Lose-lose scenario for Europe from ongoing China-US negotiations

• While there is no clear winner from the US-China trade tensions, the way in which the negotiations between the US and China are shaping up does not bode well for the European Union (EU). Our previous report analyzed the missed opportunity that a trade deal between the US and China could imply for some key European exporter sectors (See: A US-China trade deal for China to buy back its future? Europe would be a key loser 18 May 2018). If China were to offer the concession that the US has requested in terms of banning import tariffs for some previously targeted sectors, then this can only be bad news for those sectors in Europe, except for the parts of the value chain that are produced in the US and exported to China. In other words, we should expect trade diversion away from Europe and in favor of US.
• In this context, the key European beneficiaries that were supposed to replace US exports: car manufacturers and aircraft producers (by substituting US exports into China in the event of higher tariffs) will shift to be the losers in a quick deal between China and the US is reached. Chart 1 and 2 show that most of the benefits of a US-led trade war for Europe would have come from the Chinese market and not so much the US one due to the sectoral similarities of US and EU exports into China.
• The second part of the US reason to start a trade war with China relates to the large role of the State and a heavy handed industrial policy. If China were to follow the US towards additional reform versus a market economy and opening up to foreign competition, it would of course be very good news for Europe as a net exporter of goods and foreign direct investment. Unfortunately, President Xi’s speech at the 40th anniversary of China’s reform and opening up yesterday seems to indicate that China is not keen on following the US mandate (See: Our Take-Away from President Xi’s Speech: China’s Reform and Opening-Up not that Important even under US Pressure 18 December 2018). In fact, President Xi made it very clear that China’s policies would not be influenced by the West. The lack of any formal announcement of opening up could imply that China has realized that there is limited scope for concessions in expanding its market access even under pressure from the US and the rest of the world. This should come with the realization that the role of the State in the production of goods and services is still very large and that there seems to be little intention to reduce it. In other words, it will be unlikely for Europe to benefit from better market access (Charts 5 and 6).
• In a nutshell, a hastily agreed trade deal between China and the US may be good to ease the negative sentiment in global financial markets but it will probably come at a large cost for Europe since it will probably divert European exports to China towards US ones without an expectation of a larger market for European exports in the absence of additional opening up by Chinese authorities.

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