US-China trade and tech war: who gains, who loses

The trade and technology war between the US and China is surely escalating. President Trump has announced fresh rounds of additional duties on already-tariffed imports from China, and holds out the threat of bringing the remaining Chinese imports under higher tariffs. China has swiftly reciprocated with retaliatory tariffs. In addition, the US has blacklisted the Chinese telecom major Huawei alleging that it is involved in espionage, thereby effectively banning Huawei from acquiring American components and technology.

Trump has even boasted that even if American consumers could temporarily lose as a result of higher prices on some products, the US is emerging the “big winner” in this war.

What does economic theory and available empirical evidence tell us?

First, a trade deficit is not necessarily an indication of loss. If it were, then we should never go to a store to buy anything as the store does not buy anything from us in return. Second, multilateral trade deficit is more significant than deficit with a single country. Third, the overall deficit is basically a reflection of overspending by the deficit country. So, if the deficit country (US) tries to reduce deficit with one country (China) by imposing higher tariffs (rather than cutting overspending), it would end up buying more from other countries (like Vietnam, Mexico) with little effect on the multilateral trade deficit.

With tariffs, consumers lose (due to higher price and forced cut-back in consumption), domestic producers gain (as wages, employment and profits go up in protected but globally non-competitive domestic industries) and government gets additional customs revenue.

Cancelling the gains against losses, there remains a net national loss, unless there is a sufficiently large reduction in prices charged by the exporting countries (‘terms of trade gains’). The ‘infant industry argument’ for temporary protection does not apply to US industries. However, tariffs and threat to impose tariffs as a strategic tool can be justified (even by free traders) if it forces the ‘protectionist’ trade partner (China) to move towards free trade by dismantling existing tariffs and other objectionable practices, like forcing US companies to transfer technology or indulging in violation of intellectual property rights.

But this justification becomes valid only if a new trade deal ensuring freer trade and acceptance of multilateral rules by both parties is reached. There is no indication at this time that such an agreement is round the corner and the US is willing to give up the practice of violating multilateral rules under the guise of ‘national security’ and ‘America first’ policy.

Short-run impact

There is one careful and detailed study: ‘The Impact of 2018 Trade War on US Prices and Welfare’ (Centre for Economic Policy Research, UK) which estimates the short-run impact of US tariffs till the end of 2018. It shows that the US has become a net loser after the imposition of tariffs because the foreign suppliers (in China and other countries to which some US imports from China have been diverted) have not reduced their export prices (no ‘terms of trade gain’ for US) and the full cost of tariffs have been passed on to American customers. Even if the net loss per year is not big (less than 0.1% of US annual GDP), it is certainly not a ‘huge win’ for the US, as Trump wants people to believe.

This does not mean that China is not losing. It is quite likely that the Chinese economy is worse off due to Trump’s tariffs along with China’s retaliatory tariffs on US goods and the losses may well be more for China than for the US. But there is no publicly available empirical study on the impact on China.

Third countries would also be affected. For example, it opens up a window of opportunity for India to the extent some producers (Chinese and others) may like to shift part of their global supply chains to India to beat tariffs in China and US. Indian policymakers may help the process by reducing tariffs on imports of components, with higher tariffs on finished products to encourage shifting of labour-intensive assembly operations to India.

Over time, producers in India would learn to gradually move up the global value chain by indigenising components manufacturing. The flip side is that some Chinese producers — denied US markets —may like to dump excess stocks of goods in Indian markets, making life more difficult for Indian producers of similar products.

Who gains and who loses from the US attempts to prevent or at least delay the emergence of Chinese firms in high tech areas? The US tech leadership, embodied in the patents owned by US companies like Microsoft, Boeing, Apple or Pfizer, clearly benefits the shareholders of those firms. But, as a consequence, consumers in the US and elsewhere have to pay a much higher price. If these patented technologies were freely available (or could be ‘copied’ by others without paying royalty), production would have switched to the firms which are able to produce at the lowest cost, and consumers everywhere would have benefitted enormously.

Even now, US firms with patented technologies are shifting their production to cheaper countries but consumer prices are not coming down, only profits are going up. American workers are not gaining jobs either. In fact, the incentive for US firms to produce in cheaper locations abroad in search of higher profits is more with patents than if the patented tech could have been copied by, say, Chinese or Indian firms to give them stiffer competition.

So, under the present arrangement, US jobs are going abroad, consumers everywhere are worse off while shareholders and high-tech workers and management people with stock options in such US firms benefit, thereby accentuating the much talked about rising income inequality.

(The author is a former Professor of Economics, IIM, Calcutta)