A China-US decoupling? You ain’t seen nothing yet

Wed Feb 07 2024
Eric Whitman (301 articles)
A China-US decoupling? You ain’t seen nothing yet

The U.S. trade deficit with China is on track to fall to its lowest in a decade. This looks, at first glance, like a decoupling of the two economies thanks to the steep tariffs President Donald Trump slapped on Chinese imports in 2018.

Trump is spoiling to finish the job, floating a 60%, or higher, tariff on all Chinese imports if he’s re-elected this fall.

The U.S., though, hasn’t kicked the Chinese import habit as much as the data suggest. Chinese and Western manufacturers have found numerous ways around tariffs; they are likely to redouble those efforts if the levies go higher.

Last year, the overall U.S. trade deficit shrank to $1.1 trillion from $1.2 trillion in 2022, according to preliminary data from the Commerce Department. As a share of gross domestic product, it fell to 4%, the lowest in a decade.

Most of the reduction came via the gap with China. This dropped by more than $100 billion to $281 billion in the 12 months through November from the same period a year earlier. December data will be released Wednesday morning.

One reason the deficit shrank is that U.S. importers might have overordered in 2022, leading to swollen inventories and less imports in 2023 even as consumption stayed strong.

More fundamentally, the shrinking trade deficit overstates how much the U.S. has reduced its consumption of Chinese-made products. As the trade war heated up, many manufacturers began moving production to other countries to avoid U.S. tariffs. So the U.S. trade deficit with Mexico leapt to $151 billion in the 12 months through November, more than double the 2017 figure. The deficit with Vietnam ran at $104 billion, almost triple the level of 2017.

A lot of the value of those increased imports from Vietnam and Mexico actually consisted of inputs originally sourced in China. It’s hard to say how much because of gaps in the data. Still, the McKinsey Global Institute recently reported that even as China’s share of U.S. manufactured imports declined from 2017 to 2020, its share of the value added in goods consumed in the U.S. actually rose.

Furthermore, Chinese companies have been exploiting a decades-old provision in U.S. trade law that allows packages worth less than $800 to enter the U.S. duty-free.

Federal data compiled by the Yale University economist Amit Khandelwal and a co-author show the number of packages entering the U.S. under that “de minimis” exception has tripled since 2017 to a billion last year.

This doesn’t mean the tariffs had no effect. Khandelwal and others found the tariffs reduced imports of the affected products by 30%; some of that was made up for by purchases of other Chinese, foreign or American-made products. The authors estimate the total cost to the U.S. economy at 0.04% of GDP, as losses to consumers slightly offset gains to U.S. producers and the U.S. Treasury.

A separate study by David Autor of the Massachusetts Institute of Technology and co-authors found that counties whose companies were meant to benefit from tariffs marginally gained employment. But, on average, those gains were more than offset by losses when China retaliated. (Nonetheless, it found those counties rewarded Trump politically, the study found.)

The fundamental obstacle to decoupling is that China’s dominant position in world manufacturing makes it hard to find substitutes. Its economy is hard-wired to manufacture more than it can consume, dictating that it export the surplus. As collapsing property investment undercuts growth, the ruling Communist Party has leaned even more on manufacturing, though many companies are already unprofitable.

“2024 will be the year of overcapacity, and pressure on exporters in China will be sky-high,” said Joerg Wuttke, president emeritus of the European Union Chamber of Commerce in China. “In wind turbines, solar panels, everyone is losing money. In cars, one company makes money, the other 100 lose money.”

So, if tariffs of 25% barely reduced the U.S.’s dependence on China, would 60% do more? Probably. Khandelwal ran the numbers for a 35% tariff. He estimates a much larger effect on imports and resulting cost, equal to 0.8% of GDP.

Still, Brad Setser of the Council on Foreign Relations predicts China would double down on efforts to evade or neutralize higher tariffs. “The incentive to disassemble the product, take out a few screws, find an alternative screw supplier, ship them to a third party so it’s not 100% Chinese content, and package it as an export from the third party is just overwhelming,” he said. Its companies would make even greater use of the de minimis exception, he added.

This doesn’t mean the U.S. and China are destined to stay coupled. Historically, supply chains move gradually. Often, just one step or component goes offshore before an ecosystem of suppliers develops. Over time, the Chinese component in U.S. imports from third countries seems destined to drop.

“Greenfield foreign direct investment into developing countries has remained constant, but the share that’s going to countries that are not China and not Russia has gone way, way up,” said Olivia White, one of the authors of the McKinsey report. “That’s consistent with that investment helping those countries’ capacity to do more and more.”

To make India a base for mobile-phone production, Apple is moving more suppliers there. Samsung has done the same in Vietnam.

The catch is that Chinese companies are playing that game too. To get around American tariffs, their electric-vehicle and battery companies are building or contemplating new factories in countries that have trade agreements with the U.S., such as Mexico, South Korea and Morocco.

Setser predicts that China, to make up for lost exports to the U.S., would drive down its currency to boost exports to countries that haven’t raised tariffs—expanding Chinese companies’ presence in those economies.

Of course, the U.S. could try to keep those imports out by hitting other trading partners with tariffs. Trump has proposed a 10% levy on all imports, not just from China.

This, though, is a recipe for the decoupling of the U.S. not just from China, but the whole world.

Eric Whitman

Eric Whitman

Eric Whitman is our Senior Correspondent who has been reporting on Stock Market for last 5+ years. He handles news for UK and Europe. He is based in London