US China Trade War – Understanding the Dynamics..

The tariff hike on some of the Chinese goods by US government has shown that Mr Donald Trump is serious about what he talked about during his election campaign. Even though he has been facing severe criticism for his protectionist trade policies, his point of view with regard to China needs to be understood properly. A brief attempt..

The point of contention is one basic fact – huge trade surplus that China enjoys. As per WTO figures, US imports from China was over $500 bn during 2017 whereas it exported barely $130 bn, leading to deficit of $375 bn. (On aggregate basis, exports were $1.5 trillion whereas imports were much higher at $2.4 tr, leading to a trade deficit of almost $0.9 tr). This means over 40% of its trade deficit originates from China. Over last ten years, its cumulative trade deficit with China exceeds whopping $3 trillion, higher than India’s annual GDP..! 

His basic assertion is that these imports have displaced domestic manufacturing putting millions of people out of job. As per a report, US manufacturing sector jobs have shrunk by as much as 25% since the beginning of this decade.

While US does have an upper edge in trade in services, its volume is much less than the trade in goods. While service exports was worth $760 bn, the imports were $516 leading to surplus of $244bn, only about one-fourth of the trade deficit. (The surplus with China is only about $25 bn). .

It would be pertinent to understand what magic wand China has that enables it to generate trade surplus with most of the countries. More so, because it is importing almost all of the raw material where it cannot command price advantage. Cheap labour provides some edge but that is not sufficient as on an average, 70-80% of cost of a product is raw material.

The answer to the question is that China restricts the movement of its currency within a band. Simple economics says that if China is running a trade surplus, there will excess supply of foreign currency in the local market and the local currency would appreciate. This would increase the price of export goods, decrease the price of imports and thus, reduce the trade imbalance. (If local currency appreciates from $0.12 per ¥ to $0.16 per ¥, the cost of a product worth ¥25 would increase from $3 to $4). However, it does not allow that for fear of destabilising its economy, job losses and so on. As per, Yuan has remained constant at about $0.145 over last ten years even though it appreciated to $0.165 around 2014.

The deficit is ultimately financed by issue of government bonds which Chineses government purchases or purchase of fixed assets in USA. It may be noted that China has often been accused of acquiring assets of strategic importance such as ports in smaller nations. This is in lieu of debt accumulated due to trade surplus, also called “Economic Imperialism”. While US is not exposed to such a threat because of the sheer size of its economy, the logic still stands valid.  .

The theory of ‘comparative advantage’ has helped increase the world output as long as there was relatively sufficient employment opportunities and insufficient production capacities. Global balance over last about two decades, more so, after 2008 financial crisis has shifted to excess of both labour and production capacities. This has led to a clash between countries with excess capacity and the ones facing the threat. It is important to understand that trade can sustain in the longer run only when there is a balance and not an imbalance.

(NOTE – The views expressed are personal. The Reader may or may not agree with it)

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