Who wins a trade war between the US and China?

If Conor McGregor loses his fight against Floyd Mayweather but earns more than $75 million, way more than he ever earned for any other fight, is he really going to feel like he lost? 

 

Similarly, as we consider the possibility of a heavyweight trade war between the world’s two largest economies, the US and China, predicting a “winner” depends on how you’re measuring—exports, profits, jobs, political impact, etc.  You can find opinions on both sides.  Below we breakdown what the primary fallout will likely be with an eye toward which side could hold the line longer.

 

Short term economic impact: US Wins

If you think exports are the only way to “win” at trade then no doubt you would favor the US. .  Limit exports and people lose jobs, so the argument goes.  China’s exports to the US are 4 times US exports to China so if exports are the measuring stick, no doubt the US wins.  It has more leverage.

 

Medium to longer term economic impact: US victory margin erodes

But that’s a narrow view.  Prices would rise in the US.  Plus China would retaliate.  Key sectors, like agriculture, would see their exports punished.  Many American companies, including giants like Apple, GM, Ford, GE, and P&G, derive substantial profits and growth from China.  Lower profits means less ability to invest and create new jobs anywhere.  Short-term, the impact on China might be greater.  But those who think exports impact jobs but prices and profits don’t are not seeing the big picture.  Over time it is likely the impact on US GDP would be far too large too ignore. 

 

Political pressure: China wins

It’s the politicians who set the policies, so maybe should consider the political angle.  There is strong protectionist sentiment in the US currently, on both sides of the aisle.  But if higher prices and the impact of retaliation starts to bite, will protectionist enthusiasm remain strong?  Donald Trump has certainly signaled he is willing to play hardball.  Only time would tell if he is willing to withstand the pressure that would come with economic pain.  On the other side we have Xi Jinping, who has not only assiduously built his position as the strongest and most powerful Chinese leader since Mao, he has also squashed dissent more than any recent predecessor.  It’s hard to see how Xi would feel any political pressure worth noting, so China should probably get the nod relative to political pressure.

 

Critical variable #1: Capital flight is a big risk for China

Then again, if Xi is in such a strong position, why has he been so desperate to support growth by issuing debt?  China’s debt-to-GDP level has risen from roughly 120% in 2008 to almost 300% today, a dangerously high level accumulated at a dangerously rapid rate.  Xi has to know this is bad for the economy in the long run yet he allowed the debt buildup anyway.  Why?  Well, political dissent might be impossible in China, but economic dissent, primarily via capital flight, is actually common.  Capital has flowed out of China at a historical rate over the past few years, leading Xi to lean heavily on administrative capital controls to try to limit the outflows.  But that is a blunt tool that masks the underlying problem.  It doesn’t solve it.  If a trade battle saps confidence and spreads pessimism about the next stage of China’s growth, capital outflows could accelerate again which could have a significant negative impact on China’s economy. 

 

Critical Variable #2: Prosperity and stability means America can take a punch

Which brings us to our final point—the US is a developed country while China is a developing country.  America’s per capita GDP is 400% larger than China’s.  Despite high levels of debt, America retains a high credit rating and, in general, a high currency value.  To put is succinctly, as a more prosperous and stable economy, America is better positioned than China to withstand economic duress of any kind, including a trade war. 

 

Winning” would not be worth the price

While America might be in a somewhat better position than China to “win” a trade war, it is important to remember that every fight you can win is not necessarily a fight worth fighting (Muhammed Ali’s career attests to that).  America’s “victory” would not be without sacrifice.  If China feels significant economic pain, chances are America will as well. 

 

Trump so far: Fiery rhetoric, practical approach

Fortunately, the Trump administration does not appear eager for a trade war.  Despite the fiery rhetoric, so far the Trump approach has been measured, reasonable, and practical.  No 45% tariff.  No currency manipulation designation.  Rather, Trump has taken a targeted approach, identifying specific sectors or issues, like steel or intellectual property, and addressing those areas individually.  That approach is much less likely to lead to a broad trade war. 

 

A win for everyone: A reasonable deal on IP and IT

Intellectual property (IP) and the IT sector, which is the most recent focus of Trump’s China trade agenda, is critical area that requires attention.  While we can’t solve all the IP problems over night, progress in this area is important.  With the right approach, we just might be able to make good progress without a trade war.  That would be a win for everyone.