Tag: trade liberalization
US-China Trade War of 2018 and Its Consequences
The trade war between the United States and China has become one of the main events in the global economy this year. What could be its consequences for the US and China, and how might it affect other countries – for example, Russia?
Chronology of the trade war
Donald Trump started the war, raising import tariffs on solar panels in January 2018, of which the main supplier is China. In response, on April 2nd, China raised import duties on 128 commodities originating from the United States. On July 6th, the US increased tariffs on Chinese goods by 25 pp., imports worth $34 billion. China responded symmetrically. In August, the United States increased the tariffs on another $16 billion of imported goods from China, to which a symmetrical response again followed. In September, the United States again applied higher tariffs for $200 billion of Chinese exports, and China for $60 billion of US exports. At each stage of the conflict escalation, China appealed to the WTO with complaints about the actions of the United States, pointing to the inconsistency of their actions with the obligations and principles of the WTO. There were several meetings of official representatives from the United States and China – without any significant results.
What are the main reasons for this unprecedented escalation?
Imbalance and intellectual property
The economies of the US and China today are by far the largest in the world, and the trade turnover between the two countries is one of the most important. A remarkable feature of these trade flows over last decades is their imbalance. In 2017, the United States imported $526 billion worth of goods from China, while China’s imports from the United States amounted to $154 billion. Part of this imbalance is offset by trade in services, but it is not enough to even it out: in the same the year the United States delivered $57 billion worth of services to China while importing services of $17 billion from China.
Experts have different views on this imbalance. On the one hand, there is a perception that it is a source of world economy vulnerability, a source of potential crisis. Therefore, it is necessary to reduce the trade deficit. Another point of view is that this imbalance merely reflects the fact that the US economy and its assets are very attractive to investors from all over the world, including Chinese – and that, in turn, requires that the surplus of capital flows biased to US side, was compensated by the corresponding deficit of trade in goods and services. One such investor is the Chinese state itself, which for many years has been pursuing a policy of exchange rate undervaluation in order to promote foreign trade. It led to an enormous accumulation of foreign exchange reserves and as of January 2018, China held $1.17 trillion of US bonds and was the largest creditor of US government.
US President Donald Trump referred to this trade imbalance as one of the reasons for the outbreak of this trade war against China. Trump aims at reducing the deficit by $100 billion from the current $375 billion. The unilateral increase in import tariffs applied to Chinese goods was the first action of the US administration in this direction.
The second, no less important, formal reason for the trade war is the inadequate protection of intellectual property rights in China. China’s production of counterfeit products, the lack of adequate practices and laws to protect foreign technologies from illegal dissemination in the country, is not news to anyone. And although the almost two decades since China’s WTO accession have meant a largely modernized legal framework in this regard, a number of important provisions are still inconsistent with international practices, and the implementation of existing intellectual property rights leaves much to be desired. Established in 2012, The Commission on the Theft of American Intellectual Property identifies China as the most malicious violator of US rights. The exact damage is not known, but the commission assessment of the losses to the American economy due to the forced transfer of technology to Chinese partners – which is an unspoken condition of foreign manufacturers access to the Chinese market – industrial espionage, contradictions in legislation, requirements for the storage of sensitive data in China are in the range from $225 to $600 billion per year (Office of US Trade Representative, 2018).
While both the trade deficit and the intellectual property rights issue were recognized for many years, it was in 2018 that Trump started acting on them. Therefore, in order to discuss the potential impact of the conflict between the world’s largest economies on themselves and other economies, such as Russia, it is important to understand what drives the actions undertaken by Trump’s administration.
Populism
Trump won the elections in 2016 with a minimum margin against the Democratic rival. To provide support for his decisions and to increase the chances of being reelected for the next term in 2020, it is crucial to maximize the pool of his supporters. Trade policy measures aimed at import substitution are very effective populist policies in any country. One of the first steps made by the US toward trade war was the increase in import tariffs on steel and aluminum – for all countries. Metallurgy and coal industries are among the most organized and strong lobbyists in any country. The European Union as an economic organization started with the European Coal and Steel Association. By aligning interests with these sectors much can be achieved in relation to trade liberalization, and vice versa – by increasing the level of protectionism, a significant popularity increase can be among voters whose incomes depend on the success of companies in these industries.
Deterrence
China works hard raising the technological level of its economy. In recent years the Chinese government and Communist party launched a number of ambitious programs aimed at achieving a technological breakthrough, lessening the dependence on imported technologies by substituting them with ones produced by domestic innovation centers. These programs specify the priority sectors, in which state subsidies are provided for the acquisition of foreign technologies by Chinese companies and their adaptation. One of the common arguments was that the United States believes that powerful state support for technology sectors in China, along with the existing problems in protecting intellectual property rights, increases the risks and potential losses of American companies.
However, while these concerns seem reasonable at first, they should not be taken at the face value.
China’s ability to push out American companies in the high-tech sector on the world market seems rather limited. So far, China has only succeeded in increasing its share in the middle and low technology segments. Instead, in recent years, China is rapidly increasing its defense spending, which in 2017, for the first time, reached a level of 1 trillion yuan (about $150 billion). China’s defense spending is the second highest in the world after the United States. Moreover, it’s growing very fast. While in 2005 the Chinese nominal defense expenses were only 10% of American expenses, in 2018 they are already around 40%. The dominance of state enterprises in the defense industry in China implies that the real purchasing value of these expenditures is quite comparable. New and existing Chinese industrial policy programs target military and dual-use industries among others. Therefore whilst addressing the intellectual property rights problem in China now, Trump’s administration also aims at preserving US leadership position in the military sector, which finds widespread support in Trump’s main voter groups among Republicans.
Obsolete weapon
Historically, trade wars implied tariff escalations to protect domestic industries from foreign competition. Today, the Trump administration behaves in a similar manner. However, the circumstances now are fundamentally different from those in the first half of 20th century and earlier. Firms not only trade in final goods, but more and more they trade in intermediate products and within firms themselves (Baldwin, 2012). The distribution of the production process to many companies across different countries of the world leads to two important effects, which were not observed in previous trade wars.
First, it is the effect of the escalation of tariff protection in the framework of the value chains. The import tariff is applied to the gross value of the product crossing the customs border. However, the exporting firm’s contribution to the gross value might be quite small. So the effective level of the tariff will be higher than the nominal level of the tariff, known as a so called amplification effect (World Bank, 2017, page 98). It means that the effective growth of the tariff by 25 percentage points in relation to Chinese imports will significantly exceed 25 % and in some cases can even become prohibitive. So, the tariff warfare will result in significantly greater losses for the sectors involved in the value chains, compared to the sectors less exposed to them. It means that foreign investors and multinational companies in China will suffer bigger losses compared to purely domestic Chinese companies. The Peterson Institute for International Economics made an assessment and confirmed these observations (Lovely and Yang, 2018).
Second, China’s participation in international multinational companies most often occurs in the assembly segments, while developed countries’ companies contribute at other stages, such as with innovation, design, financial and consulting services, marketing, and after-sales services. Then, the protectionist measures against goods produced in China by multinational companies will hit an American economy, generating losses in the service segments. A similar episode happened, for example, in 2006, when the European Union introduced anti-dumping duties on imported footwear from China and Vietnam, which in turn lead to a decline in the services sector in Europe – imported footwear contained a significant share of the value added created by European designers and distributors (World Bank, 2017). Obviously, we will observe the same consequences in the United States now, since the role of the American services sector in creating and promoting Chinese goods on the American market is significant and according to World Bank estimates in 2011, the contribution of value added generated by foreign services in China’s gross exports amounted to about 15% (World Bank, 2017).
Thus, not only the economy of China, but also the US economy itself will suffer from the growth of import tariffs in the USA. The USA is not an exception here – the governments of most countries continue to live in the paradigm of trade policy, which suits the structure of the world trade as at the beginning of the 20th century, while trade has gone far ahead and requires much more elaborate effective regulatory tools than tariffs on imported goods.
Consequences for Russia
The consequences of the US trade war with China for the Russian economy depend on what the main goals of the war are. If the motive is primarily electoral – to secure enough support in 2020, one can expect that the protective measures will be short-lived, and the geographical distribution of investment flows will remain almost intact and that China will remain an important location for global value chains transactions. The trade war will in this case lead to some economic slowdown in the short term. The main effects will be related to the redistribution of income within economies, where protected sectors will benefit on the expense of all other sectors. In these circumstances, Russia would suffer direct losses from the growth of tariffs on their exports to US (now it is predominantly steel and aluminum), but for the economy as a whole, the losses will not be significant, especially relative to the losses Russia bears because of sanctions.
However, if the main reason for the trade war has a long-term perspective, the investors will be forced to adjust the geography of their investment plans and China will face a significant outflow of foreign investments, which will significantly affect Chinese – and global – economic growth. In this case, both for Russia and for the whole world, the indirect effect of the US-Chinese trade conflict will be quite noticeable and it will take years to create new trade links and restore world trade and global value chains.
References
- Baldwin, Richard, 2012. “Global supply chains: why they emerged, why they matter, and where they are going”, CTEI Working papers 2012-13, The Graduate Institute, Geneve
- Lovely, Mary E., and Liang Yang, 2018. “Revised Tariffs Against China Hit Chinese Non-Supply Chains Even Harder.” PIIE Policy brief, Peterson Institute
- Office of the US Trade Representative. March 22, 2018. “Executive office of the President findings of the investigation into China’s acts, policies, and practices related to technology transfer, intellectual property, and innovation under section 301 of the trade act of 1974.” https://ustr.gov/sites/default/files/Section%20301%20FINAL.PDF
- World Bank, 2017. “Measuring and analyzing the impact of GVCs on economic development”. World Bank, Washington DC.
Note
A longer version of this brief has been published in Russian by Republic: https://republic.ru/posts/92217
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
“New Goods” Trade in the Baltics
We analyze the role of the new goods margin—those goods that initially account for very small volumes of trade—in the Baltic states’ trade growth during the 1995-2008 period. We find that, on average, the basket of goods that in 1995 accounted for 10% of total Baltic exports and imports to their main trade partners, represented nearly 50% and 25% of total exports and imports in 2008, respectively. Moreover, we find that the share of Baltic new-goods exports outpaced that of other transition economies of Central and Eastern Europe. As the International Trade literature has recently shown, these increases in newly-traded goods could in turn have significant implications in terms of welfare and productivity gains within the Baltic economies.
New EU members, new trade opportunities
The Eastern enlargements of the European Union (EU) that have taken place since 2004 included the liberalization of trade as one of their main pillars and consequently provided new opportunities for the expansion of trade among the new and old members. Growth in trade following trade liberalization episodes such as the ones contemplated in the recent EU expansions could occur because of two reasons. First, because countries export and import more of the goods that they had already been trading. Alternatively, trade liberalization could promote the exchange of goods that had previously not been traded. The latter alternative is usually referred to as increases in the extensive margin of trade, or the new goods margin.
The new goods margin has been receiving a considerable amount of attention in the International Trade literature. For example, Broda and Weinstein (2006) estimate the value to American consumers derived from the growth in the variety of import products between 1972 and 2001 to be as large as 2.6% of GDP, while Chen and Hong (2012) find a figure of 4.9% of GDP for the Chinese case between 1997 and 2008. Similarly, Feenstra and Kee (2008) find that, in a sample of 44 countries, the total increase in export variety is associated with an average 3.3% productivity gain per year for exporters over the 1980–2000 period. This suggests that the new goods margin has significant implications in terms of both welfare and productivity.
In a forthcoming article (Cho and Díaz, in press) we study the patterns of the new goods margin for the three Baltic states: Estonia, Latvia and Lithuania. We investigate whether the period of rapid trade expansion experienced by these countries after gaining independence in 1991—average exports grew by more than 700% between 1995 and 2008 in nominal terms, and average imports by more than 800%—also coincided with increases in newly-traded goods by quantifying the relative importance of the new goods margin between 1995 and 2008. This policy brief summarizes our results.
Why focus on the Baltics?
The Baltic economies present an interesting case for a series of reasons. First, along a number of dimensions, the Baltic countries stood out as leaders among the formerly centrally-planned economies in implementing market- and trade-liberalization reforms. Indeed, those are the kind of structural changes that Kehoe and Ruhl (2013) identify as the main drivers of extensive margin increases. Second, unlike other transition economies, as part of the Soviet Union the Baltics lacked any degree of autonomy. Thus, upon independence, they faced a vast array of challenges, among them the difficult task of establishing trade relationships with the rest of the world, which prior to 1991 were determined solely from Moscow. Lastly, as former Soviet republics, the Baltic states had sizable portions of ethnic Russian-speaking population, most of which remained in the Baltics even after their independence. At least in principle, this gave the Baltic economies a unique potential to better tap into the Russian market.
Defining “new goods”
We use bilateral merchandise trade data for Estonia, Latvia and Lithuania starting in 1995 and ending in 2008, the year before the Global Financial Crisis (GFC). The data are taken from the World Bank’s World Integrated Trade Solution database. The trade data are disaggregated at the 5-digit level of the SITC Revision 2 code, which implies that our analysis deals with 1,836 different goods.
To construct a measure of the new goods margin, we follow the methodology laid out in Kehoe and Ruhl (2013). First, for each good we compute the average export and import value during the first three years in the sample (in our case, 1995 to 1997), to avoid any distortions that could arise from our choice of the initial year. Next, goods are sorted in ascending order according to the three-year average. Finally, the cumulative value of the ranked goods is grouped into 10 brackets, each containing 10% of total trade. The basket of goods in the bottom decile is labeled as the “new” goods or “least-traded” goods, since it contains goods that initially recorded zero trade, as well as goods that were traded in positive—but low—volumes. We then trace the evolution of the trade value of the goods in the bottom decile, which represents the growth of trade in least-traded goods.
Findings
For ease of exposition, we present the results for the average Baltic exports and imports of least-traded goods, rather than the trade flows for each country. Results for each individual country can be found in Cho and Díaz (in press). We report the least-traded exports and imports to and from the Baltics’ main trade partners: the EU15, composed of the 15-country bloc that constituted the EU prior to the 2004 expansion; Germany, which within the EU15 stands out as the main trade partner of Latvia and Lithuania; the “Nordics”, a group that combines Finland and Sweden, Estonia’s largest trade partners; and Russia, because of its historical ties with the Baltic states and its relative importance in their total trade.
Least-traded exports
Figure 1 shows the evolution over time of the share in total exports of the goods that were initially labeled as “new goods”, i.e., those products that accounted for 10% of total trade in 1995. We find that the Baltic states were able to increase their least-traded exports significantly, and by 2008 such exports accounted for nearly 40% of total exports to the EU15, and close to 53%, 49% and 49% of total exports to Germany, the Nordic countries, and Russia, respectively. Moreover, we find that the fastest growth in least-traded exports to the EU15 and its individual members coincided with the periods when the Association Agreements and accession to the EU took place. Finally, we discover that the rapid increase in least-traded exports to the EU15 during the late 1990s and early 2000s is accompanied by a stagnation of least-traded exports to Russia. This suggest that, as the Baltics received preferential treatment from the EU, they expanded their export variety mix in that market at the expense of the Russian. Growth in least-traded exports to Russia only resumed in the mid 2000s, when the Baltics became EU members and were granted the same preferential treatment in the Russian market that the other EU members enjoyed.
Figure 1. Baltic least-traded exports
Source: Cho and Díaz (in press).
Least-traded imports
Figure 2 plots the evolution of Baltic least-traded imports between 1995 and 2008. We find that new goods imports also grew at robust rates, but their growth is about half the magnitude of the growth in the least-traded exports—the least-traded imports nearly doubled their share, whereas the least-traded exports quadrupled it. The least-traded imports from the EU15 and its individual members exhibited consistent growth throughout. On the other hand, imports of new goods from Russia—which had also been growing since 1995—started a continuous decline starting in 2003. This change in patterns can be attributed to the Baltics joining the EU customs union. Prior to their EU accession, the average Baltic tariff was in general low. Upon EU accession, the Baltics adopted the EU’s Commercial Common Policy, which removed trade restrictions for EU goods flowing into the Baltics, but—from the perspective of the Baltic countries—raised tariffs on non-EU imports, in turn discouraging the imports of Russian new goods.
Figure 2. Baltic least-traded imports
Source: Cho and Díaz (in press).
Are the Baltics different?
Figure 1 shows that the Baltic states were able to increase their least-traded exports by a significant margin. A natural question follows: Is this a feature that is unique of the Baltic economies, or is it instead a generalized trend among the transition countries?
Table 1: Growth of the share of least-traded exports (percent, annual average)
Source: Cho and Díaz (in press).
Table 1 reveals that the new goods margin played a much larger role for the Baltic states than for other transition economies such as the Czech Republic, Hungary and Poland (which we label as “Non-Baltics”), for all the export destinations we consider. Moreover, we find that while until 2004—the year of the EU accession—both Baltic and Non-Baltic countries displayed high and comparable growth rates of least-traded exports, this trend changed after 2004. Indeed, while there is no noticeable slowdown in the Baltic growth rate, after 2004 the Non-Baltic growth of least-traded exports to the world and to the EU15 all but stops, with the only exception being the Nordic destinations.
Conclusion
The Baltic states, and in particular Estonia, are usually portrayed as exemplary models of trade liberalization among the transition economies. Our results indicate that the Baltics substantially increased both their imports and exports of least-traded goods between 1995 and 2008. Since increases in the import variety mix have been shown to entail non-negligible welfare effects, we expect large welfare gains for the Baltic consumers experienced due to the increases in the imports of previously least-traded goods. Moreover, the literature has documented that increases in export variety are associated with increases in labor productivity. Our findings reveal that the Baltics’ increases in their exports of least-traded goods were even larger than their imports of new goods, thus underscoring the importance of the new goods margin because of their contribution to labor productivity gains.
References
- Broda, Christian; and David E. Weinstein, 2006. “Globalization and the gains from variety,” Quarterly Journal of Economics, Vol. 121 (2), pp. 541–585.
- Chen, Bo; and Ma Hong, 2012. “Import variety and welfare gain in China,” Review of International Economics, Vol. 20 (4), pp. 807–820.
- Cho, Sang-Wook (Stanley); and Julián P. Díaz. “The new goods margin in new markets,” Journal of Comparative Economics, in press.
- Feenstra, Robert C.; and Hiau Looi Kee, 2008. “Export variety and country productivity: estimating the monopolistic competition model with endogenous productivity,” Journal of International Economics, Vol. 74 (2), pp. 500–518.
- Kehoe, Timothy J.; and Kim J. Ruhl, 2013. “How important is the new goods margin in international trade?” Journal of Political Economy, Vol. 121 (2), pp. 358–392.