The US-China trade war and domestic reforms


On 24 September 2018, the US imposed a 10 per cent tariff on $200 billion worth of annual Chinese imports, with the tariff rate rising to 25 per cent beginning 1 January 2019. In addition, the US has threatened further duties on $267 billion worth of goods should China retaliate – which it did.

Coming into effect on 24 September as well, China enacted 10 per cent tariffs on $60 billion worth of US goods. This, at the time of writing, has been the latest scrimmage in the ongoing 2018 Sino-US trade war, and the largest round of tariffs imposed on Chinese imports by the US. From the onset of this trade war back in March 2018, mainstream media and academia have been in a frenzy – speculating on the possible ways to “win”, how each side will react, and what the ultimate outcome would look like. However, while both the media and academic literature have drawn in large audiences on both sides of the Pacific, they failed to notice, and thereby understand, the ongoing structural changes within the Chinese economy.

Mainstream media and academia have duly noted that China cannot win this trade war on a tariff basis. Simply put, China does not import nearly enough US products and services for a tariff-oriented tactic to have meaningful effect. In effect, it is the structural difference between the two economies that have already dictated the outcome of this trade war, should it remain on the tariffs battlefield. The US dollar – the de facto global currency – affords the US a unique advantage; that is, the exchange of fiat money for tangible goods, thereby rendering the US an import powerhouse. China does not possess this advantage, nor is its economy as strong and resilient as that of the US. It would seem, then, China would be playing a losing game, as many industry analysts have predicted that the Chinese economy would take on serious damage in 2019 should this trade war continue.

Yet, this trade war affords China many opportunities to clean up the economic mess left behind by decades of strong growth. The Chinese economy, which developed based on massive volumes of exports, cheap currency and labour, has slowed down in recent years and is now faced with many systemic issues, most of which relate to the mountains of sub-national and corporate debt accumulated as part of its growth. Despite having brought unprecedented wealth to China, this export-oriented model has allowed debt-related economic and financial problems to jeopardize the country’s future growth and the longevity of its ruling party, as well as imbued the economy with substantial systemic risks making it more susceptible to both internal and external shocks.

The trade-war has so far provided the Xi Jinping Administration with ample firepower to push forward two sets of domestic reforms which, if successful, will clean up much of the rust left behind by the export-oriented model and reorient it towards a more consumption and innovation-based structure. The first set of reforms is aimed at aiding China’s economic transition. Since the beginning of 2018, the government has made progress on further opening up its domestic market to foreign capital on a number of occasions. For example, in July, tariffs on nearly 1,500 consumer goods, automobiles and automobile parts were cut – in some cases, by more than half of their original rate. Again, in November, China released another round of cuts in consumer goods tariffs, this time on products ranging from machinery, electrical equipment and textiles. The effects of these cuts were almost immediate: in August, China’s automobile imports rose 70% with Japanese and European vehicles leading the charge. While such reforms might have been rolled out regardless, it is undeniable that the additional pressures created by the trade war have played a key role by imbuing such reforms with a new sense of urgency.

The second set of reforms is geared towards improving financial stability and overall economic resiliency. These reforms have worked hand-in-hand with Xi Jinping’s deleveraging campaign and provided wider powers to China’s financial regulators: the China Securities Regulatory Commission; the China Banking Regulatory Commission; and the China Insurance Regulatory Commission. In April, the latter two regulators were merged into a superagency – the China Banking and Insurance Regulatory Commission, allowing for improved cross-sector supervision of financial products. The banking and insurance industries have, in recent years, seen a rise of shadow banking activity as many small and medium enterprises are squeezed out of traditional channels of financing due to insufficient upfront collateral. The rise in shadow banking contributed in large part to the spike of Chinese corporate debt, but recent regulations have sought to clamp down on its growth. In tandem with the drive for deleveraging, the National Development and Reform Commission (NDRC) – also known as the “small State Council” – announced in June that real estate and infrastructure companies, as well as local governments, will have their funds raised from offshore bonds limited to repaying existing debt, banning them from using such proceeds to invest in domestic property projects and replenishing working capital. In a similar vein, the Chinese cabinet released new guidelines on deleveraging for 30 state-owned firms in September. These guidelines also address local government debt indirectly by prohibiting authorities from hiding financial liabilities by issuing corporate bonds. These are but a few examples of China’s financial sector and economy-wide reforms implemented in 2018. Taken together, they paint a picture of a more cautious and conservative Chinese leadership that has committed to cleaning up and reorienting the economy.

The 2018 Sino-US trade war has not yet dealt any substantial damage to either side, and there is now a slight chance that this may all conclude before 2019: on 2 November, President Trump asked his cabinet to draft a potential trade deal with China, and many media outlets are speculating that this trade issue may be resolved at the upcoming G20 summit in Argentina where Xi and Trump are due to meet. Regardless, this trade war has undoubtedly shown the Chinese leadership the urgency of much needed domestic reforms.

Risk Advisory’s Business Intelligence Asia team has over 20 years’ experience helping clients conduct due diligence and strategic intelligence across industries.

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