Chinese Premier Li Keqiang just issued a strong message to Donald Trump: You really don’t want to start a trade war with us.
Speaking at a news conference on Wednesday, Li cited an article from “an authoritative international think tank” showing that “should a trade war break out between China and the United States, it would be foreign-invested companies, in particular US firms, that would bear the brunt of it.”
“We don't want to see any trade war breaking out between the two countries. That wouldn’t make our trade fairer,” he added.
Is Li right that US companies would end up hit harder than Chinese companies in the event of a trade war?
It’s true that a lot of US companies like Apple that rely on manufacturing their products in China would take a big hit from a dramatic escalation of tariffs, or border taxes, on goods flowing from China to the US.
But saying that those companies would really bear the brunt of a trade war eclipses a few important points. The first has to do with something called “import substitutability” — the ease with which the US can find substitutes for what it imports from China.
The reality is that companies like Apple or big US clothing companies would ultimately be able to move their operations to other countries with cheap labor such as Thailand or Mexico.
In fact, given that China’s swiftly rising manufacturing wages are approaching levels seen in Europe, a lot of foreign firms in China are already starting to make that pivot. So slapping tariffs on goods flowing from China to the US would accelerate a dynamic that’s already taking hold.
By contrast, Chinese companies importing key goods from the US won’t necessarily be able to find a substitute nearly as easily. Daniel Rosen, a founding partner and economic analyst at the research firm Rhodium Group, says that China would struggle to find replacements for huge quantities of agricultural goods and high-end technology that China sources from the US.
“The Chinese can’t buy replacement parts for a Boeing from other countries,” he explains.
In other words, many US companies can be more agile in their response to tariffs than Chinese ones. But more broadly speaking, it’s probably not better to think of trade wars between two countries whose economies are as tightly interwoven as the US and China as having winners and losers. It’s best to think of it as an “everyone loses situation.”
The conventional wisdom is that China relies more heavily on the US to keep its enormous export operation going, so it would suffer a bigger wound from a trade war. This analysis points to the fact that China exports a lot more to the US than the US exports to China.
The US goods trade deficit with China — that is, the amount by which its imports from China exceed its exports to China — is close to $370 billion. And the growth of the Chinese economy overall relies much more on trade than US economic growth does.
But the US also needs China, and aggressive tariffs on American goods going into China would be hugely damaging to its economy. Since the turn of the millennium, China has leapt from the 11th-largest export market for the US to the third-largest export market. The large volume of exports to China helps employ Americans — about 1.8 million of them, according to an Oxford Economics report published in January.
The US also benefits economically from the cheap Chinese goods that the US opens itself up to. Trade with China saves typical American households up to $850 a year, and that extra money gets spread across the economy and helps keep people employed in a variety of domestic industries.
Services that the US provides to China would also take a hit. Chinese restrictions on students and travelers coming to the US would hurt the revenues of higher education institutions and the tourism industry. “You can’t really find any American city that has a big tourism sector that’s not chomping at the bit to make China a bigger part of their game plan,” Rosen says.
Given the huge cost for both the US and China that would result from a trade war, it’s best to think of it as an event that would have no true victors — and thus something that should be avoided at all costs.