Who Wins in a U.S.-China Trade War?

U.S. President Donald Trump, during his campaign last year, made bold, incendiary claims against China. The nation of 1.4 billion people is a currency manipulator that has stolen American intellectual property and manufacturing jobs, he postured. Though Mr. Trump has since watered down this inflammatory rhetoric, many remain concerned that Washington’s failure to see eye to eye with Beijing on economic matters could spark a damaging trade war between the world’s two largest economies.

A trade war, which would involve both sides putting up import barriers and other protectionist measures, would certainly be detrimental to both parties. China is one of America’s most important trade partners. It exported $463 billion worth of goods and services to the U.S. in 2016, representing about a fifth of total U.S. imports that year.

The U.S. is also heavily reliant on China, which has quickly become our third biggest export market after Canada and Mexico. Through global supply networks, we are inextricably linked to the Chinese economy and vice versa. And even though China relies heavily on the U.S. consumer market, America may actually have more to lose from a trade war.

China’s Weapons in a Trade War

There is no question that increased tariffs on Chinese imports – such as the 45% tariff Mr. Trump has contemplated – would result in reduced demand for Chinese exports and, therefore, downward pressure on the renminbi. But if Mr. Trump were actually to slap higher tariffs on Chinese goods or implement other protectionist measures, the world’s second-largest economy has a variety of tools at its disposal to fight back.

For starters, China is one of our biggest foreign creditors, owning $1.06 trillion worth of U.S. Treasuries as of February 2017. That’s second only to Japan, which owned $1.115 trillion of U.S. debt in February. In the event of a trade war, the Chinese could decide to offload this debt and, by doing so, implicitly refuse to fund our chronic budget deficits.

China could also reduce purchases of certain U.S. goods such as aircraft and heavy machinery, impose an embargo on U.S. agricultural commodities such as soybeans, and sharply curtail its demand for other U.S. goods and services. Such moves could cost the U.S. hundreds of thousands of jobs and drastically reduce corporate profits.

U.S.-based retailers such as Walmart and Target would undoubtedly feel the pinch as they rely heavily on products manufactured in China. Technology companies such as Apple would suffer too as they depend on Chinese laborers to assemble their iPhones. If Chinese labor markets were no longer accessible to these companies, their production costs could rise significantly, ultimately hurting consumers. In fact, according to a new report by the U.S.-China Business Council, trade with China saves American households up to $850 per year.

However, some observers argue that U.S.-based technology firms and retailers could more easily find substitutes for Chinese labor than the Chinese could for U.S. agricultural commodities and high-end machinery and equipment. For instance, U.S. firms could simply shift their manufacturing operations to other countries with cheap labor – such as Thailand or Mexico – but China would be hard pressed to find replacement parts for, say, a commercial airliner.

Mr. Trump, who in January formally abandoned the Trans-Pacific Partnership trade deal that would have strengthened economic ties between the U.S. and several Pacific Rim countries, has also vowed to renegotiate the North American Free Trade Agreement. He has blamed NAFTA for U.S. economic woes ranging from a declining manufacturing sector to our trade deficit with Mexico.

But renegotiating NAFTA would almost certainly be a boon to China, allowing it to solidify its position in the global supply chain and benefit from less efficient production in North America. Larry Summers, the legendary economist and former U.S. Treasury Secretary, has argued that there is “no bigger strategic and economic gift we could give China than for the U.S. to move away from NAFTA.”

A Pyrrhic Victory?

Aggressive protectionist measures against China – because of how they would impact U.S. corporate profits and international trade – could cause a sharp correction in U.S. equity markets, which are already on fragile ground as investors increasingly question the merits of the Trump ‘reflation trade.’

A trade war could also fuel inflationary pressures in the U.S., potentially causing the Federal Reserve to raise interest rates faster and higher than it otherwise would, which would put further downward pressure on equity markets. For a businessman like Mr. Trump – who prides himself on the success of his investments – a stock market collapse could be an indelible and embarrassing blemish on his tenure as president.

In sum, it is abundantly clear that a trade war between the U.S. and China would be detrimental for both parties, as well as for global trade. As China navigates the precarious transition from an investment- and export-led economic model towards a consumption-driven one, Washington and Beijing must work together to implement sensible trade policies that further our common goals of economic progress and geopolitical stability.

– Arjun Sreekumar, M.B.A. Candidate 2017