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Economic conflicts between nations, resulting from extreme protectionism, where states impose trade barriers against each other, tend to impact the global economy. The ongoing US-China trade war is getting nastier by the day, not only causing damage to the two economies involved, but also to other countries on the sidelines. In this protectionism scenario, the level of global real GDP has declined to 0.8% in 2019, with expectations of 1.4% in 2020. These figures are only marginally above the 2.0% threshold for a global recession.
The timing of this trade war coincides with the gradual wearing off of monetary stimulus, increasing oil prices and a rise in political risks across the world. Global output and growth is slowing. To understand the effects of the trade war, we will first need to look at the causes of the dispute. Why are China and the United States at loggerheads?
US President Donald Trump had been complaining about the unfair trade practices used by China, even before he took office in 2016. Experts say that it was one of the prime reasons that he got elected in the first place. In 2017, the US launched an investigation into Chinese trade policies and, as a result, imposed tariffs on $250 billion worth of Chinese goods. The main area of concern was the increasing US trade deficit. A record US trade deficit of $375 billion was revealed in 2017.
In 2018, the US imported goods worth $539.5 billion from China and exported goods worth $120.3 billion, resulting in a trade deficit of $419.2 billion. This deficit has been on the rise for several years now, ever since China became a major manufacturing hub for goods, due to the availability of low-cost labour. This has impacted the US manufacturing industry, as well as job growth. Along with lost manufacturing jobs, wage growth has also remained low. The US blames this deficit on a lack of market access and investment cases in China.
Another issue is the technology transfer and hi-tech industrial policy of China, the Made in China (MIC) 2025 initiative. The US government thinks that this will enable Chinese companies to unfairly dominate strategic industries, such as food, medicines, fuel and semiconductors, where US companies have been global leaders so far. MIC 2025 is China’s key strategy to upgrade its industrial sector by concentrating on high-value manufacturing sectors, such as aerospace, robotics and electric vehicles.
As a result of this initiative, China could surpass the US as the global leader in advanced manufacturing. Until now, China had only focused on manufacturing and exporting basic consumer goods. According to the US, the state-funded MIC initiative puts US companies at an unfair disadvantage. The US tariffs has been levied to impede China’s growth trajectory.
There are allegations of Chinese espionage against the United States. US academicians, businessmen, government officials and various organisations have accused China of stealing US intellectual property and military technology. The Asian giant has also been accused of putting policies in place that puts US patent holders at a disadvantageous position in the Chinese markets. To invest or sell products in the Chinese markets, US companies need to get into joint ventures with Chinese companies, which provides illegal access to their technologies.
The Commission on the Theft of American Intellectual Property says that these practices cost the US almost $600 billion each year. In March 2019, a poll revealed that one in five US technology companies had suffered from intellectual property theft, perpetrated by China, within the past one year.
On August 5, 2019, China devalued its currency to the lowest level in the past 11 years, in retaliation to which the US imposed further tariffs on $300 billion worth of Chinese goods. For the first time since 1994, the US made an official complaint against China to the international community, regarding the manipulation of the Chinese currency to gain an unfair advantage in international trade.
This complaint adds another layer to the trade dispute, especially as the International Monetary Fund agreed with the devaluation of the Chinese Yuan. The resulting currency war is causing extensive damage to regional currencies and global equities. A weaker Yuan will make it difficult for China to repay its dollar-denominated debts, worsening its economic situation. Extreme volatility has been predicted in the forex markets, and if the US decides to make the Dollar weaker, it could trigger a global recession.
Major countries have complained in the past regarding the lack of market access and huge entry barriers for investment in the Chinese markets. In 2018, the European Union also filed a complaint with the World Trade Organisation, regarding foreign companies being forced to transfer their intellectual properties to Chinese partners and establish R&D facilities in the Asian nation, to get government approvals in niche sectors, like electric vehicles. Foreign companies are restricted from entering certain business sectors, unless they form a joint venture with a domestic company, which will own the majority stake.
The Chinese government has denied many of these claims and accepted some. But, the trade war is showing no signs of slowing down. In a recent turn of events, President Trump asked US companies to exit the Chinese markets. China’s economy has been on a worrying decline since 1992, while there now are recession fears regarding the US economy.
US farmers are feeling the full brunt of the trade war, with China cancelling orders and manufacturing output dropping. According to estimates by JP Morgan, the average US household will end up paying $1,000 per year for the trade war, if the ongoing set of tariffs continues.
Hopes of quick de-escalation of the trade tensions are low and the global equities and currency markets are facing sharp volatility. Deterioration in sentiment, amidst trade tensions, will affect demand, leading to slower economies. Central Banks around the world are stepping up monetary easing to mitigate risks of economic damage. At such a time, traders in the financial markets need to keep close track of news and developments, while employing robust risk management measures. The road ahead is likely to be bumpy.
