How Much Will The Trade War Hurt China?

- Aug 25, 2018-

What is the impact of the current trade war on the Chinese economy? An analysis shows that while the immediate direct impact on the economy is certainly negative, it is small in real terms, affecting less than 0.5% of GDP. However, while the immediate economic impact may be manageable for China, the trade war itself may do damage to the longer-term relations between China and the United States, including by affecting the future rate of growth of trade in services, including education and tourism. The U.S. has a persistent, large and growing surplus in this area, which was estimated by China to be $54 billion, and by the U.S. to be $40 billion in 2017. The biggest impact from the trade war might go beyond the immediate goods that are affected now.

But first, the immediate impact: the Trump administration's new list of Chinese products to be subject to tariffs will make the import of most of these goods from China prohibitively expensive for U.S. importers, as they don't have the kind of profit margins that would enable them to absorb the cost of these tariffs. If fully implemented, these tariffs will effectively lead to a complete halt in affected Chinese exports to the U.S., potentially amounting to $250 billion.

How would that affect the Chinese economy? First of all, China, as a large economy like the United States, has always been relatively immune to external disturbances. During the past four decades, while the rates of growth of Chinese exports and imports have fluctuated like those of all other economies, the rate of growth of Chinese real GDP has remained relatively stable, and in fact has always stayed positive.

Moreover, Chinese dependence on exports has continued to decline over the past decade. The share of exports of goods within total Chinese GDP has fallen from a peak of 35.3% in 2006 to 18.1% in 2017 (see Chart 1). Specifically regarding exports of goods to the U.S. alone, this share of Chinese GDP has also fallen by more than half, from a peak of 7.2% in 2006 to 3.4% in 2017.

Exports are no longer the principal engine of Chinese economic growth. Instead, the major driver of Chinese economic growth today is its domestic demand, driven by household consumption, infrastructural investments, and public goods consumption.

The fall in Chinese exports as a result of the new U.S. tariffs would amount to 1.7% of GDP. A reduction of this magnitude is material, but quite manageable in the aggregate. Thus, even if all Chinese exports to the U.S. subject to the new tariffs were both halted and not re-directed elsewhere, the decline in Chinese GDP caused would not exceed 1.12%. Such a reduction from an expected annual growth rate of 6.5% would leave 5.4%, which is still a very respectable rate of growth compared to the world average of 3.9%, as projected by the International Monetary Fund for 2018.