Caught in the Crossfire of the US-China Trade War

Once again, a tweet by US President Donald Trump has put the world in shock: Shortly before the next negotiations with China, Trump pushed ahead with further punitive measures and increased customs duties on Chinese imports worth USD 200 billion from 10 to 25 percent. China retaliated in kind. What does this mean for China and specially the EU, which has been caught in the crossfire of Trump’s criticism, too?

What happened so far

Donald Trump criticized unfair trade practices by economic partners even before he became president of the US. He translated this criticism into action, when he took office. Even the EU, a like-minded partner of the US, was not spared. Together with China and Russia, Mr. Trump labeled the EU as a “foe”. Tariffs were imposed from both sides in 2018. A stronger focus has been on China, though, starting with an investigation into Chinese trade policy in 2017. Since then various tariffs and negotiations have marked the way towards a full-fledged US China trade war between the two superpowers.

The current state of the dispute is that Donald Trump has set China a one-month deadline to meet the US’s core demands. These include the reduction of the US trade deficit, better market access and better protection of intellectual property for American companies in China. China has put their own demands on the table and the head of delegation Liu He announced  he will not yield on fundamental matters (zai yuanze wenti shang jue bu rangbu). The last round of negotiations thus ended without concrete results and the threat of an ongoing trade war remains unresolved.

US China Trade War: Implications and options for China

The US and China are important economic partners. Their trade relations, however, have not been without tensions, even before President Trump took office. A core element of these tensions is the large trade deficit the US run with China. In 2018, China’s exports to the US in 2018 were worth about US $ 540 billion, while America’s exports to China in the same period were worth only about US $ 120 billion. It is the explicit goal of Donald Trump to reduce this imbalance, with tariffs being his means of choice. This has put China in a dilemma.

On the one hand, the “imbalance of terror” – the fact that China has more to lose in this confrontation than the US – makes its economy much more vulnerable to American measures, such as customs duties, than the US is to Chinese countermeasures. Moreover, US tariffs could hit those sectors that are the core of China’s industrial policy, e.g. the ten key sectors of “Made in China 2025” hardest, threatening China’s plans to become a major global player in these sectors.

On the other hand, far-reaching concessions threaten to undermine the foundations of China’s economic development. China is still in a catching-up process with its GDP per capita just a little above the world average. On top of that, yielding to the US could damage the authority of Beijing’s leadership in the eyes of the domestic public and the reputation of Xi Jinping within the Communist Party of China (CPC).

Given this disadvantageous position, we see three options for China:

1) Meeting American demands. This would have serious political and economic consequences for the Chinese leadership. The core of the Chinese economic system is to have a strong state as a central actor. Since US criticism is aimed at this very core, giving in for China could mean undermining her economic and political system as a whole. This is a risk that China’s leadership will not accept – and probably cannot accept without exposing itself to a highly uncertain outcome.

2) Making no concessions. It is obvious that China has no interest in systemic change and is more willing to accept economic disadvantages, even if these are very considerable. In this case, China would try to minimize the damage as much as possible – for example, by concentrating more on other markets, albeit much smaller than the US – and adjusting to the worst.

3) Muddling through. As in the previous round of negotiation, China could try to make concessions in some points, while not yielding in others. This led to a 3-months truce in Buenos Aires. Even now, being accused of not sticking to its promises, China was given another month by President Trump in order to meet his demands, which gives both sides a bit of time to look for a solution. These short-term maneuvers could go on for quite some time with an uncertain outcome for both sides, but at least avoiding a worst-case scenario for the time being.

Implications and options for the EU

The EU and the US have historically close political and economic ties. Nevertheless, the possibility of the trade war going beyond China cannot be ruled out. On the one side, this has economic consequences, since the US is the most important trade and investment partner of the EU. On the other side, there are two serious political implications.

First, current US trade policy endangers the rules-based international economic order as represented by the World Trade Organization (WTO). For the EU, the WTO, and more broadly speaking, multilateralism is the central pillar of the international trade system and should remain so.

Second, the deeper issue underlying the conflict between the US and China is of geopolitical nature. Due to the rise of China, the US is about to lose its position as the world’s only superpower. In this geopolitical conflict, the EU is in danger of getting stuck in a sandwich position, being squeezed by the US from one side and from China on the other.

In this situation, we see three options for the EU:

1) Retaliating and cooperating at the same time. Should the US turn to the EU next and threaten to enact more tariffs, the EU should take countermeasures with eye-to-eye measure, as before. This is necessary to remain a credible player in the negotiations with Donald Trump. At the same time, the EU should signal willingness to cooperate on disputable issues to find a satisfactory solution.

2) Holding up multilateralism. It might sound like a truism, but from a long-term perspective multilateralism still appears to be the first best option for international trade and investment relations. The EU should therefore push for WTO reforms and let neither the US nor China out of its responsibility for this process. Multilateralism might then get a real chance to survive.

3) Rethinking its external relations not only in regard to economic but also geopolitical aspects. Commission President Jean-Claude Juncker’s wish for a “Weltpolitikfähigkeit” of the EU, i.e. “the capacity to play a role, as a Union, in shaping global affairs”, already was a hint in this direction. China and the US are important partners of the EU, but the world is not made up of just the two. Australia, India and many countries in Latin America – such as the MERCOSUR countries, which will be topic of our next blogpost – and Africa have an interest in strengthening economic and political relations with the EU. This is where the EU should start to build more balanced and diversified external relations.

Since writing this post, President Trump has instituted sanctions believed directed at Chinese telecom giant, Huawei and China has threatened to retaliate. Follow us at @Kaihua2010 and @AnikaLaudien as this situation unfolds.