Analyzing the Impact of US-China Trade War on Australian Economy

This economics report analyzes the impact of the US-China trade war on the Australian economy. It begins with an overview of the trade war's origins, including Trump's justifications for tariffs and China's responses, such as retaliatory tariffs, currency manipulation, and reduced investment. The report explores the concept of free trade, comparative advantage, and the role of global value chains, highlighting the negative effects of protectionism. The report also examines the specific measures taken by both countries, including the imposition of tariffs on various goods. The report then delves into how the trade war affects the Australian economy. The report concludes by discussing the current state of the trade war, including the ongoing negotiations and the potential for further escalation, and provides references for further study. The report emphasizes the economic consequences of trade restrictions and their impact on global markets and trade imbalances.

Running Head: Economics
Impact of trade restrictions between USA and China on the Australian economy
Economics
Student Name

Economics
Contents
Trade War between US and China and its impact on Australia.................................................1
1) General Introduction: Trump started the Trade War. Were his reasons economically
sound?.....................................................................................................................................1
2) How did China Respond?................................................................................................6
3) How is the Trade War impacting the Australian economy?.........................................12
4) What is the current state of the Trade War?..................................................................16
References:...............................................................................................................................19

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Trade War between US and China and its impact on Australia
1) General Introduction: Trump started the Trade War. Were his reasons
economically sound?
In 2016, Donald Trump promised during his election campaign to make international trade
fairer for America. Once elected to power, President Trump started imposing duties and
tariffs on the imports from most of its trading partners. This led its trade partners to
reciprocate in a same manner and resulted in a worldwide trade-war. According to Feenstra
(2015), trade-war is an economic situation in which nations use quotas and tariffs to attack
other nation’s trades and such tit for tat practice impacts the international trade and world
economy. This trade war between the USA and China has impacted the whole world because
of the large size of these economies and dependence of other nations on these economies. If
this trade-war worsens further and tariffs are imposed on all the trade between the two
nations, then this could lead to overall market slump. It can contract the global economy by
0.6% (600 billion USD) by 2021 (Edmond, 2019).
Nations use tariffs and taxes on incoming products from other nations to make these goods
less competitive. This is done to boost a particular local industry as the local products are
now favoured over the expensive imports. It can increase the demand of these local products
and boost employment in the sector (Carbaugh, 2015). Till now the US has imposed several-
round of tariffs on Chinese imports and China has reciprocated these moves accordingly.
Trump administration has imposed duties on Chinese products worth USD 250 billion and
China has reciprocated with tariffs on American products worth USD 110 billion (Figure A).
In May 2019, the USA has increased tariffs on these Chinese imports from 10% to 25% and
Trump has threatened to impose tariffs further on USD 325 billion Chinese products (Wong
& Koty, 2019).
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Figure A: It shows the tariffs charged by both the nations on each other trades.
Source: Palumbo and Nicolaci da Costa (2019).
Free trade policy promotes friction-less international trade by not implementing any kind of
restrictions like quotas or tariffs on imports/exports (Irwin, 2015). The objective is to increase
world-wide economic output and to improve overall world economy.
Such free trade provides benefits due to the concept of comparative advantage (Krugman,
Obstfeld & Melitz, 2018). A nation is said to have comparative advantage when it produces a
product/service cheaper than other nations. In absence of any trade restriction, nations with
comparative advantages in different products can trade freely with each other for overall
economic benefit as global wealth grows. This will lead to Pareto improvement that means a
change in allocation occurs till it harms no party but helps at-least one party. This will keep
on enhancing overall economic value until Pareto equilibrium is achieved (ScienceDirect,
n.d.).
Due to the technological innovations and free trade policies, Global value chains (GVCs)
have been established to take advantage of the comparative advantages of different nations
(Blanchard, 2019). Example of such advantages is shown in figure B.
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Figure B: It shows the comparison in the price change of the products where global supply
chains are available vs. products where no such benefit exists.
Source: Schoen (2018).
Trump administration has initiated a significant retreat from free trade and has led to Pareto
dis-improvement in the economy of the world. According to Moon (2000), nations move to
protectionism by using trade restrictions that is by implementing various tariffs on imports to
protect its local industry from the foreign competition. This change from free trading position
to protectionism due to this trade battle decreased the aggregate economic output of the
nations engaged in this trade war from the exact same total resources. So, this practice has
affected the world economy in a negative manner (O’ Sullivan, 2018).
There are many reasons for this trade war between the USA and China. The main reason that
Trump mentioned is the huge trade deficit of USD 419 that the USA had with China in 2018.
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China has a comparative advantage in manufacturing due to cheap labour and this made it the
top exporter of the manufacturing products. As shown in figure C the exports from China has
been exceeding US exports by noticeable margin. Trump claims that this trade imbalance has
caused the USA to lose manufacturing jobs as local firms cannot compete with Chinese
products.
Figure C: It shows the exports of both the countries, USA and China in recent years.
Source: Bloomberg (2019).
Trump thinks that import of smartphones and other goods from China is a big loss to America
but most of these products are actually being made for the US companies by the Chinese
manufacturers due to the cheap labour. Also, this trade deficit is not same as it seems because
of the global supply chains that run via China. For example, out of the total factory cost of
IPhone just 3.6% is earned in China but in trade deficits numbers the total cost is considered
(Dedrick, Linden & Kraemer, 2019). Similar results have been found for overall trade
balance between two countries. So, these numbers are not that high but still there is trade
imbalance between two countries but even that is economically not bad. These activities
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provide China with huge amount of low paid jobs and the US companies earn huge profits
because of this low cost manufacturing. Such use of China for manufacturing has been
beneficial for the US economy but it might have impacted factory workers in US. These
global value chains benefits the US companies and consumers by providing the innovative
products at competitive price, and many individuals and companies have built their
businesses around these products. Thus created new job opportunities in the US.
The U.S. has trade deficit with China and money flows out of the US but this resulted in
increased savings for Chinese nationals. The US has comparative advantage when it comes to
investment as it has many such opportunities and generates much higher returns. So, the
money going out due to higher imports comes back in via new investments which are used to
build new businesses and increase US economic growth (Lastrapes, 2018).
If restricted trade practices are followed then in the long run it would result in lower levels of
productivity and GDP because workers and countries will be forced to produce products in
which they do not have any expertise/advantage.
Trade deficit in general is not a good measure of the impact of the international trade. Better
measures would be unemployment or wage stagnation and it needs efficient policy responses
to address these concerns directly rather than putting restrictions on trade. By reducing
overall trade, many benefits related to it are also reduced and these benefits definitely
outweigh the costs. Such trade practises can instead prove to be bad for economy and workers
(Pethokoukis, 2017).
Other reason for this trade war can be to limit technology transfer from America to China and
to push for a level playing field in China for the American organisations. Currently it is
claimed by the US that the local government in China requires the foreign organisations to
share their trade secrets and also there are lot of subsidies given to the local industry that
make it unfair for the foreign firms in China. So, the USA wants China to make structural
changes in their economy (Amadeo, 2019). These reasons might make some sense but such
policy decisions depend upon the internal policies of the country.
There are also some personal level reasons for President Trump for this trade war. Trump
sees trade as a contest of pride as he has always mentioned that other nations like China are
taking advantage of US in trade terms and laughing at them. Trump administration takes the
practice of imposing tariffs as an end in itself as it make them appear strong and it will show
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that nobody can take advantage of USA. It might not matter even if these decisions proved to
be bad for the US economy (Waldman, 2018).
2) How did China Respond?
China has been retaliating appropriately to all the actions of President Trump in this trade
war. The huge trade surplus of China with the US limits its options when it comes to tit for tat
responses in tariffs. So, China has not limited itself to measures like tariffs and duties but has
used whole set of broad economic measures to respond to the tactics of Trump
administration. The thing that worked in the favour of China is that it is not a democratic
country but an authoritarian dictatorship. So, it can take extreme measures and play dirtier
than the US without worrying about the political ramifications (White, 2018).
China purchases US products worth USD 133 billion (Figure D). Till now Trump
administration has imposed duties and tariffs on Chinese products worth 250 billion USD and
China has retaliated with tariffs on US goods worth 110 billion out of the total US exports
(BBC news, 2019).
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Figure D: It shows the products that US imports to China.
Source: Mazumdaru and Pandey (2019).
In May 2019, China retaliated to the increased US tariffs by raising tariffs on US products
worth 60 billion USD to 25 per cent. Some of the US products on which tariffs were raised
are shown in figure E. These increased tariffs cover 5140 products in total. The Chinese
government has further indicated that it will respond back strongly to all the US steps.
Figure E: Table shows some of the US products on which tariffs have been increased
recently:
Meat Chopped meat, Beef, Fresh or cold boned
sheep meat
Alcohol Tequila, Regular wine, Sprinkling wine, Gin,
Other fermented beverages
Oil seeds and fruits Plants used as medicine, Sunflower seed,
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Other oily seeds and fruits
Frozen foods Corn, Peas, Spinach, Nuts, Fruits and
Legumes
Petrochemicals Liquefied natural gas
Data Source: BBC News (2019).
China is the world’s major supplier of rare earth metals and it has also hinted to stop the
supply of rare earths to US. These metals are required for the advanced products like hybrid
cars and hi-end mobile phones. The US is dependent on China for 80 per cent of its total rare
earth metals import (Kyodo, 2019).
China has also started preparing a list of unreliable foreign entities that seems to have
damaged Chinese firm’s interests. This step is in retaliation to the US backlisting of Huawei,
though there has been some relaxation announced by the US government recently. Chinese
Ministry of Commerce has decided to blacklist foreign entities that have violated any
contractual obligations or market rules. This step will help create pressure on the US
government and it will also protect the Chinese companies from discriminatory practices by
the US firms (Zheng & Wu, 2019).
There have been talks that Chinese government has used currency manipulations by letting
the Yuan weaken to respond to the trade war. By letting the value of Yuan down, Chinese
goods appear cheaper in the international markets and it lowers the impact of increased
tariffs.
Another way China has responded is by lowering the Chinese investment in the U.S. The
Chinese investments dropped to $5 billion in 2018, year on year drop by 80 per cent
approximately (Figure F). There was also a decline in the investment in 2017 as compared to
the previous year. Considering the sales of US assets by Chinese firms its net investment was
negative 8 billion USD in 2018.
Figure F: It shows how Chinese FDI into USA has varied in the recent years.
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Source: Schott, Chorzempa and Lu (2019).
China provides a huge market for various foreign products. Another way in which China has
responded to the trade war is by lowering its purchase of the USA products. This resulted in
lower US exports of soybeans and other agricultural products. In-spite of this decrease China
is still dominant export market for US agricultural products, so it holds further leverage. In
2017, China bought US farm products worth USD 14 billion and this purchase reduced to
USD 9.3 billion in 2018 because of its retaliation to the trade war (Figure G). This reduced
US farm income to USD 69.4 billion, approximately 45 per cent lower than the 2013 high.
This made US government to promise its farmers a subsidy/aid of USD 12 billion and USD
15 billion in recent years (Layne, 2019).
Figure G: It shows this reduction in the US Soybean exports in recent years.
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Source: Braun (2019).
Other than the retaliatory tariffs the Chinese government has used its state owned firms to
reduce purchases of soybeans and natural gas from US. This hurt US exports proportionately
more than China’s exports. In the first quarter of 2019, compared to the previous year the
drop in US exports to China was 19 per cent but the drop in China’s export to US was 14 per
cent (Schuman, 2019).
China has an enormous holding of US Treasuries amounting USD 1.1 trillion. China has not
openly claimed that it will sell this US government debt to destabilise the US financial
markets. But the data showed that in March China sold the most amounts of treasury
securities in more than two years (Figure H). By dumping all the treasury US securities China
can negatively impact the USA but it will also depress its own wealth. But still such moves
like that of April can be used to reduce funds for the US government and to shake its
financial system.
Figure H: It shows net purchase of US treasuries by China (Leong, 2019).
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Source: Thomson Reuters (2019).
According to the white paper published by The State Council Information Office of The
People’s Republic of China (2019), the solution for the economic issues and trade tensions
with USA is to grow stronger by undertaking appropriate reforms and opening up its market
for other trade partners.
Chinese government has been using structural reforms to increase its GDP’s growth. China
has used some of these reforms to respond to the US trade war and it has also been providing
financial stimulus to enhance local demand and enhance the competitiveness of its companies
and products.
Due to the trade war between China and the US, the Chinese government has deployed
reforms in areas where expected dividends are big and quick. For example, the reform in
household registration system Hukou has been implemented this year which has been delayed
a lot earlier. It could increase the potential growth rate of its economy significantly by
converting migrant labourers into legal city residents. This will enhance labour supply and
improve resource allocation efficiency.
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Other supply side reforms that will give slow dividends but are required for the long term
goals are put on hold in order to prioritise the reforms in the demand-side to cope with shocks
from US-China trade war (Fang, 2019). So, the Chinese government has been using fiscal
stimulus measures to provide cushion to the growth of economy and to offset the fallout from
trade tensions. Such stimulus measures have provided protection to consumer-oriented firms.
Beijing has allowed local governments to use special bonds proceeds to fund capital projects
like highways, power supplies and railways. It will increase the local demand and have an
impact on the investment (Kapadia, 2019).
Another domestic step that China has taken to protect its economy from this trade war is
measures to reduce unemployment due to the reduced exports and slow-down in its
manufacturing sector. The government has implemented policies like refunding of
unemployment insurance payments to companies that have not expelled its employees due to
this slow down. Government has also provided subsidies to young jobless population
between 16 and 24 in comparison to earlier policy of providing help only to unemployed
graduates. This has helped China stabilise and stimulate employment to some extent during
this trade war (Leng & Lee, 2018).
3) How is the Trade War impacting the Australian economy?
From long time back, Australia majorly trades with the China. Even history is evident of the
fact that the demand of the Australian goods and services had upsurge in China when the
Chinese economy had actually performed well (Mortgage Choice, 2018). Now, if we talk
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about the relationship of Australia with the United States, then US has been the largest
foreign investor along with one of the largest trade partners of Australia (Wall Street Journal,
2019). Australian economy can be affected in a positive as well as negative manner if the US
or China’s economy would be adversely affected in future. Some of the consequences could
be as follows:
1. Tariffs imposed on the steel and aluminium from China, could increase the demand
for Australian steel and aluminium
2. US wine imports to China are imposed with heavy tariffs which could increase the
demand for Australian wines in the Chinese market. No custom duty is charged on
importing wines to China from Australia.
3. The Chinese appetite has witnessed an increase for high quality meat. China has also
put a high tariff on US meat imports. Now, it could be an advantage for the Australian
beef producers.
4. China has also put tariff on the US soybeans. This could probably increase the
demand of Australian grains and could benefit the farmers in Australia.
5. The US- China trade war could benefit the investors. No doubt, the war has caused a
great amount of volatility in the share markets. So now share traders can trade across
stocks of copper, aluminium, steel and could also include commodities like soybeans
and grains (Mortgage Choice, n.d.).
There can be many negative impacts of this trade war for Australia due to direct factors and
indirect factors because of the global slow-down. Large-scale structural macro-econometric
model, AUS-M, was used by Economic Outlooks for examining the future impact of trade
war on Australia. It showed that the GDP of Australia would be 0.5% lower after a year and
after three years it would be 1.25% lower. It also showed that the inflation rate in Australia
would rise by 0.75% after a year however after three years inflation rate would be 0.25%
lower than the baseline rate. AUS-M showed that the unemployment rate in Australia would
be 0.25 per cent higher after a year and after three years the same unemployment rate would
increase by 0.5% maximum. For real exchange rate of Australia, the model is of the view that
it would decline by 6% after a year and then it would be 4% lower forever (Citigroup Inc.,
2018).
As per new economic modelling by KPMG Australia, if all the countries around the World
get indulged in the US-China trade war it could adversely affect the National Income of
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Australia by half a trillion dollar over the period of ten years. It could also affect the real
wages paid to the worker and could lower it down to $16 per week for an average worker.
The economic model of KPMG Australia has also predicted that if all the countries would
come for the trade war then around sixty-thousand jobs lost in Australia (Rynne, 2018).
China has witnessed a lower growth as a result of on-going trade war. Australian exports to
China are dependent upon the China’s export to the rest of the World. The exports of China
to the world have become highly variable (Figure I) because of the tariff game played by the
President Trump (Murphy, 2019). China exports a major portion of iron ore from Australia
for the steel manufacturing. However, after US imposed higher tariffs on steel it adversely
impacted export demand for Australian iron ore in the Chinese market (Mousina, 2019).
China’s import and export data in January reflected a first time fall in the iron ore import.
Also, it showed the biggest wall in iron ore imports from Australia from mid-2016 (BT
Financial Group Pty Limited, 2019).
Figure I- China Merchandise Exports
Source: (Murphy, 2019)
After the announcement made by the Trump regarding higher tariffs imposition on import of
steel and aluminium both, it affected the prices of the commodity. The price of aluminium
was down around 0.7 per cent and price of steel was down around 0.4 per cent in terms of US
dollars (Reserve Bank of Australia, n.d.).
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The on-going trade tension between US and China also had a negative impact on the Wool
markets of Australia. The Eastern Market Indicator (EMI) is the Australia’s wool price index.
In the last week of 2018-2019 selling year, the trading of wool got closed at 1715 cents per
kilogram. This figure was 51 cent less, 172 cents less and 341 cents less than the previous
week, previous month and previous 2017-18 selling year respectively. After deregulation of
Australia’s wool market in the year 1991, the above stated fall was the largest till date.
Approximately, eighty per cent of wool is exported to China and because of the trade war
between America and China, the consumers have lost their confidence and therefore the
market fell to its lowest point (Thorne, 2019).
Since January 2016 to May 2019, the Aussie dollar has finished the day at a level much lower
than US dollar (Figure J).From the last three years approximately, Australian dollars is
trading lower than the pound too which itself is considered to be trading much lower because
of BREXIT uncertainties. All these are the result of Trade war going on between the US
President Donald Trump and China (Willitts, 2019).
Figure J: Aussie Falls to a Three-Year Low
Source: (Willitts, 2019)
Therefore, the future of Australian economy lies in the hand of China and United States as
both these countries are the major trading partners of Australia and latter is the significant
foreign investor too. Now, Australia needs to play well during the course of trade tension so
that it does not affect its relationship with either of the country. No doubt, there are various
benefits which Australia could fetch from the Trade war but it would be better if it play safe
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and balance well during the time of tension. Australia should try to achieve the position of
equilibrium during this hard time.
4) What is the current state of the Trade War?
US President Donald Trump was against the trade practices followed by China much before
he became President in 2016. In the year 2017, Donald Trump instructed to carry out the
investigation of China’s trade policies. Later in 2018, United States imposed high tariffs on
billion dollars of China’s products in response to which China also imposed high tariffs on
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the US products (BBC News, 2019).
Donald trump also aimed at reducing the $621 billion United States trade deficit. The motive
of reducing the trade deficit was to create more jobs in US. No doubt, US President did hard
to lower the trade deficit by imposing high tariffs on the imported products; still 2018 had
seen the highest trade deficit in many years (Figure K). In 2018, the trade deficit has gone up
by $119 billion after Donald Trump has taken the charge of US Presidency (Zarroli, 2019).
Figure K: U.S. Trade Deficit Grew To A 10-Year High In 2018
Source: (Zarroli, 2019)
The trade war even made China to buy Soybeans from other countries. After the
announcement made by the Trump regarding higher import tariffs imposition on Soybeans, it
mandated China to buy them from Brazil and other countries producing and exporting
soybeans (Schoen, 2018). In spite of serious trade wars and heavy tariffs imposition by US,
the annual trade surplus of China in 2018 had hit record. In 2018, China had witnessed
$323.32 billion in surplus with the US which was seventeen per cent above the previous year
surplus (The Wall Street Journal, 2019).
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Donald Trump also received an open letter from the Footwear Distributors and Retailers of
America, an industry trade association for footwear stating "On behalf of our hundreds of
millions of footwear consumers and hundreds of thousands of employees, we ask that you
immediately stop this action".
Earlier China thought to impose additional twenty-five per cent tariffs on the autos and auto
parts of US from April 1, 2019. This move was a kind of retaliation to the tariffs imposed by
the US but then Chinese government suspended the tariff in December 2018. Still, the US
autos and auto parts are subject to the earlier tariff rate of 15% in China. Recently in May
2019, US increased the tariffs from 10% to 25% on US $200 billion worth of Chinese
products. Later in the month of June, China responded to the US tariff increase by increasing
the tariffs on US products worth US$60 Billion. Again, in the same month US Department of
Commerce announced that Huawei and its subsidiaries would be restricted from selling their
products to the telecommunication companies of China without getting the proper approval
from US government. After this act of US, China announced that it is preparing its own
unreliable list as an answer to the US’s entity list. China further cleared the content of
unreliable list that would include organisations, individuals and foreign companies that are
indulged in breaking market rules, violating contract, damaging the legitimate interest of the
companies of China.
In the month of June, United States added five more companies of China to the entity list.
Now the added five companies would not be able to buy products and services from the US
market and companies without the permission of US Government. Among these five
companies, one company is also a state owned organisation. The targeted five companies
include Chengdu Haiguang Microelectronics Technology, Wuxi Jiangnan Institute of
Computing Technology, Sugon, Chengdu Haiguang Integrated Circuit and Higon.
Interestingly, by the June end China and US both followed the tentative truce at G20 Osaka
Summit and agreed to start the trade talks once again. However, for the talks no deadline has
been set which means that tit-for-tat rounds would be on hold for anticipated future. Also, US
President Donald Trump relaxed the ban imposed on United States exports to the Huawei
Technologies of China.
Donald Trump has also announced to exempt one hundred ten products of China from
twenty-five per cent tariffs that were imposed in the year 2018. This exemption became valid
from the month of July, 2019. Also, it was announced by the US Commerce Secretary that
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American suppliers of Huawei would get licenses to avoid the security threats (Wong &
Koty, 2019).
After the truce at G20 Osaka Summit there would be no new tariffs introduction by either of
the country but that does not mean the issue has been completely resolved. There are many
tariffs which have not been abolished by both the companies. Also, the relation between the
US and China are still very far from normal. It cannot be referred as a cold war but it is a kind
of competition focussing on technological supremacy between both the countries.
As a result of tariffs imposed by the US on its exports, China’s growth has dropped to 6.4%
in the first quarter of the year 2019 whereas it was 6.6% in the year 2018. China’s economy
could be motivated to make more efforts towards economy restructuring through better and
improved innovation. This could ultimately enhance the growth rate of China in the
upcoming quarters and years (Zhang & Ingersleben-Seip, 2019).
International Monetary Fund has even said that this trade tension could make the economy of
the entire countries poorer and its impact could hit the major segments like businesses,
households and the wider economy (Chan, 2018). Therefore, it is a high time that both United
States and China should stop thinking about their own selfish deeds of being powerful over
the other and start thinking about the world economy as a whole.
But at the end there is no winner or loser in the US-China Trade war. The countries that have
faced new tariffs have seen a significant decline in their export as well as in their Gross
Domestic Product (GDP) which even include the United States and China (IHS Markit, n.d.).
For the whole global economy, latest developments between the USA and China are good
news but it cannot be considered as a sign of relief until and unless the imposed tariffs by
both the countries do not come to a normal level.
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