The world is waiting to see who will blink first after firing the opening shots. It is not the first time that USA has hatched trade war. In 1985, Ronald Reagan managed an assault on Japan, using the Japanese currency as a weapon to trigger a global trade war. It skyrocketed the yen’s value artificially in coterie with five countries under the Plaza Accord and thwarted Japanese cheap exports. In both cases, the common allegation was that both China and Japan were intransigent to reduce trade deficit, which were vulnerable to the USA trade balance.
Nevertheless, paradoxically the two countries were different in their moves to counter the USA’s trade barriers. While Japan abstained from taking any retaliatory action against the USA’s embargo, China is assertive to retaliate against USA tit-for-tat by using tariffs as a tool. China decided to slap a 15 percent tariff on 120 items of producst imported from USA, including fruits and related products and 25 percent tariff on eight products, including pork and related products, against the USA’s intent of imposing a 25 and 10 percent tariff on steel and aluminum respectively and stretching the list worth US $50 billion under escalated tariffs, matching with Chinese products exports.
Hit by the Japanese yen appreciation, Japanese products lost cost competitiveness. Untill 1985, Japan was the biggest contributor to the USA trade deficit. In 1985, Japan accounted for 37 percent of USA’s total trade deficit in goods. Instead of wading in retaliation, Japan decided to thwart USA’s move by shifting plants in low cost countries, such as in Malaysia, Indonesia, Thailand, Philippines and in the USA to balance the trade deficit. Later , China became the hotbed for Japanese manufacturing.
As a result, Japanese investment in overseas soared. It increased by over 430 percent in 1988, three years after the Plaza Accord and continued to rise until Japan countered the Bubble Bust in 1993.
The horrors of “Hollow Investment” loomed large in Japan. Japan underwent three decades of investment recession in its domestic areas. In subsequent periods, downturn in domestic demand, shackled by aging population, shadowed inward investment in Japan. Japan, once known for three jobs after one applicant, lost the paradise of job opportunities.
Incidentally, since both Japan and China are export based economies, any trade barrier their economies are vulnerable. Nevertheless, there are differences between the two in terms of exports to the USA. This is because a large number of Chinese exports to the USA are generated by US firms investing in China. A number of US companies invested in China for cheap production and re-import into USA . Any tariff push will mean a trade boomerang to these US companies.
Who wins and who loses will be determined after the tariffs will actually be imposed.
Given the contrast relations between USA-China and USA-Japan, China will exercise more to retaliate against the USA than Japan did. Japanese hands were tied as it was a close ally to USA. Besides, the USA was the biggest importer of Japanese goods in 1985. One fifth of Japanese exports were shipped to the USA .
In contrast , politically China is an adversary to the USA. Even though the US is the biggest importer of Chinese goods and not vice versa, there are ample reasons which may haunt USA exporters, if China takes retaliatory measures. China is the biggest buyer of US soybean. About 60 percent of US soybean exports go to China. China is the biggest buyer of US sorghum. The Trump administration stuck a compensatory trade deal last year with China to balance trade. The USA would export beef and natural gas to China against imports of cooked poultry. The deal may turn into a dud if China retaliates. China may divert purchasing of Boeing aircrafts to Airbus. In November 2017, a purchase deal of 300 Boeing was made by China. China is the biggest buyer of US Treasury bonds worth US $ 1 trillion. Selling a chunk of these bonds will distort the market. China has close monopoly of 17 rare earth minerals. They are used for cell phones, displays, automobiles and atom batteries. Any sanction of these minerals may prove hardship for US industries.
Ostensibly, the size of economic inter-dependence should determine the tit-for-tat actions. USA is more significant to China than China to USA. China is an export base economy and not vice versa. In 2016, exports accounted for 18.6 percent of Chinese GDP , compared to 11.9 percent of USA’s GDP. USA is the biggest destination for Chinese exports, accounting for 18 percent of Chinese exports in 2016. In contrast, China accounted for 7.5 percent only of USA’s exports in 2016.
Given the unbalanced economic inter-dependence, China should be wary for the USA’s onslaught on its currency management as the next step for retaliation, taking a leaf from the experience to thwart Japanese exports in post Plaza Accord. The USA may mount further pressure on the Chinese renminbi, alleging that it has been kept under-valued in proportion to Chinese growth. The USA has already forced China to unpeg its currency to the US Dollar and caved into floating rates in a basket of currencies. Since then Chinese renminbi value spurred by over 22 percent.
Chinese wages leaped high. Chinese goods fell prey to expensive products. China opted for Go-out policy by investing abroad instead of investing domestically. Chinese out-bound investment surpassed its in-bound FDI. Chinese investment abroad surged to US $170 billion in 2016, against inward FDI of US $ 34 billion. This exemplifies that China has lost the paradise of cheap production, similar to Japan in post-Plaza Accord.
Does this mean that China’s heydays are in jeopardy? Given the USA’s significance as a linchpin for China’s export and holding the mantle for global currency balancing, can China afford to retaliate against USA and make a smooth run of its economic growth?
To circumvent the trade war, China should increase its overseas investment in low cost countries and re-route its exports to the USA.
In this prey, India can pose a preferable destination for Chinese investment. In recent years, China has emerged as a big ticket investor in India, albeit there are security concerns. In 2015, Chinese investment in India leapfrogged eight times and became the eighth biggest foreign investor in India. In mobile phone manufacturing, China has already established a strong base in India. More than half a dozen Chinese mobile manufacturing companies have set up their plants in India. In 2016, Chinese companies proposed US $2.3 billion worth investment in the country
India’s attraction snowballed after China lost its place as the low cost workshop of the world. According to FDI Intelligence, an outfit of Financial Times, India replaced China in receiving FDI in Greenfield projects in 2015. This unraveled India’s strength in attracting FDI amid low cost countries
(Views are personal)