US-China Trade War: Understanding the Conflict

The trade tensions between the world’s largest economies, the United States and China, reached a turning point in January 2020 with the Phase One trade deal. However, the deal didn’t come in time to mitigate the toll of US tariffs on Chinese goods, imposed with the goal of preventing China's currency manipulation measures. After reshaping trade patterns around the world and damaging global economic activity, the continuous US-China trade dispute is estimated to lower world GDP by 0.4%. 

Due to the self-correcting nature of the economy, an increase in the demand for exports causes currency appreciation, forcing export levels to fall. To keep the current account balance in a surplus, China regularly devalues the yuan. To apply this pricing policy, China buys US dollars from the market and supplies yuan in exchange. By devaluing the yuan, China gains a competitive advantage in the international markets and improves its current account, as it makes Chinese exports cheaper to buy with foreign currencies. As a result, American exporters struggle to compete with Chinese exporters because of the price levels. Given the major financial impacts of China’s devaluation policies on American exporters, the US trade deficit has risen from $10 billion in 1990 to $315 billion in 2012. 

US officials consider China’s attempt to sell products below the cost of production as unfair competition, hence designating China as a currency manipulator. Stating that the International Monetary Fund (IMF) requires governments to avoid manipulating exchange rates, the U.S levied tariffs on Chinese goods, making them less desirable in comparison to domestic goods. This protectionist strategy restricts China’s growing role in international financial markets, and most importantly protects American domestic industries from unfair foreign competition. Some of the key industries that are severely injured because of the trade war include automotive manufacturing, tech, and agriculture; by implementing tariffs, the US government hopes to reduce unemployment in these industries, improve the balance of trade, and raise revenue for the government. However, tariffs cause allocative inefficiency, since domestic resources are over-allocated to the production of certain goods. It is also crucial to recognize that tariffs are not levied directly on the trading partner’s exports but are instead paid by local consumers. China has since retaliated by imposing tariffs on American imports --- without ceasing its devaluation practice.  

Understanding the economic impact of constantly evolving dynamics between these two countries is critical for any business operating in today’s environment. According to the US-China Business Council, ​​the trade dispute resulted in the loss of 245,000 jobs in the US. On the flip side, if both sides start lowering tariffs, there will be an additional 145,000 jobs in the US by 2025. As of now, American companies accept lower profit margins, workers receive reduced wages, and consumers pay higher prices. Moreover, Oxford Economics indicates that “significant decoupling” of the US and China would reduce American GDP by $1.6 trillion over the next five years. Due to China’s retaliatory measures, farmers have lost a large portion of their Chinese sales, which was once one of the largest agricultural export markets for the US.  

In early 2020, Trump and Xi signed Phase One trade agreement that stipulated structural changes to China's economy and trade regime. Some of the main issues stated in the agreement were intellectual property rights, technology transfer, currency manipulation, and foreign exchange practices. The agreement also specified that China must increase its imports of US products by $200 billion over the next two years. Contrary to the terms of the deal, however, China imported only 60% of these goods in the first year of the agreement. Both parties suffered economic losses as a result of the trade war. However, China clearly did not suffer enough to carry out the structural reforms mentioned in the Phase One trade deal. As the trade dispute went on, China continued to reduce its reliance on US markets by lowering tariffs for other trading partners. The Biden Administration clarified that if China does not abide by the deal’s terms, the US will implement additional protectionist measures to promote American industries and to counteract China’s economic influence. Upcoming protectionist measures will surely exacerbate economic competition between the countries, increase diplomatic disputes, reduce choices for consumers, and dampen economic growth. 

On November 15, 2021, during a virtual meeting between Biden and Xi, Biden clearly indicated that the US is paving the way for limited bilateral engagement with China. Remarks released by the White House suggest that, during the meeting, Biden underlined the necessity of “common-sense guardrails,” which will guarantee that there is an open line of communication. This is a step towards ensuring that the competition between the leading economies does not turn into a threat to international peace and security. In addition, Biden emphasized the importance of collaborating when US-China interests overlap, particularly mentioning the urgent threat of climate change. Although Biden did not go into detail about economic matters, Trivium China analyst Taylor Loeb made it clear that “the US will remove tariffs in areas it deems most economically beneficial and least problematic from a national security perspective.” On the other hand, Xi did bring up trade concerns, directly stating that the US should stop using the concept of national security to justify restrictions on Chinese enterprises. There were no significant breakthroughs or major compromises reached during Biden and Xi’s meeting; instead, the meeting highlighted the long-standing conflict between the US and China.   

The US believes that trade protection is the only solution to overcome problems caused by China’s currency manipulation measures, while China believes the only way to respond to these tariffs is through retaliation. This cycle drains resources and without a resolution it will continue to disrupt the global supply chain. The world’s largest economies must engage in negotiations to address economic challenges, such as the slowdown in global GDP growth, allocative inefficiency, and reduced choices for consumers, in a realistic manner. This is the only way to help the people of two countries, end this trade war, and mitigate its consequences.