The US-China Trade War: Three Scenarios

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US-China Trade War

The US and China have been locked in a trade battle since July this year.

If things continue unchanged, the US tariff rate on US$250 billion worth of Chinese imports – about half of the total trade volume in terms of value – will jump to 25 percent on January 1, 2019.

The tariffs will be a major discussion point for participants during the upcoming Group of 20 (G20) Summit to be held at Buenos Aires in late November.

The summit and January deadline are, in fact, two hard dates for trade bureaucracies in both countries. Failure to reach a ceasefire before January and triggering the higher tariff rate could push US-China trade ties to a point of no return.

In the meantime, American business leaders are actively assessing whether they need a rethink on their China strategy, beyond the trade war.

While the ongoing tariff brinkmanship has put tremendous pressure on firms doing business in China, they were already feeling the pain of growing labor costs, mounting compliance standards, and roll-back of subsidies, besides the competition from state-controlled entities.

Here we present three distinct scenarios – as a thought experiment – for business planners in the region. In reality, any like outcome will have elements of each of these scenarios.

US-China Trade War

Rapid escalation leads to all-out trade war

How will this scenario play out?

Trump and Xi decide that negotiation is not an option; neither side wants to look weak and both sides look to establish their own cold war-type camps.

Escalating tariff and non-tariff barriers make it impossible for Chinese firms to do business in the US and vice versa.

High tariffs raise costs for suppliers, manufacturers, retailers, and consumers – albeit disproportionately in the US market.

As prices increase, production volumes decrease, profit margins diminish, companies go out of business, and jobs are lost.

China begins to invest aggressively in its market ties with Europe, Africa, Asia, and Latin America.

The US does the same. American firms will seek to shift their supply chain ecosystem out of China into Southeast Asia – in part or wholescale.

How likely is it?

The scenario is improbable as both sides will incur huge costs. Businesses will exert greater pressure on both governments to draw-back, which propaganda machinery won’t be able to cushion.

US and China are the world’s largest economies, biggest markets, and are at the heart of the global industrial supply chain.

The two countries won’t be able to sustain a trade war unscathed, and an all-out trade war could trigger a new global recession.

However, Trump has been known to react unpredictably, and China should be preparing itself for the worst case scenario – no ceasefire followed by tariff escalation.

How will we know?

American and Chinese brinkmanship at the G20 summit and other international forums will signal that both sides are unable to trust each other to start talks or reach a compromise.

This will become more clear in the days leading up to the G20 summit in late November, this year and in the immediate weeks after.

Businesses should pay attention to who the respective governments are talking to, where new investments are headed, if Chinese or American investments in either markets are getting blocked, and how regional trade arrangements are shaping up.

New status quo reached

How will this scenario play out?

Trump and Xi agree to end trade hostilities at the G20 summit and agree to talks – all the while backing it up with rhetoric in their respective countries.

Both sides retreat to their initial positions and withdraw the tariff hikes.

A new status quo is reached where trade flows resume as per usual, but business leaders in both countries seriously assess their future risk exposure.

The biggest winner from the US-China trade war is Southeast Asia as multinational companies acknowledge the need to reduce their over-reliance on China’s supply chain ecosystem.

China, on its part, continues to invest in moving up the supply chain and reducing its own reliance on foreign research and development.

How likely is it?

The scenario is relatively more likely, at least in the near term, as the US goes into Thanksgiving and Christmas mode. Retailers and consumers will feel the pain if the tariffs against Chinese imports stay high.

In the case of China, employment, financial sector reform, and slowdown in domestic consumption will push the government to engage in talks with the US.

Nevertheless, even if a ceasefire is agreed to, the trade conflict will permanently affect how US and Chinese firms do business, and how the rest of the world does business with China.

How will we know?

Official statements that talks are ongoing between high-level officials on both sides. A public handshake or announcement of future talks – either at the G20 summit in Buenos Aires in November or at public forums.

Regardless of how it may transpire, businesses should pay attention to who are leading trade negotiations and exploratory talks.

On the Chinese side, it is ideal to see the inclusion of experienced establishment officials like Liu He and Wang Qishan.

On the American side, Trump favoring more moderate voices on China will be a positive sign – for example, the active involvement of Steve Mnuchin or Larry Kudlow over Peter Navarro or Robert E. Lighthizer or even Vice President Mike Pence.

Negotiating a new trade deal

How will this scenario play out?

China and the US strike a new trade deal, with concessions negotiated on both sides.

After coming to a truce, the two governments get to the drawing board over bilateral market access, securing intellectual property rights, a more level playing field for the private sector in China, and greater regulatory and customs transparency.

Both countries ask for safeguards against future trade confrontation.

How likely is it?

A new trade deal between the two countries is possible, but not in the near term.

It will certainly take longer than the current Trump administration, and China will be wary of setting a bad precedent – where it does not hold the upper hand.

Establishing a fair and transparent trade relationship with China is a bipartisan issue in the US, and both Republicans and Democrats remain diligent on securing concessions as foreign businesses in China get impatient with the ‘market opening’ rhetoric in Xi’s speeches.

How will we know?

Frequent rounds of meetings between trade negotiators, trade and business lobby groups, consultations with high-ranking officials in both governments will be the clearest indicator that the two countries are serious about reaching a new trade deal.

In other words, it is important to assess whether the two countries are talking to each other or at each other.

The tariff escalation begun by Trump this year may not have achieved its initial objectives – reducing trade deficits and getting back US manufacturing jobs – but it has ensured that the status quo will never be the same, new deal or not.

Prepare for any trade war fallout: How should businesses respond?

The US-China tariff war has established a new reality in international trade relations and introduced systemic risks to businesses.

Companies who are overly dependent on China for sourcing, manufacturing, or both find themselves confronting rising costs, fluctuating tariffs, market restrictions, tighter regulatory oversight, and dwindling profits.

Firms that ignore these risks or fail to draw up actionable contingency plans will be compromising on their long-term stability and financial security.

Through its rapid escalation over the last six months, the US-China trade war has threatened to upend entire business processes – demonstrating the need for firms to be more agile and geographically diverse.

Businesses need to closely monitor geopolitical developments and economic stressors and establish internal systems that respond to them proactively.

Initial steps include ensuring clear lines of communication between senior management and local offices, being sensitive to the regulatory actions of state authorities, and training staff on how to manage practical risks.

More complex decisions will involve assessing the viability of business relocation, diversifying sourcing and distribution networks, and mitigating exposure to economic uncertainties.

Finally, businesses should watch the G20 and January tariff deadline as key dates but begin putting together strategic plans in place.


About Us

China Briefing is produced by Dezan Shira & Associates. The firm assists foreign investors throughout Asia and maintains offices in ChinaHong KongIndonesiaSingaporeRussia, and Vietnam. Please contact info@dezshira.com or visit our website at www.dezshira.com.

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