US-China raising the stakes towards a harming trade war

China’s attempts to calm down a furious US administration (with promises of opening-up sectors and a stronger RMB) do not seem to have convinced the US administration of toning down its protectionist actions against China. Following the two rounds of import tariff hikes earlier this year, the US has announced today that 1,333 products exported from China to the US will be subject to a 25% increase in import tariffs. The reason this time is no longer national security or safeguarding domestic industries as in the previous cases but China’s nonobservance of intellectual property rights. In only a few hours China has stepped up its retaliation from a few agriculture related products to a much larger and relevant list of 106 products, which includes higher-end products from aircrafts and automobiles.

We argue that the US strategy has evolved over time from one in which the purpose was to reduce the US trade deficit to a much more targeted strategy to prevent China from moving up the ladder. This is evident from the fact that the US has excluded most of its allies from the tariff hikes and has only targeted China on its most recent measure to defend US companies’ intellectual property rights. Out of the 1,333 products announced by the US administration, as much as 76% of them are related to China’s Grand project to move up the ladder, namely China Manufacturing 2025 goal. This list even includes products which are not produced or exported by China yet, such as products in the aircraft industry.

In this note, we address two related questions, namely the impact on Chinese corporates and the extent to which China can retaliate without hurting itself. For the former, some Chinese sectors are more dependent on overseas revenues than others but it seems clear that the US so far have not hit the core of Chinese corporate profits. For the latter, options available for trade retaliation from China is rather limited without hurting itself. The second round of retaliation shows that China has switched to measures that could hurt itself or both sides. The reason probably is that too much is at stake, namely China’s ability to compete with the US as it moves up the technological ladder

Full report available for NATIXIS clients