China Loses More From This Trade War

(Bloomberg Opinion) -- With the U.S.-China trade talks now at a halt, odds are that the recent U.S. tariffs on China will continue — and perhaps even rise and multiply. So it’s worth considering what effects those tariffs will have. One prominent argument, which can also serve as a criticism of President Donald Trump, is that the U.S. consumer is the loser. Yet in reality, China is probably in the more vulnerable position.

To be clear, there are well-done studies showing that the recent tariffs have translated into higher prices for U.S. consumers. I am not contesting that research. The question is whether those studies give sufficient weight to all relevant variables for the longer run.

To see why the full picture is more complicated, let’s say the U.S. slaps tariffs on the industrial inputs (whether materials or labor) it is buying from China. It is easy to see the immediate chain of higher costs for the U.S. businesses translating into higher prices for U.S. consumers, and that is what the afore-mentioned studies are picking up. But keep in mind China won’t be supplying those inputs forever, especially if the tariffs remain. Within a few years, a country such as Vietnam will provide the same products, perhaps at cheaper prices, because Vietnam has lower wages. So the costs to U.S. consumers are temporary, but the lost business in China will be permanent. Furthermore, the medium-term adjustment will have the effect of making China’s main competitors better exporters.

Obviously, no final long-run estimates are possible right now. But it is quite plausible that China will bear the larger costs here, not the U.S.

Another risk for China is this: As its access to U.S. markets becomes more difficult, China may be tempted to look to Europe. It remains to be seen whether the European Union will adopt additional protectionist measures, but China must consider that the possibility is more than zero.

To understand another feature of the longer-term perspective, consider that the impact of tariffs can be felt in at least two ways. In highly competitive markets, prices have to match costs, and so a cost-boosting tariff really does translate into higher consumer prices. (This is the case with many of the recent U.S. tariffs on China.) But for profitable branded goods, the economics aren’t the same. If the U.S. puts higher tariffs on Mercedes-Benz, for example, the prices of those cars will still exceed their costs of production. Mercedes, wishing to keep some of its strong market position, will probably decide to suffer some of the cost of the tariffs in the form of lower profits, rather than passing them along to its customers.

China has prominent brands as well, be it Huawei in electronics or other firms in exotic food products, and over time it aspires to climb the value chain and sell more branded goods to Americans. In fact China has an industrial policy whose goal is to be competitive in these and other areas. Tariffs will limit profits for these companies and prevent Chinese products from achieving full economies of scale. So this preemptive tariff strike will hurt the Chinese economy in the future, even if it doesn’t yet show up in the numbers.

There is also a broader reason why a trade war with the U.S. hurts China, and this gets to an important point with trade agreements more generally. A U.S. trade agreement with China would (if enforceable) certify China as a place where foreigners can invest and be protected against espionage, intellectual property theft and unfair legal treatment. That prospect of certification is now suspended. That makes investing in China less desirable for many multinationals, not just U.S. ones. That, in turn, limits Chinese domestic wages as well as long-term learning and technology transfer. A U.S. certification of China might even boost Chinese domestic investment, but again that is now off the table.

In my numerous visits to China, I’ve found that the Chinese think of themselves as much more vulnerable than Americans to a trade war. I think they are basically correct, mostly because China is a much poorer country with more fragile political institutions.

And finally: My argument isn’t about whether Trump’s policy toward China is correct. I am only trying to get the basic economics straight. Next time you hear that the costs of the trade war are simply being borne by Americans, be suspicious. In their zeal to make Trump look completely wrong, on tariffs or other issues, too many commentators pick and choose their arguments. A more fair and complete economic analysis indicates that China is also a big loser from a trade war. Trump’s threats are exerting some very real pressure on the country.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include "Big Business: A Love Letter to an American Anti-Hero."

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