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US-China Trade and Tariffs This Week

Ryan Connelly, May 16, 2019

DuckerFrontier recently launched The Lens, a weekly newsletter published by our Global Economics and Scenarios team to highlight developments and trends that will have the highest impact on business scenarios. Below is an excerpt from this week’s edition highlighting developments in the US-China trade war. 

US-China Trade Relations Overview

As US-China trade tensions heat up, DuckerFrontier brings you the most relevant insights to keep your business ahead of the curve. The US increased the tariff rate on China from 10% to 25% on $200bn of Chinese exports. At the same time, President Donald Trump threatened to impose tariffs on all remaining Chinese exports to the US. The tariff increase was scheduled to take place on January 1st, but President Donald Trump repeatedly delayed the tariff hike. This decision came following a meeting with Chinese President Xi Jinping at the G20 summit on December 1. Trump plans to meet with Xi at the G20 summit in late June.

This week, Trump re-implemented the tariff hike after China back-tracked on commitments made in earlier talks. China made significant changes to each of the seven chapters of the draft trade deal pertaining to legal implementation of forced technology transfers from entering into Chinese law. The motivation for these changes remains open-ended, with two potential scenarios:

  • Chinese leaders overestimated Trump’s desire to reach a deal and underestimated bipartisan support to address issues with China. These include forced technology transfer, IP theft, and domestic subsidization. That is, Chinese leaders thought they could improve the deal without consequence.
  • Chinese hawks, pushing for a harder line in talks, won the internal argument to push back against US demands. Up to now, Chinese leadership has kept its hawks muted, and has not yet sought to stir up anti-US nationalist sentiment that would result in regulatory harassment and consumer boycotts.

As a result of these changes, companies have begun moving manufacturing operations away from China. They are instead focusing on alternative hubs like India, Vietnam, and Mexico to avoid increased US tariffs. DuckerFrontier expects tensions surrounding the US-China trade war to continue long-term and create uncertainty for firms operating in China. Further trade war escalations will harm US goods in particular. They will lose global competitiveness as US companies with production centers located in China pay higher taxes.

Our View On US-China Trade

Trump wanted to reach an agreement with China so he could shift his focus to trade talks with the EU and Japan. As Chinese backtracking surprised Trump, he announced that he will delay the imposition of global auto tariffs by six months. Trump’s intention is to spend additional time and political capital on trade talks with China. We do not expect Trump to impose the next round of tariffs immediately. We expect him to use them as part of the re-launch of trade negotiations. This will begin after his meeting with Xi in late-June.

In our US-China trade war scenarios, Chinese escalation remains a concern. The US has been the aggressor and China has responded in a measured way that allowed it to save face while not escalating the trade war. The US may decide to apply tariffs on all Chinese exports and continue to implement other non-tariff measures. These may include restrictions on technology transfer and research exchange into China. If this occurs, China may be forced to respond with its own non-tariff barriers. These may specifically target US firms exporting out of China, but also target US firms with domestic Chinese revenue streams. As we have seen in previous disputes between China and Japan/South Korea, China has a potent tool in tapping domestic nationalism to hurt foreign multinationals operating inside China.

The US-China trade war will not cease in the short or medium term. US firms should look to alternative manufacturing hubs to avoid higher costs to production and to protect consumers at home. Mexico, India, and Vietnam are options where risk and uncertainty are lower. These locations would allow firms to produce goods closer to demand centers.

Business Implications

So far, US tariffs have mainly avoided consumer products, targeting intermediate goods. Firms impacted by tariffs have been forced to compress margins or pass on costs to consumers, though overall US inflation has remained weak. If Trump imposes tariffs on the remaining Chinese exports, low-margin consumer products will be hit. This will lead to inflationary pressures that disproportionately affect low-income households. Firms can stockpile goods to protect themselves again the risk of higher tariffs, and can implement pricing strategies to manage price distortions caused by tariffs.

The longer term issue for US firms is that it has become a corporate mandate to develop more resilient supply chains that avoid such a large reliance on direct US-China links. Companies operating in China are likely to face hits to profit margins as more revenue is needed to cover tariffs. These costs will also be further transferred to the consumer, hurting consumer confidence and spending, and decreasing overall competitiveness of the firm. Therefore, US firms with operations in China should ensure good relationships with local party officials and to ensure full compliance with environmental regulations.

FrontierView clients: See our report on Managing the US-China trade war for further insights

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