It’s already tomorrow in Osaka, Japan, where President Trump and President Xi are scheduled to meet during the G20 Summit to discuss the trade conflict between the United States and China. The two sides are attempting to return to the table and come to an agreement about thorny issues around the trade balance, intellectual property, foreign direct investment, and monetary and industrial policy.
It’s a heavy lift, and recently both sides have retreated into harsher rhetoric and expectation management. Treasury Secretary Mnuchin said that the United States and China “were 90 percent of the way to a deal” and that he hoped China would be willing to return to the table. Meanwhile, statements this week by Chinese officials emphasized the country’s pride and sense of victimhood at the hands of the Trump Administration’s tariffs.
The downside risk is that talks fall apart and the United States imposes 25 percent tariffs on the remaining $300 billion of Chinese goods that have so far been unaffected by the trade war. In contrast to previous rounds of duties, which mostly targeted agricultural and industrial commodities, the next tariffs will land squarely on consumer goods.
Two factors introduce more uncertainty into the negotiations than most trade talks. The first is that the United States has powerful incentives to use tariffs to reset the country’s economic relationship with China – in fact, this was part of the goal of the Trans-Pacific Trade Partnership (TPP), which sought to establish closer links with Asia-Pacific countries in a bid to isolate China. The second factor is President Trump’s own unpredictability, which is either a bug or a feature depending on your politics. Both factors contribute to uncertainty and are causing businesses to redesign their supply chains out of an abundance of caution.
The flight of manufacturing and capital from China is already hitting its economy hard. The number of Chinese corporate defaults by issuer count and principal amount is likely to reach new highs this year, from 45 issuers and CNY110.5 billion in 2018, due to rising refinancing pressure, sluggish industrial-sector growth and weaker investor sentiment caused by the ongoing trade dispute with the U.S., Fitch Ratings reported.
So who benefits from a restructured trans-Pacific trade flow, one re-imagined to minimize companies’ exposure to tariffs on Chinese goods? Who will be the next China?
The short answer is that there is no next China. There are no countries that have the available manufacturing and logistics bandwidth to take on a significant amount of China’s exports to the United States, worth $539.5 billion in 2018. Mexico’s total exports to the United States in 2018 were $346.4 billion.
Vietnam is often cited as a beneficiary of the U.S.-China trade war, and indeed it is – according to Statista, in the first four months of 2019, Vietnamese exports to the U.S. grew 38.4 percent year-over-year. But keep in mind that Vietnam is a poor, relatively undeveloped country. Vietnam’s entire gross domestic product (GDP) is less than half the value of China’s exports to the U.S. Vietnam’s exports to the United States in 2018 totaled $57.8 billion, or 8.8 percent of China’s exports to the U.S.
Still, a structural transformation of the U.S.-China trade relationship is coming, and much of it has to do with internal changes in China. Average manufacturing labor costs in China are now higher than in Vietnam or Mexico. China’s share of global exports of clothing, footwear and furniture – low-end goods – peaked in 2014 and has been declining ever since. Competition from emerging markets like Vietnam and Bangladesh play a role there.
China’s exports are also getting squeezed at the high end by tech-centric economies in Japan, Singapore, South Korea and Taiwan. In the first four months of 2019, Taiwanese exports to the United States grew 22.1 percent compared to the same period in 2018; South Korea’s exports climbed 17.1 percent, according to Statista.
Meanwhile, so far this year the United States has imported between 20 percent and 40 percent less of the commodities from China that were subjected to tariffs. Overall imports from China decreased 12.8 percent. Chinese GDP growth is projected to slow to 6.2 percent, but from a very large base – the country is still adding the equivalent of Australia’s economy, about $1.1 trillion, to its economy every year. That is if, of course, you believe official Chinese government data, but that’s a different story.
Rerouting one of the major trade flows in the global economy will be a multi-year process. Countries like Vietnam are already growing their exports in excess of the country’s infrastructure capacity. Both of Vietnam’s international airports are rated as being among the most congested in the world, and plans to build a third, the Long Thanh International Airport, were approved just last month.