $50 billion worth of Chinese exports, the US is contemplating further action to compensate for its claim of theft of intellectual property of American companies from Chinese trade practices.

If and when such measures are ever to take their course and no country gives in to effect a compromise or a settlement, a full scale trade war would be inevitable.

The consequences of such a war on the world economy, on other major trading nations and on small countries simply dependent on trade could be mainly disastrous for all.

Most economies will be price-takers. Those other economies that are harmed or likely to be harmed could take measures to protect their own interests.

Country exemptions against the steel tariffs. When the Trump administration announced the imposition of the steel tariffs, a howl of protests and threats to retaliate by major exporters of that product to the US were made.

This led to the exemption of Canada and Mexico when the executive order on tariffs was signed. Later, the Trump government acceded to the exemption of four other countries – the European Union (a group of many countries), Brazil, Argentina and South Korea.

As the US Trade Representative explained to the US Senate Finance Committee, they were granted exemptions “based on a certain set of criteria” related to the steel tariffs that they were negotiating with the United States.

Such acts of exemption has silenced momentarily the countries that had threatened to retaliate, most of which are the substantial exporters of steel to the US.

In particular, the European Union’s argument that they were America’s allies had perhaps resonated with the Trump claim that the protection of the steel industry was a national security issue.

As these outcomes might indicate, a trade war could be multilateralized to involve more countries looking after their own interests. Yet, it is possible they could also become a polarizing medium for making a two-power economic rivalry turn into a trade war between the polar two rivals, with others potentially aligned to one or the other.

Big powers and international trade disputes. All these measures and counter-measures are taking place outside the rules of dispute settlements under the World Trade Organization (WTO). For the most part in the past, the big powers have used the WTO dispute mechanism to settle their disagreements.

Trump’s election in the United States changed the picture immensely, with this announced protectionist actions. Tariffs imposed by countries are supposed to be non-discriminatory and not directed against specific countries. When big powers ignore the rules that they have negotiated with all other countries to settle amicably trade issues that arise among themselves, they weaken the institutions that they have created.

Bad examples by the big and powerful countries create for world disarray and lack of respect of the same rules, and smaller countries could themselves be goaded into similar acts.

The head of the WTO, Roberto Azevedo, urged countries to use WTO’s trade dispute mechanisms. He recently said: “Actions taken outside these collective processes greatly increase the risk of escalation in a confrontation that will have no winners, and which could quickly lead to a less stable trading system.”

Yet, big powers want to settle their problems bilaterally or through their own might when it suits them. In taking action against China, the Trump administration hopes to achieve a grand trade bargain with that country.

Whether it succeeds or not depends on the willingness of China to deal with the US. Is China hurting enough to want to accept certain demands or is it willing to compromise? China’s economy has now grown big enough that it has achieved leverage to deal with US trade issues on the basis of strength.

For instance, China’s limited response so far has been to inflict calculated hurt against certain segments of the American economy that could influence political developments. It was not by accident that the 128 products targeted particular agricultural states with important voice in national elections that could hurt the constituencies of President Trump.

This could escalate. The size of China’s economy has gotten large and significant in terms of market power. For instance, it could shift its purchases simply by changing suppliers. Imagine sorghum and soybean and other agricultural produce sources being shifted to competitors like Brazil or other countries.

If the stakes are raised, it could hurt major American companies. For example, the aircraft industries could be threatened simply by realigning the fleeting of Chinese airlines from Boeing to Airbus (a European company). There are other measures beyond the use of trade instruments that could be relied upon, because of China’s economic scale.

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