How US trade war is spreading from goods to services

After months of trade threats, the Trump administration announced its 25% tariff on $34 billion of Chinese imports effective in early July, while threatening levies on another $16 billion of imports. To defend its sovereign interest, China responded with 25% tariffs on $34 billion of US imports and recently imposed an additional tariff of 25% on $16 billion of US imports effective on August 23.

As Trump is escalating his tariff war, a total of $50 billion of goods on each side will be taxed as of Thursday.

Not so long ago, there was still relatively serious talk about the US-China Bilateral Investment Treaty (BIT). After all, Chinese foreign direct investment soared to a record $46 billion in 2016. But that was in the pre-Trump era.

Last year, Trump threats caused Chinese investment in the US to plunge to $29 billion, partly due to deleveraging in China but mainly thanks to very stringent US regulatory reviews of inbound acquisitions. After months of trade war, Chinese investment in 2018, asset divestitures included, is negative in the US.

In the coming weeks, things will go from bad to worse, as US tariffs are about to spread from goods to services. Ironically, that’s when much of the collateral damage will hit the US, however.

 

Collateral damage in services wars

Historically, advanced economies tend to enjoy service surpluses but goods deficits in trade, thanks to higher productivity and value-added. And US-Chinese trade ties are no exception.

According to most recent data (2017), US goods exports to China are $130 billion, whereas imports from China are to $506 billion. As a result, US trade deficit with China amounts to $375 billion. In contrast, US services exports to China are $54 billion, while services imports from China are $16 billion (2016 figures). Consequently, US trade services trade surplus with China is $38 billion.

As China exports far more goods to US than vice versa, Chinese retaliations already cover more US goods (85%) than US tariffs cover Chinese imports (50%). So as the ongoing trade war shifts from goods tariffs to non-tariff actions in services, China is likely to target US services. But China will not be the first to do so.

A few weeks ago, when Trump unleashed a tweet storm against Germany and the European Union (EU), German Chancellor Angela Merkel rightly pointed out that it is misleading to focus on goods trade, in which the US has deficit against the EU, when the US excels in services trade, in which it has a surplus against the EU. With other EU leaders, Merkel is backing a “digital tax” against US multinationals like Amazon, Facebook or Google, which have come under fire for shifting earnings around Europe to pay lower taxes.

 

Trump tariffs undermine U.S. high-margin services

Ironically, Trump’s tariffs have potential to undermine America’s most important competitive advantage in the postwar era – high-value, high-margin services, which range from the technology sector to big pharma.

Since 2001, US services surplus with China has increased nine-fold. A major beneficiary of the surplus is Houston, Texas. Last fall, Mayor Sylvester Turner led a Houston business delegation to China with energy execs, hospital administrators, physicians, medical researchers and entrepreneurs. The visit fostered many collaborative projects, including a medical center based on imported technology and consulting services from Houston.

Much of US services trade surplus with China can be attributed to Chinese travelers’ spending on US business, medical treatment and education, as well as increasingly innovative Chinese companies spending on US licensing fees and royalties for intellectual property. Yet, in Texas, Trump’s tariffs are now endangering major projects that took years to build.

As collateral damage will spread, so will the costs. If US metropolitan centers will take severe hits, the stakes will be much higher with US states. Last year, California’s trade with China totaled $170 billion, covering electric cars, engines, auto parts and aluminum. “A trade war is stupid,” warns Governor Jerry Brown, and for a reason. Among the US states, California, which is already facing a $1.6 billion budget deficit, stands to suffer the greatest pain if Trump’s tariff wars worsen.

Yet, this could be only the beginning. If trade wars spill from goods to services, neither Silicon Valley nor Hollywood will remain immune.

 

Global growth no longer immune

By upping the stakes in its trade war, the Trump administration is endangering US services surpluses not just with China, but with its other “deficit targets.” Trump’s dream is to defeat China in the trade war and then use that “demonstration effect” to force others – EU, Canada and Mexico, Japan and South Korea – on their knees.

That’s the White House’s ultimate goal: First to shock and awe its trade adversaries, and then to negotiate the best terms for the US – America First.

However, the White House severely underestimates the resilience of the Chinese economy and its people. Moreover, US tariff wars against its partners in Europe, North America and Asia Pacific are not a matter of principle, just a matter of time.

This trade war will have no winners. Instead, expect an avalanche of defaults soon.

 

Dr. Dan Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see https://www.differencegroup.net/

 

• A shorter version of the commentary was published by China Daily on August 22, 2018.

 

Dan Steinbock