What does the US-China trade war mean for businesses?
Singapore businesses need to be prepared for the short and longer-term implications of the US-China trade tensions
The latest round of trade negotiations between China and the United States suffered an embarrassing collapse in early May. What had appeared to be growing optimism of a conclusive deal rapidly unraveled in the final stages.
After President Trump tweeted his preference for retaining tariffs on Chinese exports to the United States, Washington announced an increase in rates from 10 to 25 per cent, to be applied to the full suite of Chinese goods. Beijing promptly retaliated with an equivalent tariff rate hike, followed by a declaration by President Xi that the country was prepared for a new “Long March” and would see through the fight till the end.
While some observers have suggested that rational self-interest will eventually prevail — and therefore hold on to the hope of a speedy resolution to the trade war — such beliefs are premised on an inadequate understanding of the historical, political, and economic setting.
Contrary to popular belief, the U.S. has not always been a pro-capitalist, free-trading nation. Protectionist sentiment was rampant in the economy through the 19th century, and only in the aftermath of the Second World War did trade liberalisation take root, led by the General Agreement on Tariffs and Trade, the predecessor to the World Trade Organization (WTO). But by the turn of the millennium, the global trading system was widely recognized as one heavily shaped by the ideals and preferences of the world’s largest economy.
With its entry to the WTO in 2001, China signed on to the global trading regime, supercharging its domestic economy and export engine, but at a significant cost to low-skilled workers in industrialised economies. These displaced workers, many of whom have experienced wage stagnation over the past two decades, are increasingly vocal, giving rise to populist governments throughout the West. As these embattled workers secure ever greater political leverage, the U.S. has reverted to its old protectionist strategies. The combination of historical legacy and contemporary politics — amplified by an otherwise mercurial president that has remained remarkably consistent in his mercantilist posturing — implies that a tough stance on trade has become irresistible.
On the other side of the coin, China is haunted by its historical aversion to signing unequal treaties during its century of humiliation. This stubborn insistence on political sovereignty is further bolstered by nationalistic rhetoric, and the ability of the government to steer the heavily centralised economy away from economic activities and relationships it deems undesirable. We are already witnessing the extent to which China is willing to endure economic pain. Compared to the European Union, China has displayed a greater willingness to target politically-sensitive sectors and states in its chosen countermeasures, even when it would cause itself more pain. And unlike the U.S., China can deploy a host of non-market strategies, such as boycotts of American goods, bans in the sales of economically-critical commodities (such as rare earths), and enabling a large depreciation in its exchange rate.
Even in the unlikely event that the trade war were to be resolved relatively quickly, disruptions to international economic activity have already occurred, the implications of which will almost certainly reverberate into the years ahead. It, therefore, behooves Singaporean businesses to be prepared for the short and longer-term implications of the conflict.
By and large, credible studies of the trade war on the American and Chinese economies suggest that direct effects are likely to be fairly small — in the order of about a half percentage point of GDP — with China almost certainly bearing a greater brunt of the impact. However, this does not mean that the economic costs are negligible for individual businesses. In fact, the small headline contraction will inevitably be accompanied by much larger redistributive consequences, especially for trade-dependent businesses.
For third parties such as Singaporean businesses, this means that existing business relationships run the risk of being broken. For instance, a raw materials supplier may find diminished demand from China, as their downstream counterpart experiences reduced business from the U.S.; by a similar token, intermediate goods manufacturers feeding into U.S. supply chains may enjoy a temporary boost, as American manufacturers shift away from their Chinese counterparts.
Direct competitors to China and the U.S. will probably benefit the most. Businesses that produce substitute manufactured goods — especially those with comparable price-quality ratios, such as Malaysia, Thailand, or Vietnam — may find opportunity from an upsurge in American demand, and agricultural producers in Australia and Brazil may see strong Chinese demand. Such shifts may even turn out to be permanent, once existing trade links are adjusted. The upshot for any given local business, then, depends on whether it deals mostly with the trade war-afflicted nations, or other third-party economies.
That said, given the linkages between firms in the production process owing to the intricacies of the East Asian value chain, the net effect of all this upending and restructuring of supply chains and trading arrangements is likely to be negative.
Perhaps more perniciously, the uncertainty associated with the trade shock can easily be corrosive for investment, which tends to flourish only when the business environment is predictable. Even in the best case scenario, businesses may choose to temporarily postpone their cross-border capital expenditures until the policy environment stabilises. If so, the unanticipated drop in investment could easily tip China or the U.S. into recession, given how their economies are already tiptoeing around a window of vulnerability. It is worth recalling that it was the Smoot-Hawley tariffs that set the stage for the Great Depression, and — perhaps depressingly — effective tariffs in the U.S. are now approaching that which prevailed at the time.
In the longer run, trade tensions could lead to a breakdown of the global trading system, giving rise to China- and US-centred blocs. As much as President Trump might celebrate the reshoring of U.S. production in order to circumscribe tariff barriers, China could also seize the opportunity to build in-house capabilities in key production processes. This was already demonstrated in 2018, when actions taken against Chinese telecommunications firm ZTE led to its self-sufficiency in semiconductor manufacturing by year-end. For third countries, the risk is a return to bilateral deals, instead of reliance on an increasingly embattled multilateral trading system. This would be especially detrimental for outward-oriented economies such as Singapore, and that is perhaps the most worrisome aspect of this unfortunate war.
The writer Jamus Lim is an associate professor of economics at ESSEC Business School and the chief economist at Thirdrock Group.
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