Can China afford a trade war?

NS Venkataraman

NS Venkataraman

By NS Venkataraman

CHENNAI, India, 24 March 2018

Over the last one decade or so, the world economy has been largely driven by the industrial and economic growth in China, which is more than any other individual country. China’s share of world output has gone up from 6.3% in 1996 to 17.8% in 2016.

US President Trump has announced at least $50 billion worth of annual tariffs and other penalties on China, on the reasoning that China is artificially keeping prices of Chinese products low to compete in the world market.

China’s growth and dominance

China is the world’s third largest country after Russia and Canada. China is only 15% of the global economy, but contributes 25 to 30% to global growth. China’s installed capacity and production of steel, aluminium, coal, power, and most chemical products have increased by leaps and bounds in the last ten years. China is the largest single consuming country in the world for chemicals. Its share in the global chemical consumption is now around 30%.

Of the global annual production of around 58 million tonne of aluminium, China’s share is around 32 million tonne. Chinese manufacturers continue to augment production capacities in the North-Western provinces at lower cost. This is expected to increase global aluminium supply in the coming years.

Steel production in the world is dominated by China and followed by Japan. China’s crude steel production is around 790 million tonne per annum, which is around 52% of the world crude steel production.

Reflecting China’s growing focus on the production of higher-value goods, the output of computers, telecommunications equipment and other electronics rose 12.1 percent on year.

Such steep increases in capacity and production with regard to several products inevitably resulted in China aggressively seeking export markets to find outlets for the products, as the installed capacity and production growth has been much higher than the domestic demand growth for the products.

In the process, China’s thrust on export has created problems for other countries, as Chinese prices have been much less than the price quoted by other producers, leading to falls in production or industrial plant closures in several countries including the US and India.

For example, production of citric acid in China, which was 6,00,000 tonne in 2003, climbed to 15,00,000 tonne in 2016. China now exports citric acid to more than 100 countries. As a result of export penetration by China, several citric acid plants have closed in number of countries. China now supplies 60% of the global demand for citric acid.

China has been repeatedly accused by several countries of artificially keeping prices of Chinese products low to compete in the world market, by providing soft cushions for the Chinese industries by way of concessions, unsustainable state subsidized production practices, soft loans, etc. Also, Chinese industries have been criticized for not observing the required environmental norms and violating the safety issues for the sake of boosting the capacity build-up and production.

However, in the last few years, China has realized the need to ensure the optimal performance of industry, by imposing strict environmental rules and stipulating norms for consumption of raw material and utility and enforcing closure of unviable units . Several units have also been forced to shift from unsafe location to industrial parks. China could take such corrective steps boldly, since it has built so much of over capacity, with the units operating at low-capacity utilization level in the last few years. and therefore, closure of some capacities do not really result in significant loss to overall production.

According to a survey of a basket of 16 chemicals studied by the European Union of Chamber of Commerce of China, as many as eleven face low-capacity utilisation issues in China.

While the growth rate in China has slowed in 2017 compared to 2016, these growth rates remain higher than in any other country in the world.

China’s vulnerability to global trade war

China’s total debt has been building up in the economy during the last several years to support growth. China’s debt surpassed 300% of GDP in 2017.

The People’s Bank of China has enabled the buildup of debt with “huge lending” to commercial banks. Debt-fueled consumer demand accounted for 71% of China’s economic growth in the first three quarters of 2016. China’s economic growth is being held up through extremely high credit generation, that is not sustainable for long without substantial damage to the economy and financial system.

In such a difficult scenario, China’s product offerings have to shift from the mid to high end in the value chain based on innovation-driven development to remain globally competitive without price-slashing in the coming years. China has to upgrade its manufacturing sector and take market share from high tech countries such as Japan, South Korea, US, and Europe for higher-end products. Obviously, to achieve such requirements, China’s export market has to be sustained and its global market penetration has to be enhanced.

In such a scenario, any fall in Chinese export due to trade war can cause huge setback to China’s plans and strategies.

China’s compulsive need for export

Overcapacity in industrial enterprises is the biggest problem that China is facing today.

China now has far more capacity than it — or for that matter, the world — needs. In some cases, over-capacity exists to the level of 30% of domestic need.

Over-capacity has been built up not only by domestic private Chinese companies but also by foreign companies, who target both Chinese and global markets.

The over-capacity problem has been exacerbated in recent times by the clear slowdown of China’s economy. Particularly impactful is the slowdown in infrastructure projects and in the real estate sectors. Over-capacity in the manufacturing sector could take far longer to be sorted out, especially given the state of the global economy.

To tackle such conditions and avoid an impending crisis, China faces a compulsive need to boost exports, as its domestic demand cannot absorb the production at a higher-capacity utilisation level than is needed to sustain the economy.

A trade attack by the US

US President Trump announced at least $50 billion worth of annual tariffs and other penalties on China, due to what the US terms “China’s theft of technology and trade secrets”, which US administration officials say has robbed American companies of billions of dollars in revenue and killed thousands of jobs.

The measures of the US government are targeted at imported Chinese goods in as many as 100 categories — hitting everything from shoes and clothing to consumer electronics — and will impose restrictions on Chinese investments in the United States..

President Trump says that he has instructed the Treasury Department to pursue restrictions on certain types of Chinese investments to counter China’s ambitious industrial policy, which aims at dominating cutting-edge sectors such as artificial intelligence and mobile technology.

The announcement comes hard on the heels of Mr Trump’s tariffs on steel and aluminium imports, and are aimed at combating a flood of cheap metals into the United States, including Chinese steel.

What about vulnerability of US and other countries?

In China, 31% of the ownership of industrial and production enterprises is by foreign companies, 21% is owned by state-owned enterprises, and the remaining 48% by the domestic private sector.

Billions of dollars are being invested by foreign companies in China year after year.

Almost every major multinational company in the world has investments in China. For example, BASF, a multi-national giant, has invested approximately €6 billion and above €8 billion with partners in China during the last 20 years.

Clearly, entry into the Chinese market is a high priority for foreign companies, in order to participate in this major growth region. Foreign companies remain optimistic about the prospects and opportunities in the Chinese market and continue to invest in the country. One strategy the foreign companies are adopting is in the building of local manufacturing facilities in China.

Any fall in economy or trade of China will adversely impact the performance and profit of foreign companies operating in China, most of which are multinational companies based in the US, Japan, South Korea, Western Europe and Middle East region. In view of their huge investment in China, any problems faced by them in China will directly and indirectly impact the economy of the developed countries where these multinational companies are based.

US President Trump believes that the imposition of tariffs will safeguard American jobs, but many economists say the impact of price increases for users of steel and aluminium, such as the auto and oil industries, will destroy more jobs in the US than curbs on imports create. Further, the effect of the China tariffs imposed by the US would have a bigger impact on United States consumers, who are heavy purchasers of electronics, clothing and other Chinese products.

China has argued that both the US and China benefit from the flow of Chinese money into the United States.

Why does US think a trade war is necessary?

Though the US President claims that the US has imposed steep tariffs on Chinese goods to protect the US economy, this may not be entirely true. It has to be noted that he has not imposed similar tariffs on other European countries and India so far, though these regions also have substantial share in US imports. Obviously, the focus of the US is on hurting China.

China, in recent years, has shown expansionist tendencies with its aggressive postures in the South China Sea, Senkaku Island, threatening India with border war, claiming India’s Arunachal Pradesh as its own, and several other claims. China’s aggressive takeover of Tibet is a classic example of China’s territorial expansion targets.

Last year, military spending in China was budgeted to increase by 7 percent, to 1.044 trillion yuan ($164.60 billion) about one-quarter of the proposed US defence spending for the year, which is obviously to support China’s warlike posture towards its neighbours.

Apart from territorial expansion ambition, China has also been focusing on economic domination of the world. It has considerably penetrated into the economy of weaker neighbours such as Pakistan, Bangladesh, Sri Lanka, Mauritius, Myanmar, and others.

Key infrastructure projects across Asia, Africa, and Europe under Belt and Road (BRI), are aimed at extending China’s global influence on the basis of its economic prowess. BRI is interwoven with official efforts to export Chinese rail, hydro-power, and other technologies, and steel, aluminium, and other industrial goods. Around $1.8 trillion of infrastructure investments across Asia, Africa, and the Middle East include Chinese money or other involvement.

Obviously, the US and several other countries are concerned about China’s aggressive approach and are of the view that China has to be checked to avoid it becoming an aggressive super power, perhaps, even stronger than the US.

While military warfare with China is ruled out, the only option left for the US is to impose checks and controls on China by starting a trade war.

Can China afford a trade war?

China says that it does not want a trade war with the United States, but it will defend its interests if the US would choose to launch a trade war.

However, it is extremely doubtful as to whether China can sustain a trade war, since Chinese economy would virtually collapse if the export of Chinese products were to be considerably curbed.

It remains to be seen as to what would be President Trump’s further strategies and whether the US would ask its allies also to join in the trade war against China. While the allies may not go to the full extent in supporting the US, nevertheless, they are watching with sustained interest the moves of President Trump, and perhaps want the US President to succeed.

About the author

NS Venkataraman is a chemical engineer as well as a social activist in Chennai, India. He is the founder trustee of Nandini Voice for the Deprived, a Chennai-based not-for-profit organisation serving the cause of the deprived and down-trodden, and working for probity in public life.

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