Trump continues to boast that his that his trade war with China is a one-sided winner for the U.S., a campaign that’s inflicting such unbearable pain on our opponent, and minimal damage at home, that China will inevitably cave. But a close look at the costs shows that it’s China—not the U.S.—that’s proving the master in the art of the trade war. Beijing is deploying a strategy of shrewdly calibrated counter-moves on the tariff front that’s minimizing damage to its economy, while the U.S. is using a scorched earth, tax-everything-bigly approach that’s forcing our manufacturers, and consumers, to pay tens of billions of dollars more for imported products and parts.
The latest economic data suggests that the trade conflict is hitting America hard. The ISM Purchasing Managers Index (PMI) released on October 2, recorded the lowest levels of activity in manufacturing since the great recession; the worst signal of all was the sharp drop in exports. The following day, the PMI for services posted the slowest reading in three years, and confirmed suspicions that the trade-driven malaise in manufacturing is slowing sectors from packaging to consulting.
While the U.S. is clearly suffering from the proliferation of tariffs, contrary to Trump’s claims, is it possible that the China’s suffering even more? For each nation, two numbers establish how much the trade war is slowing current and future GDP. The first is the drop in U.S. exports to China, or Chinese exports to the U.S. The second, overriding factor is the extra cost each nation is paying to source more expensive goods from third countries that they used to buy at better prices from each other, an efficiency-killer known to economists as “deadweight costs.”
Who’s feeling the most pain, China or the U.S.?
In 2018, China sent $540 billion in semiconductors, auto parts, steel, sneakers, laptops and sundry other products and components to the U.S. In 2018, the U.S. imposed 10% tariffs on $250 billion Chinese-made goods through early May, then raised the duty to 25%. Trump in August of this year announced new 10% tariffs on an additional $300 billion in consumer goods (some products were later temporarily exempted), with plans to bring the duty to 25% if the two sides fail to reach a deal. Hence, virtually all goods from China are now subject to tariffs.
For the first seven months of 2019, a period when about half of Chinese goods were subject to tariffs, Chinese imports to the U.S. dropped roughly 10%, or $27 billion on an annualized basis. Two factors will substantially raise that yearly hit in the future, assuming no trade deal. First, tariffs now apply, or will soon apply, not to half, but to virtually all $500 billion-plus in Chinese imports. Second, the 25% duties already in place or promised will be much higher in 2019 than the prevailing tariffs in the first seven months of this year.
So let’s forecast that rising tariffs, on double the imports, causes a huge, 20% drop in the value of goods China sells to the U.S. That’s a drop of $110 billion, a worst-worst case scenario. But that $110 billion doesn’t represent the actual loss to China’s GDP, a point made by Nicholas Lardy, an an economist at the Peterson Institute for International Economics (PIIE). The reason Lardy cites: When China sells mobile phones or appliances to the U.S., a big portion of the parts in those and most other products are made in Vietnam, Malaysia, Japan, or other countries that feed China’s factories. The value of the components that Chinese plants contribute to the finished goods, plus value of the labor and machinery use in final assembly, account for only half the sales price of the goods shipped to America. So in our forecast, China’s lost production, the decrease in the portion of the products it actually makes, amounts to fifty percent of the $110 billion total, or $55 billion. That’s the hit to its GDP.
China’s GDP of $14 trillion is currently growing at roughly 6.2%, adjusted for inflation. Let’s assume that continues, meaning that its economy will produce an additional $865 billion in goods and services in 2019, including the $55 billion hit from loss of the exports actually made and assembled in China as opposed to supplier-countries. If China hadn’t lost that $55 billion in exports, its national income would grow at $920 billion ($865 + $55 billion), at 6.6%, or .4% faster. The penalty could well be lower, because it’s probable, according to Lardy, that China is finding markets in third countries for the products it’s no longer selling to the U.S.
But for now, let’s take the conservative approach, and use a high number.
Projected cost to China of falling exports to the U.S.: .4% of GDP.
How about the U.S.? Last year, we sold about one-fifth as much to China, some $120 billion, as Beijing shipped stateside. In the first seven months of this year, China’s retaliatory tariffs cut our exports, versus the same period in 2018, by 18%. Assuming that trend is durable, U.S. shipments to China will shrink by $22 billion on an annual basis. The U.S. value-added in exports is much higher than for China, around 90%. So the net hit is closer to $20 billion. In 2020, the CBO predicts that the U.S. national income will expand at 2.0%, or add around $390 billion. That means if the U.S. had held exports to China flat, our economy would grow (from this factor alone), .1 point faster. So mainly because we sell so much less to China than they sell to us, the drop in our exports would only subtract .1% from national income.
Projected cost to the U.S. of falling exports to China: .1% of GDP.
For the U.S., the killer is the deadweight cost
China is following an explicit strategy of imposing heavy duties only on U.S. goods that it can’t readily purchase, at about the same cost, from Vietnam, Japan, Canada or another third country. As economists Chad Bown, Euijin Jung, and Eva Zhang of PIIE state in a recent report (“Trump Has Gotten China to Lower Its Tariffs. Just Toward Everyone Else“), “China has been rolling out the red carpet to rest of the world. Everyone else is enjoying much improved access to China’s 1.4 billion consumers.”
At the start of 2018, China imposed average tariffs of 8% across imports from all countries. The U.S. paid the same duties, and competed on an equal footing, with the other foreign enterprises selling to China. But in retaliation to U.S. tariffs on its exports, China between April of 2018 and June of 2019 more than doubled the average duties on U.S. products to 20.7%. It did with a scalpel, not a bludgeon. China imposed no new duties at all on around half of the goods, measured by value, that it imported from the U.S. The products it spared were the ones that weren’t available from non-U.S. suppliers, or would cost far more if purchased from third countries. China lowered its duties on U.S. autos and parts by eight points to 12.6%, held tariffs below 3% for aircraft and pharmaceuticals, and raised them on only half its imports of U.S. petroleum products.
In comparison, China hammered U.S. goods that it could easily purchase from third countries, especially commodities selling on global markets, slapping 28% tariffs on soybeans, 22.3% on wood, paper and metal products, and 19.3% on chemicals. In each case, those duties more than doubled. Meanwhile, China lowered average tariffs to all other countries from 8% to 6.7%. For example, it’s now buying soybeans from Brazil and Argentina at a 3% duty, and Pacific salmon from Japan at 18.9%, cutting purchases from the U.S fisheries on the West Coast that now pay a 42.4% tariff.
The gambit is designed to limit damage to the Chinese economy. “Unlike Trump, the Chinese recognize that tariffs are a tax [on consumers and producers],” notes Lardy. The gap between the higher prices U.S. producers are forced to charge versus rivals from France or Japan put stateside exporters at a big competitive disadvantage, both against other foreign suppliers, and domestic Chinese producers.
According to the PIIE economists, China is not paying significantly more for the soybeans, chemicals and other products that it used to buy from America, and now sources from Argentina or Canada. Even if the third party prices are slightly higher, they’re offset by the reduction in tariffs on all non-U.S. suppliers. As a result, say the PIIE economists, China is shouldering virtually no deadweight costs at all. It’s remarkable that U.S. tariffs have driven China to the market-driven, trade-enhancing reform shift of lowering barriers to the rest of the world.
Projected deadweight cost to China: zero.
The U.S., on the other hand, has either imposed, or plans to impose, average tariffs 25% or more on all Chinese imports. When American families or importers pay higher prices for sneakers, circuit boards, or farm machinery, the Treasury recoups an equivalent amount in tax revenue via the tariffs. That money is available, for example, to be rebated to farmers, who received $12 billion extra subsidies in 2018 to compensate for the hit to trade. So the tax receipts blunt the blow from higher prices, leaving economic growth about the same. But as tariffs on Chinese finished goods and components have grown, U.S. importers increasingly source the same products and parts from Vietnam, Singapore and EU nations, at higher costs. At a 25% tariff on Chinese clothing, it’s worth it to pay an extra 10% to 15% for the same shirts and jeans from Malaysia.
But on those higher-cost imports, the U.S. gets no extra tariff revenue to balance the higher prices. When companies and consumers pay more for essentially the same goods, the economy incurs a deadweight cost that directly hits GDP growth dollar for dollar, equal to the difference. It’s that simple.
In 2018, when the U.S. imposed tariffs on around half of all Chinese imports, the annual deadweight cost per American household stood at $640, according to a study by economists Mary Amiti of the New York Fed, Stephen Redding of Princeton, and David Weinstein of Columbia (“New Chinese Tariff Increase Costs to U.S. Households”). That’s a total of $80 billion. But today, almost all Chinese imports are covered by tariffs.
So what’s a good estimate of the total deadweight costs looking forward? As the three PIIE economists point out, “Deadweight losses tend to rise more than proportionately as tariffs rise because importers are induced to shift to ever more expensive sources of supply as the tariffs rise.” A fair estimate is that doubling the goods subject to tariffs, and continuing to increase the rates, will also double the deadweight costs to the U.S. economy. So we can project that for 2020, the hit will rise to around $160 billion. Right now, the CBO forecasts that real GDP will expand by the $390 billion we just cited. That implies that if the U.S. had never imposed tariffs, national income would have waxed by $160 billion more, or $550 billion. In that scenario, GDP would rise .9 points faster, from nixing deadweight costs alone, than the forecast 2.0%.
Projected deadweight cost to the U.S.: .9 points.
A scorecard for the trade war
The damage to China from loss of exports to the U.S. is .4, and zip for deadweight costs, for a total of .4%. For the U.S., the tally is .1% from lost exports to China, and .9 points from overpaying for third-country imports, for a total of 1.0%. China wins in a two-and-a-half-to-one walk away. It’s like winning the Super Bowl 40 to 16. Losing .4% of your growth when you’re expanding at over 6% is a lot easier to bear than losing 1.0% when you’re growing at 2.0%, the predicament for America. A French CEO, who loved business history, once told me, “England had the industrial revolution. The French just talked. They had the verbal revolution.”
Trump is claiming a rhetorical triumph, while China wages a rout.
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