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August 17, 2019

When titans clash


August 17, 2019

The trade war between the globe’s two largest economies is beginning to sting China. The second quarter (April-June) of 2019 saw the Asian giant’s economic growth sputter to 6.2 percent, which is the slowest over past 25 years, from 6.4 percent during the previous quarter, as another round of tariff hike by the US in May put downward pressure on both domestic and foreign demand. Has China’s fantastic economic journey finally encountered insurmountable obstacles?

The last two decades have seen a gradual downswing in the economic strength of the US and an upsurge in that of China. Between 1997 and 2018, the US economy registered a modest average annual growth of 2.3 percent to surpass $20 trillion. By contrast, the Chinese economy grew on average 9.0 percent a year to reach $13.6 trillion. It is widely forecast that at the current growth rates, China will overtake the US as the world’s largest economy in next two decades. Although militarily Washington will remain well ahead of Beijing, a redistribution of economic power will act heavily on each nation’s capability to shape international events.

Since the mid-1980s when China began to liberalize its socialist economy, its consistently high growth rate has been underpinned by a spectacular export performance. The country’s merchandise exports, which were only $18 billion in 1980, rose to $62 billion by 1990, $249 billion by 2000 and $1.6 trillion by 2010. In 2018, China exported $2.5 trillion worth of goods. This economic and export growth saga is unprecedented. In 2007, China overtook the US as the globe’s largest exporter – a position that the Asian giant has maintained to date.

The phenomenal growth has served as a catalyst for China’s economic turnaround. For instance, in 1980 per capita income in China, the world’s most heavily populated nation, was as low as $185, which by 1990 had gone up to $318 and further to $960 by the turn of the century. The new millennium saw a rapid increase in Chinese per capita income, which reached $9771 in 2018. China has graduated from a low income to an upper middle income economy and is set to become a high income economy (per capita income of $12,376 or more) during the next decade. The rise in per capita income and, by implication, living standards was politically enormously significant in case of China, which remains a one-party totalitarian state. A weak economic performance may have sounded the death-knell for the communist regime.

As the Chinese economy opened up, imports also went up substantially from $19 billion in 1980 to $2.1 trillion in 2018. However, the increase in imports has consistently lagged behind that in exports. In 2018, the country ran close to $400 billion trade surplus. Over the years, the high trade surplus has enabled China to accumulate massive foreign exchange reserves, which stood at $3.1 trillion at the end of July 2019. It’s this surplus capital that has bankrolled the country’s growing international commitments, arising out of the leadership’s desire to play a significant role in shaping world affairs commensurate with the economic strength, including the One-Belt-One-Road (OBOR) initiative of the current president.

While China was running a massive trade surplus and accumulating reserves, the US was facing an even higher trade deficit. During the past one decade (2009-2018), the US has incurred average annual trade deficit of $776 billion including $946 billion last year. China has been the principal source of America’s trade deficit. On average, China accounted for 45 percent ($347 billion a year) of total US trade deficit during this period. A country which runs trade deficit accumulates debt. At the end of 2018, US external was recorded at $19.6 trillion, which accounted for nearly 97 percent of the total economic output.

The US has set down its external deficit to two things: it has one of the most liberal trade regimes in the world; and it avowedly plays by the rules more conscientiously than its trading partners do. China, in particular, has from time to time been charged by Washington with stealing intellectual property rights of US-based firms and manipulating the domestic currency. The familiar argument is that China has over the year maintained its currency – the yuan – undervalued, which has made its exports cheaper and imports more expensive than would have been had the exchange rate been left to the market forces. This argument is not without merit: a country running a large trade surplus must see its currency appreciate relative to other currencies, as the world demand for its goods exceeds its domestic demand for foreign goods. However, the yuan has not appreciated corresponding to China’s export expansion, as the government has maintained a fixed exchange rate.

The first short in the trade war was fired when in March 2018 the Donald Trump administration slapped 25 percent punitive tariffs on import of steel from China and some other countries. Beijing retaliated by levying up to 25 percent tariffs on American imports. So far the US has imposed tariffs between 10 and 25 percent on Chinese goods valuing $250 billion. Beijing has hit back with tariffs on $110 billion worth of American imports.

The imposition of additional tariffs marginally reduced US exports to China from $130 billion in 2017 to $120 billion in 2018. On the other hand, China’s exports to the US went up from $526 billion to $563 billion, thus increasing the bilateral trade deficit from $396 billion in 2017 to $443 billion in 2018. One reason may be that foreign trade orders are placed months in advance. So it will take time before enhanced tariffs begin to cast their shadow on bilateral trade.

Sino-US trade talks have been held but on each occasion the negotiations broke down as some thorny issues remain on the table. In his second State of the Union address in February this year, Trump told Congress that a trade deal with China would require structural changes to end ‘unfair’ trade practices, such as subsidization of domestic businesses and making it obligatory on foreign companies to transfer technology to their Chinese counterparts. Such changes may be difficult to come by – at least in the foreseeable future – as they underpin China’s economic development model. In case the two sides fail to strike a deal, Washington has threatened to impose 25 percent tariffs on another $300 billion worth of Chinese imports by the end of this year. Even if an agreement is reached, it may fall apart in case the US trade deficit doesn’t significantly come down.

Although slowly, the trade war is beginning to cast its pall over the Chinese economy. After the growth had slowed down from 6.8 percent in 2017 to 6.6 percent in 2018, it decelerated further to 6.3 percent in the first half of the current year. The IMF forecasts for the full 2019 and 2020 put the economic growth at 6.2 percent and 6.0 percent respectively.

The Chinese government has taken different measures, such as cuts in tax and interest rates, to counteract the impact of tariff escalation on domestic businesses. The yuan has also been devalued to make sure that Chinese products stay competitive in the US market. The depreciation will lend credence to Washington’s allegations that Beijing by design keeps the exchange rate undervalued.

The slowdown of the Chinese economy and the currency depreciation doesn’t augur well for Pakistan for which China is a major export market and the largest source of imports. The growth contraction will put the brakes on demand for Pakistan’s products in the Chinese market. The yuan’s depreciation will make Pakistan’s exports to China expensive and Chinese imports cheaper thus exacerbating the bilateral trade imbalance, which was recorded at $12.7 billion for 2018. When titans clash, lesser mortals invariably suffer.

The writer is an Islamabad-based columnist.

Email: [email protected]

Twitter: @hussainhzaidi