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Stalemate

The Trump administration’s July 11 release of a list of $200 billion in Chinese exports to the United States subject to 10% tariffs signals a worsening stalemate between two of the world’s largest trading powers. China’s reaction was predictable, and consisted largely of the same language used by its centralized state organs as at the start of trade disputes: namely, China protests ‘U.S. protectionism’ and that ‘China will reciprocate in kind.’

The $200bn signifies the Trump administration’s obsession with forcing China to change its political-economic structure, which U.S. officials had repeatedly tried to put across during what few negotiations it held with Beijing’s finest ‘barbarian handlers’ such as Vice Premier Liu He. On this point, Beijing has always been very clear: China’s political-economic model sits way behind its red line and is not open for negotiation.

This has exacerbated the stalemate between the two countries, with Washington’s aggressive tariffs meeting with a wall of inflexibility from Beijing. However, indicators are starting to emerge of a potential change of strategy from Beijing that is moving away from open confrontation to contingency planning. The result of this process could see structural changes occurring in China’s trade model, but maybe not as Trump would have liked.

Old and New Tricks

China’s tactics thus far have consisted of four components:

  • Engage the international community in protesting against ‘U.S. protectionism:’ limited effectiveness not helped by China’s less-than-great reputation as a fair player
  • Official negotiations with U.S. counterparts, with market access as a compromise: failure after what appeared to be initial consensus due to ideological rifts within the Trump administration
  • Proportional tariff retaliations: calculated to cause minimal disruption to the Chinese economy; completely reactive to U.S. first moves and not pronounced as an ‘offensive measure’
  • Targeted, industry/product specific, non-tariff barriers to trade: against small components of U.S. imports, usually in the form of investigations; act as limited pressure points with minimal impact

Beijing should be coming to the realization that the trade frictions with the U.S. will not disappear through deft negotiation or promises of open markets. With a radical change of China’s political-economic structure out of the question, it is likely that Beijing is considering alternative solutions to get out of the current impasse. While these will incur risks that Beijing is wary of taking, the erratic, ideologically-driven, and often irrational demands from the Trump team is leaving Beijing little choice but to consider contingency plans. These could include:

De-coupling

One option could be to diversify import sources away from the U.S. Although it will take time, China does not overly depend on the U.S. in many sectors, and other countries are likely to be more than happy to boost their economies by taking up the slack. China could use this opportunity to ‘de-couple’ from the U.S. at least in terms of trade. Structurally, this would shield China more from potential U.S. pressures in the future.

While this option is high risk and carries an unpredictable timeline, it may become necessary. If the 10% tariffs on $200 billion in Chinese exports are implemented following public consultation in the U.S., the total volume of goods covered will be nearing the total volume of goods exported by China to the U.S. This pressure will make this de-coupling option a necessity for China if it wants to continue to grow its economy.

china trade deficit
top us imports from chinatrade war trends

Indigenization

Whether the Trump administration likes it or not, China still sits at the heart of the global supply chain, with many U.S. firms operating there to supply both Chinese and global client bases. Likewise, China needs these U.S. companies to help upgrade its own sluggish economy and outdated industrial models.

It is not inconceivable that China will ask U.S. firms that are highly integrated into the local economy (such as retailers and manufacturers) to develop their Chinese consumer/client base more. Instead of importing increasingly expensive U.S. goods for sale in China, these firms could produce premium products in China by upgrading their domestic supply chain and industrial infrastructure, in return for a huge growing market of Chinese consumers. This will mean more jobs, higher quality products, and improved infrastructure for China.

This scenario can help companies offset any loss of market share in the United States due to inevitable tariff-related price rises, and can be an attractive option for companies provided they can put up an effective ‘America first smokescreen’ back in the United States. – i.e. engage in a process of quiet ‘indigenization’ in China while conducting headline-grabbing yet token ‘America first’ investments in the United States.

Selective Market Denial

One upside of the trade disputes has been China’s opening of certain markets to foreign investment, such as financial services. Beijing has also been hinting strongly that while it will not openly retaliate against existing U.S. firms operating in China, it might deny entry into newly opened sectors for U.S. companies.

This approach allows the Chinese government to benefit from foreign investment from European and other countries and beef up its services sector, while at the same time claim that it is not attacking U.S. companies’ revenue as there is none to restrict. However, U.S. firms may never make up for lost time in the future following a delay in market entry and will struggle to gain market share thereafter. The loss in potential rather than actual revenue will still be considerable.

Winners and Losers

Should China pursue these options, there will be a substantial shift in how it interacts with the global economy and manages its domestic economic model:

  • China changes structurally to accommodate for lost U.S. imports and suffers some short-term economic damage, but ultimately recovers. The real casualty will be the U.S. consumer in the long-term when the tariffs start to bite.
  • U.S. companies might want to buffer their exposure by considering how to expand in the Chinese market. Ironically, the government will likely become more open to U.S. companies that can contribute to national consumption upgrading objectives.
  • Trade frictions could pose good news for Europe and other regions seeking to expand their exports to China. Non-U.S. aerospace and agricultural companies will benefit the most. The pressure to diversify quickly will likely give non-U.S. companies an advantage during price negotiations.
  • Likewise, non-U.S. companies will experience a marked advantage when new service sectors are opened by the Chinese government.
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Gary Li

Gary Li is an associate director specializing in Chinese public policy based in APCO Worldwide's Beijing office. Read More