The trade ‘war’ between the US and China has been continuing since July 2018. Trade tensions between the two super-economies has had a substantial impact on global trade and growth. The negative impact on trade extends beyond the shrinkage of bilateral trade because globally China is the hub of the manufacturing supply chain network. The reduction in its domestic production for export, for example, would decrease its imports from input suppliers from the East Asian economies and the rest of the world.

Up until February 2020, Korea, Germany and Japan seemed to have had the largest negative impact while Vietnamese exports to US increased. The trade war also led to a decrease in the growth rate given the withered domestic consumption and corporate investments following the GFC in 2007-2009. This justifies why the resolution of the trade war is particularly important to raise/maintain the current economic growth rate for most countries.

The phase one deal signed in January 2020 is positive as it assured no further deterioration of the trade war in the immediate future. However, the problem is that the conflict has yet to be resolved as President Donald Trump publicly announced. Therefore, we need to examine carefully the phase one deal and its implications. This agreement provides important information about the origins of the trade dispute, allowing us to draw some implications for government policy and multinational’s global strategy. 

The 18-month-long war between the two super-economies has resulted in escalated import tariffs and business uncertainties. The trade war broke out when US began to levy 25% tariffs on $34 billion worth (818 items) of imports from China in July 2018, followed by China’s levy of retaliative tariffs on US products, which in turn invited the levy of US tariffs on $200 billion worth of imports from China and so on. The agreed deal indicates that there are both political and economic reasons behind the trade dispute.

The sustained US trade deficit could be one of the reasons, according to President Trump. The size of US trade deficit in 2019 was $616.8 billion and 56% of this ($345.6 billion) was from trade with China. However, the trade deficit itself should not be blamed unless the composition of imports is dominated by luxury consumer goods. Indeed, most of the US’ imports from China are desirable goods such as computers, mobile phones and clothing/footwear.

President Trump’s emphasis on the trade deficit problem is misleading—rather it conveys his intention to justify his actions to decrease trade deficits for political gain and potential re-election in November 2020. This political agenda is confirmed by the deal highlighting China’s agreement to purchase $200 billion worth of US goods, including agricultural products, over the next two years. In response, the US cut the tariff levy from 15% to 7.5% on $120 billion worth of imports and cancelled the tariffs on $160 billion worth of imports from 15 December 2019.  

In this deal, China also promised a strengthened protection of intellectual property right and abolition of demand for technology transfer from the US multinationals. The emergence of China as the G2 and President Xi Jinping’s ambitious plan of the China 2020 to modernise and level-up the Chinese economy and technology has also been regarded as a threat to US hegemony in high-tech industries, such as the 5G technology. Without effective protection of intellectual property rights, US multinationals are reported to be pressured by the Chinese government to transfer their high-tech to local companies as a pre-requisite to run their businesses in China.

China also agreed to open financial markets including share markets and promised no government intervention to devaluate the Yuan. Compared to other agreements, implementation of Yuan exchange rate policy is somewhat complex and could be controversial. In contrast to the manufacturing sector, the global competitiveness of China’s financial market has yet to be developed. The opening of its share market could encourage foreign investor’s portfolio investments. The decreased return on investment, in combination with relocation of multinational firms from China to ASEAN and India, along with the trade war, would facilitate the replacement of foreign direct investments with portfolio investments.

As a result, the value of the Chinese currency, would be more vulnerable to shocks in the global market. Due partly to the sustained business uncertainty in the global market, a high demand for the US dollar has been maintained. This capital injection in combination with the sustained domestic consumption has contributed to US economic growth, despite poor performance of all other developed countries. This puts upward pressure on the appreciation of Yuan, which is effectively pegged to the stronger US dollar, however the deal prohibits government intervention to devalue the Yuan which is different from other emerging economies’ currencies.

This is detrimental to the growth of the Chinese economy—particularly when both domestic consumption and investments are shrinking—whilst most other emerging nations competitively depreciate their own currencies (i.e. global currency war). The dwindling of consumption and corporate investments has also been worsened by the eruption of Covid- 19 in early 2020. The Covid-19 is expected to impact negatively on the real economy through fallen financial markets leading to a decrease in household consumption (i.e. wealth effect), keeping consumers at home (i.e. consumer confidence) and disruption of supply chain networks. In order to restore his authority and growth, President Xi will have a strong desire to depreciate the Yuan to prevent its GDP growth rate from dropping below a critical level, perhaps 6%.

Though not included in this phase one deal, the issue of a level playing field has often been addressed by US representatives during the last 12 rounds of negotiations. In particular, the Chinese government’s subsidies for state-owned enterprises (SOE) remains an issue to be resolved. This is a challenging issue because China considers it as related to national sovereignty and internal legal system while US regards it as an issue of fair competition and a norm to be accepted by all participants in the global market. The portion of SOE is around 65% of all the Chinese firms, which are approximately 70-80% of listed firms in the Shanghai share market, are SOE and these are strong supporters of President Xi.

The debt problem of SOE has been deteriorating since 2014 and existing debts have amounted to 135 trillion Yuan ($18.9 trillion). These listed SOE have increased leverage using the issued shares as collateral to invest in property and other sectors. Currently, more than 8% of total revenue (24 trillion Yuan, equivalent to $3.4 trillion) of the SOE are used to service the interest component of the debts. SOE account for half of new credit but have recorded added value that is less than half that of the private sector. The high leverage and low profitability of SOE has eroded capital adequacy ratio of most local banks that provided the debt.

The growth in lending by banks to shadow banking entities is another potential problem to deteriorate the ratio. These shadow banking entities, such as non-bank financial institutions, wealth management products, mutual funds and trusts had assets of about 123 trillion Yuan ($17.22 trillion) in 2016, according to Nomura. Most local governments have also played a Ponzi game referring to the continuous issuance of new bonds to pay back the existing debts and interest payments. Fiscal soundness of most local governments except Shanghai is also worrisome. The estimated debts of local government ranged between 16 and 42 trillion Yuan ($2.24-5.88 trillion), depending on different sources such as the China’s Ministry of Finance and IMF.

China may adopt expansionary monetary and fiscal policies to overcome the expected recession caused by the trade war and the spread of coronavirus. The expected low economic growth combined with low profitability of SOE and deficits of local governments will increase pressure for Chinese governments to continue the subsidies, contradictory to the US expectation. President Trump wishes the remaining issues of opening internet markets, intellectual property rights in high-tech and subsidies to SOE to be completely resolved in the upcoming phase two deal so that he would not need to consider any further deals. Contrary to this expectation the phase two negotiation could be a beginning of many more deals as it will seriously tackle the hegemony in new technology and the level playing field, which is closely related to the Chinese national legal system, political regime and, to some extent, social value.


Dr Byung-Seong Min is a Senior Lecturer in the Department of Business Strategy and Innovation.