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CHINA-US TRADE CONUNDRUM

Conflict has potential of spreading to other countries

When the US decided to raise the stakes on its on-going trade and technology conflict with China little did it anticipate the kind of response, it elicited from the dragon.  President Donald Trump had to ban Huawei from the US market as concerns rose about Beijing’s likely use of its tech colossus for espionage.  The US Commerce Department added Huawei Technologies Co and 70 affiliates to its ‘Entity List’ in a move that would preclude the Chinese company from acquiring components and technology from US firms without prior US government approval.  Trump issued an executive order banning US firms from using telecom equipment made by companies suspected to pose a national security risk.  Although it was not explicitly mentioned, the target was clearly Huawei.

Huawei is viewed in China as an integral part of the ‘Rise of China’ narrative.  An attack on Huawei is considered as an assault on China. The US has also put forwarded charges against Meng Wanzhou.  Huawei’s chief financial officer was incarcerated in Canada in December 2018.  This US-China conflict isn’t restricted to the two countries anymore.

Washington has been persuading its allies to keep Huawei out of mobile networks.  Most recently Dutch intelligence services have been investigating Huawei for possibly facilitating classified information for the Chinese government by leaving a ‘back door.’  In the UK, telecom service provider BT removed Huawei equipment from key areas of its 4G network.  Australia, New Zealand and Japan have already banned Huawei’s 5G equipment, while most countries in Europe are having second thoughts regarding their ties with the Chinese tech colossus.

The US might be considering the action against Huawei as a bargaining chip in its China trade negotiations, which have hit a nadir.  The arbitrations when resumed, would take several more months.  China’s possible retaliation would be to boycott US products, favour other companies over American companies.  In addition, they may also enforce nuisance regulatory enforcements and inspections.

The discord, which was close to a resolution just a few weeks ago, is once again getting aggravated with the US intensifying the pressure by raising tariffs on a list of $200 billion worth of Chinese imports to 25% from 10%, and China responding with higher tariffs on a revised list of $60 billion worth of US products.

With neither Chinese President Xi Jinping nor  US President Trump agreeing to reconcile, China-US trade tensions could culminate into a no holds bar trade war.  China’s Ministry of Commerce forewarned that the discord may lead to “the largest trade war in economic history till date”. 

On-going tariff brinkmanship has resulted in putting tremendous stress on firms doing business in China.  They were albeit already feeling the pain of enhanced labour costs and mounting compliance standards.  To address crucial concerns American trade negotiators are exhorting China to introduce real structural reforms by alleviating the role of the state in it’s economy and opening up market access to private sector players.

How Will the US-China Trade War End?

Basing analysis on, information available and the posture adopted by two titans (China and the US) following three possible scenarios emerge. 

Further Escalation Leads to All-out Trade War: Scenario 1

Xi and Trump are not able to fructify the negotiation.  Neither side wants to look timid.  Both sides look to establish their own cold war-type camps. Skyrocketing tariff and non-tariff barriers make it impossible for Chinese firms to do business in the US and vice versa.

High tariffs raise costs for suppliers, manufacturers, retailers, and consumers albeit disproportionately in the US market.  As prices increase, production volumes decrease, profit margins diminish, companies go out of business, and jobs are lost.  China begins to invest aggressively in its EuropeAfricaAsia, and Latin America.  The US does the same.  American firms seek to shift their supply chain ecosystem out of China into Southeast Asia, in part or completely.

New Status quo Restored: Scenario 2

Xi and Trump agree to end trade hostilities and agree to talks.  All the while, continuing to indulge in rhetoric in their respective countries.  Both sides retreat to their initial positions and withdraw the tariff hikes.  A new status quo is reached where trade flows resume as per usual, but business leaders in both countries seriously assess their future risk exposure.

The biggest winner from the US-China trade war is Southeast Asia as multinational companies acknowledge the need to reduce their over-reliance on China’s supply chain ecosystem.  China, on its part, continues to invest in moving up the supply chain and reducing its own reliance on foreign research and development.

Negotiating a New Trade Deal: Scenario 3

China and the US strike a new trade deal, with concessions negotiated on both sides.  After coming to a truce, the two governments get to the drawing board over bilateral market access, securing intellectual property rights, a more level playing field for the private sector in China, and greater regulatory and customs transparency.  And both countries start asking for safeguards against future trade confrontation.

Viewpoint

Scenario 1 is improbable as both sides will incur huge costs.  Businesses will exert greater pressure on both governments to retreat.  US and China are the world’s largest economies, biggest markets, and are at the heart of the global industrial supply chain.  It would not be feasible for both the two countries to sustain a trade war. 

Moreover, an all-out trade war could trigger a new global recession.  However, Trump has been known to react unpredictably, and China should prepare for the worst case scenario 

Scenario 2 is relatively more likely, at least in the near term, as the US stock market has not reacted kindly to the growing economic uncertainties due to the trade war.  Retailers and consumers will also feel the pain more acutely if the tariffs against Chinese imports stay high.

In the case of China, a decline in employment, financial sector reform, and a slowdown in the manufacturing sector and domestic consumption will push the government to engage in talks with the US.  Nevertheless, even if a ceasefire is agreed to, the trade conflict will permanently affect how US and Chinese firms do business with each other.  It could also impact how the rest of the world does business with China.

Scenario 3, a new trade deal between the two countries is possible, but not in the near term.  It will certainly take longer than the current Trump administration, and China will be wary of setting a bad precedent, where it does not hold the upper hand.

For the time being the crisis continues.  Out of three scenarios, which one will finally culminate, only time will tell.

24 May 19/Friday                                                              Written by Naphisa

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