America raises tariffs on China, and the stakes in a trade war

Last week a deal seemed close. Now the fear is of full-blown commercial conflict

MEETING IN WASHINGTON, Chinese and American trade negotiators made it through dinner without hurling the plates at each other. But there was no truce on the menu. One minute after midnight in Washington on May 10th, America carried through on its threat to ratchet up tariffs on Chinese goods. Two minutes later, China vowed to hit back. And so the world’s two biggest economies staggered a couple of steps closer to all-out trade war. Such an outcome is still far from certain: talks are continuing and, until recently, had been making progress. But the risks are rising of economic damage in both countries, and of a rupture in their already strained relationship.

The Economist reports that the increased tariffs apply to a $200bn tranche of imports from China, including a wide range of industrial inputs such as car parts and circuit boards. Last September, in an early salvo, America hit this tranche with 10% tariffs (a further $50bn-worth had already been struck by tariffs of 25%). Now that 10% has been raised to 25% too, meaning the rate applies to almost half of Chinese exports of goods to America. China has yet to detail its retaliation plans, though it is likely to apply proportionate tariffs: aiming at fewer goods (since it imports less from America than America does from it) but also raising duties to 25%. Liquefied natural gas, meat and fruit are expected to be on its list.

With this escalation the cost from their trade brawl will soon become more visible. The new tariffs will shave as much as half a percentage point off China’s growth rate this year, according to most estimates. When tariffs were 10%, companies could generally digest the higher prices for Chinese imports, which were offset in part by a weaker yuan. At 25% they will struggle to do that, forcing them to pass more pain on to consumers. Inflation in America could increase by about half a percentage point as a result, according to economists at Société Générale, a French bank. And there could be worse to come. President Donald Trump said that America was starting the paperwork to impose 25% tariffs on the remaining $300bn or so of imports from China not yet affected.

Just a week ago the mood regarding the talks was upbeat. Chinese and American officials had met multiple times since the start of the year. The outlines of a deal were becoming visible. China would go at least partway to addressing American demands that it enhance protection of intellectual property, stop coerced technology transfers and open its market more widely to foreign investors. It would also throw in pledges to buy large volumes of American goods, notably farm products, in order to narrow its bilateral trade surplus, a long-standing gripe of Mr Trump’s. America, in turn, would agree to remove at least some tariffs on Chinese products. On April 28th Steven Mnuchin, America’s treasury secretary, said talks were in their “final laps”.

Then, on May 5th, Mr Trump fired off a pair of tweets that shattered the optimism. China, he said, had been attempting to renegotiate the deal. The nature of the dispute is itself a matter of dispute. According to Reuters, citing American government sources, Chinese officials had asked for sweeping edits to a 150-page draft agreement. Robert Lighthizer, the United States Trade Representative, wanted China’s commitments to be enshrined in legislation; Chinese negotiators countered that regulatory changes would be sufficient. But according to Chinese government advisers, the disagreements may run even deeper. They say that American negotiators have, in effect, asked China to undermine its own economic model in demanding that it eliminate subsidies to favoured industries and state-owned firms.

Given the prospect of a breakdown in negotiations, it was heartening that Liu He, China’s lead trade envoy, still went to Washington for talks that began on May 9th. Some had speculated that China might call off the meetings entirely. But the scope for progress seems limited for now. Chinese officials have long said that they will not make deals in the face of threats. Comments by Mr Liu on his arrival at the talks suggested that he was there more to reinforce that message than to make any big concessions. “I have come with sincerity,” he told Chinese state media, speaking in measured tones. The two delegations met and had dinner on May 9th and were due to resume their talks on May 10th, albeit with higher tariffs in place.

The big worry is the potential political fallout from failed talks. Allegations that China reneged on its commitments are catnip for American critics of engagement with it. Trade is, after all, just one aspect of a spiralling mistrust that encompasses politics, technology and armed forces. In China, hawks have always suspected that America’s ultimate goal is to stop it from rising—a belief that has been reinforced by the trade dispute. Left-wing scholars argue that it would amount to treachery for China to give in to America’s demands. Their commercial relationship used to help bind China and America together; now it is driving a wedge between them.
Most economists still think that the two countries will eventually reach a deal. As the downsides from tariffs become clearer, the reasons to strike an agreement, however tenuous, will prevail. But that is another way of saying that things may have to get worse before they get better. Exactly how much worse is the question.