SINGAPORE (May 27): The tussle between the US and China has taken a turn for the worse. US President Donald Trump has abruptly returned to confrontation with China, re-imposing tariffs and attacking Chinese technology firms with potentially fatal restrictions. Southeast Asia will be hurt; it is already enduring weaker global demand, rising risks of a Middle East conflict that could cause oil prices to spike and uncertainties such as Brexit. This trade-technology war is the last thing the region needs.
Still, one should not exaggerate the downsides. Yes, it is true that the trade war is a subset of a wider strategic battle for global influence between the US and China — which means that the frictions between the two could last a long time. But that does not preclude the two powers from making tactical deals when it suits their interests. Remember that during the Cold War, when the US and Soviet Union were engaged in an even more bitter contest for power, they found areas of agreement such as treaties to limit nuclear proliferation and mechanisms to improve security in Europe. Today’s Cold War involves two countries that are inextricably linked together in interdependencies of trade, investment and technology; that means they have an even greater incentive to avoid a downward spiral into conflict.
And that is why our baseline scenario is that the US and China will cut a trade deal within the next few months, one that prevents an outright trade war and allows businesses around the world to breathe a sigh of relief.
First, the bad news…
The US is putting immense pressure on China. Not only did Trump go ahead with tariff increases on a range of Chinese goods, which he had initially postponed, he also threatened to impose tariffs on another US$300 billion ($414.6 billion) of Chinese exports, hitting virtually all Chinese exports to the US.
The Americans have now gone further, to attack China’s soft technology under-belly. Under Trump’s latest executive order, US firms cannot use any telecommunications equipment manufactured by Huawei Technologies. Worse still, they cannot supply critical components, software and technology to Huawei or its 70-odd subsidiaries unless they are given special licences. Now, there is also talk of the US extending these restrictions to many other Chinese technology firms such as Hangzhou Hikvision Digital Technology Co, a video surveillance company, which will be barred from buying US technology.
As a result, companies providing Chinese firms with critical components or software are getting jittery and proactively imposing their own restrictions. Google has said it will have to suspend the delivery of Android-related software and technical services to Huawei. ARM Holdings, a major chip designer that provides vital chips used around the world, has apparently decided to suspend work with Huawei and its subsidiaries so as to comply with the Trump administration’s restrictive regime.
The Trump administration’s use of technology to hammer China is only just beginning. Reports have been emerging in the media of US intelligence chiefs engaging in a sustained series of briefings over the past few months to warn US corporate leaders about how China threatens American interests. Moreover, despite the toxic partisanship that marks the US political system, the idea that it is time to put China in its place commands widespread bipartisan support. Indeed, there is a strong consensus across the American political, business and intellectual elite that tough measures are needed to make the US safe from a threatening China.
The US seems to be in a stronger position than China
How all this will unfold in the coming months will depend on the relative bargaining positions of each party. At first glance, it does seem that the US is in a better position than China:
• First, the US administration has reduced its frictions with other trading partners so as to be able to focus on China. It deferred a decision to impose tariffs on imported cars and auto parts from the European Union and Japan by six months and also agreed to remove steel and aluminium tariffs on Canada and Mexico so as to speed up ratification of the US-Mexico-Canada trade deal.
• Second, the US economy is robust enough to persuade Americans that they can contain any economic fallout from tariffs and disruptions to supply chains caused by the technological restrictions. On the other hand, the data for the Chinese economy’s performance in April was disappointing: The economy is losing momentum despite an aggressive stimulus programme. Worse still for China, inflationary pressures are rising as a result of disease reducing pork supplies and bad weather restricting the supply of fruits. China’s economy is much more vulnerable to a trade war and exports are more of an essential engine of economic growth than in the US.
• Third, despite all the hype over China’s tremendous advances in science and technology, it seems that the country still depends on US technology — to the point that companies such as ZTE and Huawei may flounder or even fail without access to US components and software. The US does not suffer such critical dependence on China.
Yet, we believe that the US has overestimated its clout and underestimated China
In the coming weeks, the US could increase pressure on China on many fronts other than trade, in an effort to bludgeon the latter into making concessions in trade and other areas. The US will fail in this strategy for a number of reasons:
• Fundamentally, Chinese leaders appreciate that they are in the early stage of a long political struggle with the US. They probably understand that making early concessions would only encourage the US to demand ever more concessions from China. President Xi Jinping has to demonstrate that China cannot be pushed around, something even more important for a leader like him, who has made nationalism his trademark. This is so much more the case this year, a year filled with sensitive political anniversaries. We have just had the 100th anniversary of the May 4th movement, in which Chinese students rose against foreign domination. Within weeks, we will have the 30th anniversary of the Tiananmen incident that almost brought down the Chinese Communist Party and then, in October, China will celebrate the 70th anniversary of the founding of the People’s Republic of China.
• While the Chinese economy is indeed faltering, Chinese policymakers have the wherewithal to counter it through stimulus policies such as fiscal spending and relaxing credit policies. And neither is the US economy all that strong. The latest “nowcast” estimates of 2Q growth in the US range between 1.2% and 1.7%, a sharp deceleration from 3.2% in 1Q. US businesses have substantial operations in China and depend on the Chinese market as well as on Chinese supplies of intermediate goods; they will be uneasy about where US-China relations are going and, as a result, may well cut back on capital spending and expansion plans for a while. That would further weaken the US economy. Tariffs on the remaining US$300 billion of Chinese exports not yet covered will raise prices for American consumers as well.
• Moreover, corporate America will also suffer from the Trump administration’s campaign against China. Huawei is a huge market for US businesses — it spent US$70 billion on component procurement in 2018 and of this, about US$11 billion was captured by US firms such as Qualcomm, Intel and Micron Technology. This is one reason why Trump hastily retracted parts of his ban on Huawei within days of imposing it.
• Neither is China bereft of retaliatory messages. For example, it cannot be a coincidence that Xi decided to make a high-profile visit to a rare earths processing plant just as trade tensions erupted, accompanied by other senior leaders such as Vice-Premier Liu He, who leads trade negotiations with China. China produces about 71% of the global output of these rare earth minerals, which are vital in the manufacturing of high-tech products such as miniature motors, smartphone speakers, electric turbines and hard disk drives. Recall that China used this leverage against Japan during a period of tension between the two countries in 2010, so there is a history of China using its dominant position in rare earths to achieve strategic objectives.
Thus, we believe that the incentives are there for both sides to resume negotiations in the coming weeks. Trump is focused like a laser on his re-election campaign next year. How American voters feel about the economy around the middle of an election year plays a big role in their voting preferences. Trump will not want to risk a weak US economy — it is about the only thing that can ensure his re-election. Note, too, that Trump has a record of bluster and threats followed by an unexpected shift to a more conciliatory position. We saw this in his approach to North Korea. He is also capable of backtracking quickly on tactics, as seen in his approach to Iran recently. There, he had drummed up pressure, even sending US naval vessels to intimidate Iran. But when he saw that the risk of an actual conflict was higher than he had initially expected, he was quick to turn down the tensions.
How soon a resumption of talks will lead to an actual deal is difficult to predict. There could be some progress made when Trump and Xi meet on the sidelines of the G20 summit meeting at the end of June and that could then pave the way for compromises that result in a deal in July or August.
Implications for the region
First, there is little doubt that the increased uncertainty and potential disruption of supply chains as a result of tariffs and technology restrictions will slow global economic growth. The recovery in capital spending that we thought might drive a rebound in global demand for Asian manufactured goods will not come about anytime soon now.
Second, major economies are likely to shift to stimulative policies. China, for sure, will ramp up stimulus measures to protect its economy as well as to signal to the Americans that it will not let a weaker economy undermine its negotiating position. The US Federal Reserve Bank will maintain its pause on raising rates while central banks in the eurozone and Japan will keep adding liquidity. This should help offset some, but not all, of the negative effects on global growth. It should also support financial asset prices.
Third, the pace of production relocation out of China to Southeast Asia and elsewhere will accelerate as it becomes clear that the US-China contest will persist for a long time. Data for foreign investment approvals around this region already suggests that relocation is boosting foreign investment. Not only will we see more relocation, we should also see a broader range of countries benefiting from this trend.
In short, we have a bad situation and it may even get worse in the coming weeks. But the most likely scenario remains one where a trade deal is eventually done.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
This story appears in The Edge Singapore (Issue 883, week of May 27) which is on sale now. Subscribe here
