Newly imposed American tariffs on Chinese goods have been followed by retaliatory action from China. Why are the two biggest economies engaged in a tariff war, and how far can it disrupt world trade?

After having threatened higher import tariffs on each other’s goods for months, the US and China last week fired the opening salvos of what could turn into a full-fledged trade war between the world’s two biggest economies. The moves, apart from the immediate bilateral impact, could disrupt world trade in the coming months as two-thirds of goods traded are linked to global value chains.

Punitive tariffs

Tariffs, or customs duties, are border taxes charged on foreign imports by a country. On Friday, the US government slapped sweeping tariffs on imported Chinese goods worth $34 billion, including aircraft parts, flat-screen televisions, and medical devices. All these will now face a high 25% levy when imported into the US. China responded with retaliatory tariffs of 25% on US goods worth an equivalent $34 billion, including soybean, automobiles, and marine products such as lobsters.

Last year, China had imported $130 billion in US goods, while the US bought goods worth $506 billion from China, according to US government data. So, the goods trade is weighed in favour of China.

From the Donald Trump administration’s point of view, the tariffs are aimed at penalising China for arm-twisting foreign businesses to hand over technology to Chinese firms in lieu of access to the Chinese market. On the other hand, besides slapping retaliatory tariffs on US goods, the Chinese could leverage an anti-American sentiment among consumers to boycott US goods. In 2012, Chinese nationalists boycotted Japanese cars and stores because of a territorial dispute, badly denting sales of Japanese goods.

Collateral impact

The latest set of tariffs is just the beginning. The US is expected to impose border taxes on Chinese goods worth an additional $16 billion over the next fortnight and Trump has indicated that he is considering imposing levies on Chinese goods worth another $500 billion in the coming months. China is bound to react, leading to further collateral damage.

The US has indicated this action is specifically aimed at protectionist measures by China, especially its “Made in China 2025” programme — an initiative to transform China into an advanced manufacturing powerhouse. Trump has also accused China of subsidising steel exports in a practice termed dumping — selling a product at lower than the cost of production to gain market share — on the rest of the world, which he argues has hit jobs in the US. China’s retaliatory tariffs specifically targets crucial US agricultural exports that come from heartland states that had voted for Trump in the last election.

How long?

Analysts feel the trade war may be shortlived, and impending negotiations will help defuse the tension. There are three possible reasons. First, the federal law that President Trump has used to issue a notice seeking public comments for the imposition of 25% customs duty requires his administration to seek “consultations” with China before imposing the levies.

Second, the Chinese government has indicated earlier that it would appeal to the World Trade Organization’s Dispute Settlement Body. This requires consultations before China presents its case. If the appeal is admitted, trade analysts predict that China could have the upper hand, given the record of plaintiffs almost always ending up on the winning side. The US, however, has so far ignored the WTO.

Third, the retaliatory tariffs by China could potentially spark dissent and pressure from US domestic lobbies. China imports about 60% of the global soybean production, and about 40% of this import is from the US. Midwestern states such as Iowa, a leading producer of soybean, and other agrarian states had voted for Trump in the presidential election. Earlier this year, in response to the Trump administration announcing higher tariff on steel and aluminum imports, the EU had retaliated by targeting American products from key

Republican-run states, including the imposition of higher duties on Harley-Davidson motorcycles made in Speaker Paul Ryan’s home state of Wisconsin, levies on bourbon made in Senate Majority Leader Mitch McConnell’s state of Kentucky, and duties on orange juice that would impact Florida — widely seen as a key swing state.

Impact of tariff wars

Trade experts have traditionally questioned the effectiveness of tariff wars, which they say hamper the basic efficiency of the market and fail to accomplish the desired objectives. A case in point is a set of rules known as the Smoot-Hawley Tariff Act enacted in the US, which is blamed in part for worsening the impact of the Great Depression in the late 1920s.

While the US managed to lower its import dependence immediately after the legislation, the retaliatory measures from other countries led to an over 60% dip in US exports by 1933. The Act was eventually repealed with the enactment of the Reciprocal Trade Agreements Act of 1934.

After the latest series of tariff strikes by the US and China, Morgan Stanley released estimates that world trade could be seriously disrupted as two-thirds of goods traded are linked to global value chains. The Peterson Institute for International Economics projected that almost two-thirds of US imports from China came in from companies with foreign capital and, based on foreign investment flows, the capital is likely to have come mostly


from the US, Japan and South Korea. Singapore-based DBS said the US economy could actually suffer more than China’s, and that South Korea, Malaysia, Taiwan and Singapore are the economies most at risk in Asia based on trade openness and exposure to supply chains involving China.

India impact

In the long term, a full-fledged trade war is bad news. Senior trade officials of India and the US will meet this month in Washington to wrap up negotiations on a “mutually-acceptable trade package”. Last month, an American team held talks with Indian officials here on several contentious issues, including the extra US duty on Indian steel and aluminium, and the next meeting will be a follow-up. Since India, late last month, proposed additional tariff worth $235 million on 29 US goods — including almonds and apples — that were seen as retaliatory in nature, any rollback of the additional duty on Indian steel (25%) and aluminium (10%) by the US could lead to a withdrawal of retaliatory action imposed by New Delhi as well. Otherwise, India’s proposed additional tariffs will take effect from August 4.

India has time and again raised concerns over negative impact of tightening of visa norms by the US on the Indian IT sector. It has also asked America to continue extending duty-free access under the Generalized System of Preferences (GSP) to its products such as chemicals and engineering. India also wants exemption from the hike in import duty on certain steel and aluminium items.

Trump’s pointed attack on duty flow imports from India into the US has specifically targeted the GSP programme. Exports from India to the US under GSP have been consistently on the rise, bucking the broader declining trend in overall exports. Out of the total GSP imports into the US under this programme, India has consistently accounted for a quarter of this (see graph). India’s total exports have been faltering, down from $310.53 billion in FY15 to $262.29 billion in FY16, before recovering marginally to $276.55 billion in FY17.

(Adapted from The Indian Express)