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Building on a macro model of the global economy, Rod Tyers & Yixiao Zhou highlight key patterns that emerged from elevated US tariffs against China and their possible implications for a resolution of the US-China trade war.

The dispute between China and the US over tariffs and exchange rate policy has been among the most notable of the large country economic conflicts in recent years. While the trade dispute originated in 2018, accusations by the US government that Asian economies have protected their economies beyond the spirit of agreed rules, including by ‘currency manipulation’, go back decades. Cases in point are the use of US broader bargaining power to place pressure on Japan in the 1980s, and subsequently China, to appreciate their currencies against the US dollar.

Following the failures of post-Uruguay rounds of multinational negotiations, China’s rapid development during the 2000s and the publication of its Made in China 2025 plan (State Council, 2015), concern in the US refocused towards the race to dominate the global technological frontier. The intention of subsequent US policy developments has therefore been to secure US firms’ market access and intellectual property, as well as to combat special assistance rendered to state-owned and otherwise favoured Chinese firms.

One of the more superficial concerns to emerge has been with China’s bilateral trade surplus. While bilateral imbalances have no particular economic significance they are seen by some as indicating that the gains from trade are being manipulated to the advantage of one partner. Yet the China-US bilateral imbalance is significantly enhanced by China’s role as an assembly point for wider Asian component manufacture, via recently emerging global value chains, leading to a mismatch between trade value and Chinese value-added content.

The elevated tariffs observed between the US and China today are attempts to modify their domestic terms of trade to favour home firms, in each case causing domestic consumers to shift to local brands and those from regions unaffected by tariff increases at the expense of Chinese imports. We analyse these effects using a macro model of the global economy. Two key patterns emerge. First, the larger scale of the US economy is dominant in that its tariffs yield domestic benefits that are generally neither overcome by the negative effects of the resulting contractions in the rest of the world, nor by Chinese retaliation. Second, China is virtually always the largest proportional loser from the conflict, suggesting that it has the most to gain from negotiating a resolution.

In the figure it is shown that the US tariffs against China raise the purchasing power of per-capita home incomes after tax as well as US low-skill real wages, while reducing these globally. The policy is therefore ‘beggar-thy-neighbour’ in nature. The greatest damage is suffered by third countries dependent on China’s trade, like Australia. As a proportion of current real after-tax income however, China is the largest loser. Yet, although the imposition of retaliatory bilateral tariffs by China reduces the US net gains, they remain positive. It turns out that China’s best response to US tariffs is to find a formula to resolve the conflict, inevitably implying some liberalisation.

This blog post summarises results from two studies: Tyers, R. and Y. Zhou (2019a), “The US-China trade dispute: a macro perspective”, CAMA Working Paper 11/2019, Australian National University https://cama.crawford.anu.edu.au/publication/cama-working-paper-series/1... and (2019c), “The US-China rivalry: the macro policy choices”, CAMA Working Paper 35/2019, Australian National University, https://cama.crawford.anu.edu.au/publication/cama-working-paper-series/1... .

Rod Tyers is Professor of Economics at the UWA. His research and teaching centre on applied international economics and macroeconomics. His teaching and research has focused on models based on the economic theory of optimising agents. While his models are used for projection and policy analysis, their primary roles are to enhance our understanding of economic behaviour in the aggregate, with applications to commodity market protection and volatility, the labour market effects of trade liberalisation, demographic change, automation and other deflation determinants, and the performance of the Chinese economy.

Yixiao Zhou is a Research Fellow at Crawford School of Public Policy, the ANU. Yixiao’s research encompasses a range of topics in economic growth and development. Her PhD thesis examines channels of technological catch-up and industrial upgrading in economic development. Her current key projects include the economics of innovation and automation, economic growth in China and its macroeconomic relationships with the world, inequality of opportunity, and the impacts of trade on wages and economic growth.