Here come the tariffs!

". . .a 10% tariff could cost China at least USD 36 billion, and a 60% tariff could incur losses of USD 90 billion. The impact would be more severe because of the indirect effect of tariffs."

Multinational corporations operating in China are expressing significant concerns regarding the potential policies that the incoming US administration may enact against the country.

This unease is not unfounded: Aside from the new administration's ongoing rhetoric on tariffs, the appointment of staunch critics of China to pivotal roles, and the fact that there will be a Republican majority in Congress for at least two years, there is a growing consensus in Washington that China has been taking advantage of the global free trade system and international organizations (e.g., the WTO) to the detriment of the US – and they are of the view that?this needs to be fixed. As such, the possibility that the new US administration will pursue and be able to enact a tougher policy approach vis-à-vis China is very real.

However, it’s difficult to say with absolute certainty what this will mean in practice. While there is a prevailing expectation for heightened import tariffs on Chinese goods, it is unclear whether these will uniformly escalate to 60% across the board or vary by sector, and by what time. It is also an open question whether China’s permanent normal trade relations status will be revoked, a move advocated by the incoming head of the US Trade Representative Office. A more “positive” scenario is that this will all be used as a negotiation tool to enhance US exports to China, thereby allowing for negotiations that could help prevent a significant escalation of tensions.

There have been other pledges, including stopping Chinese companies from using countries like Mexico as gateways to the US market; advancing technological decoupling; repatriating manufacturing jobs to the US; and pursuing a foreign policy focused on achieving “peace through strength”, implying increased power projection in regions of geostrategic interest for the US – the question is: how will this impact the “Taiwan issue” and the South China Sea??

All this said, it is evident that multinationals engaged in operations, investments, and exports to China will have to navigate an increasingly disruptive business environment.

Consider the ramifications of potential tariffs. Despite efforts by Chinese exporters to diversify their market dependence in recent years, the US remains the largest destination for Chinese exports, and is likely to account for over 15% of the total in 2024. Exports have gained prominence as a key growth driver for China, especially in light of domestic economic challenges, contributing nearly a quarter of the GDP growth for the first three quarters of this year. This underscores the growing significance of US external demand for the Chinese economy.

Now, our calculations suggest that a 10% tariff on Chinese imports could reduce China’s GDP by about 0.2%, and a 60% tariff by 0.5%. To put this into perspective, the size of the Chinese economy (i.e. nominal GDP) is expected to surpass USD 18 trillion in 2024. This means that a 10% tariff could cost China at least USD 36 billion, and a 60% tariff could incur losses of USD 90 billion. The impact would be more severe because of the indirect effect of tariffs.?

There?are already several studies indicating that a higher level of tariffs could lead to increased inflation in the US, affecting both businesses and consumers (see here). What has not been mentioned as much is that the increase in costs would have to be partly absorbed by China-based manufacturers (foreign and Chinese) to maintain their competitiveness in the US market. This would exacerbate the downward pressures on profits that they are already facing in China because of weakness in consumption and intense price-based competition. And along with tighter tech restrictions and US policy incentives to reshore production, this would exacerbate pressures that MNCs are facing to redefine the role that China plays in their global supply chains.

Moreover, as mentioned, the new US administration wants to stop Chinese companies from circumventing tariffs and investment restrictions by leveraging third countries, and especially Mexico, as springboards to the US market. With the free-trade agreement among US, Mexico and Canada (USMCA) coming up for review in 2026, it is likely that local content requirements will be tightened, and other clauses will be incorporated to make it harder for Chinese companies and investors to access the US market. And this is already having an impact, with several Chinese companies reportedly delaying planned investments in Mexico.

The above analysis is a preliminary examination of one aspect of the potential impact on China, specifically regarding import tariffs, and operates under a static assumption (i.e. ceteris paribus) which oversimplifies the reality. In truth, the implications of the new US administration's policies for China will be complex and multifaceted, and I believe they will primarily revolve around three key areas: (i) trade and investment; (ii) technology competition; and (iii) geopolitical dynamics.

How will these three variables intersect with each other, and what will this mean for the US-China relationship and the global business landscape? This remains to be seen. We won’t have to wait too long for this though – 20 January 2025 is the date.

Well, this is it for this month. Let me know if you have any comments and/or questions about my views above.

Until next time,

Alfredo Montufar-Helu