What will be China’s weapons in the trade war arsenal?

Trade war between China and the US escalated recently

The trade war of China and the US finally exploded on July 6th when the US imposed 25% tariff on China's imports with the total target of USD 34 billion and China retaliated back with the same tariff rate on the same amount of the US imports.

Right after Chinese announcement, Trump threatened to impose another 10% on China's USD 200 billion goods immediately, which marks the escalation of the trade war between China and the US. Apparently, it has made it impossible for China to implement a similar retaliatory tariff measure since China's total exports to the US only amounted to USD 150 billion last year. To a certain extent, the Trump's move is drawing a new deadline for China and the US to reach an agreement in the near future.

 

How will China fight back in the trade war?

Except for the retaliatory tariff measure, China actually has many other weapons in the arsenal to fight back. Below we list a number of policy options for China to fight back the US tariff measures. We then assess their feasibility as well as pros-and-cons to Chinese economy.

(i) Retaliatory tariff measures

This "mirror" retaliatory tariff strategy has its natural limitation since US imports much more from China than its exports to China. In 2017 the US imported Chinese goods of USD 500 billion while only exported USD155 billion of US goods to China. As Trump decided to expand its punitive tariff to USD 200 billion of Chinese exports as he threatened, it is impossible for China to find the same amount of US imports for retaliatory tariff. (Chart 1)

China

(ii) Restrictions on US business in China

China could use some non-tariff measures to retaliate as well. Some people suggest that China could limit investment or market access of US firms in China. Indeed, US firms have a large presence in China. Some estimates show that the stock of US investment in China amounted to USD 256 billion as of 2017. (Chart 2) China could seek to punish these US firms in China for retaliation.

chart

In this respect, the retaliatory measures could include: (i) to conduct more inspections on the US firms in China; (ii) to put restrictions on Chinese firms which are on the supply chain of these US firms; (iii) to increase penalties for US firms in China and delay their licensing approvals. Actually, China used these measures in the past when its territorial dispute with South Korea and Japan became acute.

However, these measures also have strong side effects on Chinese economy. First of all, one important goal of Trump's administration is to move US companies overseas back to the US. Therefore, by harassing US firms China's authorities are indeed doing a favor to the Trump administration to expedite the departure of these US firms. Second, these retaliatory measures could create a bad impression for investors from other countries and reduce the attractiveness of China as a FDI destination.

Download The Full China Economic Watch

This document was prepared by Banco Bilbao Vizcaya Argentaria’s (BBVA) Research Department on behalf of itself and its affiliated companies (each a BBVA Group Company) for distribution in the United States and the rest of the world and is provided for information purposes only. The information, opinions, estimates and forecasts contained herein refer to that specific date and are subject to changes without notice due to market fluctuations. The information, opinions, estimates and forecasts contained in this document have been gathered or obtained from public sources believed to be correct by the Company concerning their accuracy, completeness, and/or correctness. This document is not an offer to sell or a solicitation to acquire or dispose of an interest in securities.