Trade wars have never ended well as every trade war in the known history of civilization has resulted in actual war. The conclusions of previous trade wars, no matter how unfair, were concluded at the end of a barrel.
As most of civilization veers away from war, especially when between two nuclear powers such as the United States and China, it will be hard to imagine how the current China-US trade war reaches its conclusion.
Tariffs at a Glance
Tariffs are taxes paid by the importer when goods arrive to their destination country if that destination country has imposed tariffs on those goods or their origin country.
At a glance, this means any business that intends to continue to sell goods which have tariffs imposed on them must pay those taxes. This is of course very true, except you then have to consider how that business intends to recoup those costs.
If a business can import an item with tariffs placed against it, but comfortably raise the final sale price of that product to the end user, they will very much do so. This is especially true if there is no other source for those products.
In effect, it becomes a tax on the consumer and as existing stock levels dwindle to be replaced by newly tariffed goods, this will become more apparent in the market.
The point of a punitive tariff is to make it so that businesses are unable to continue sourcing their products from the targeted country forces business to seek suppliers where the punitive tariffs do not apply.
This could be an effort to boost manufacturing in the home country or in the case of the China-US trade war, punitive actions in order to force economic change.
Cost of Manufacturing
It should be no surprise that manufacturing is a very expensive endeavor. Take it from the Central Standard Timing company’s Kickstarter to fund the CST-01, a thin e-ink smartwatch. After CST-01’s Kickstarter raised over $1 million USD, the project declared bankruptcy three years later and not a single product was shipped.
Central Standard Timing’s team were more than likely completely unaware of the actual time and money it would take to develop a product from scratch, especially one that required unique technology. Prior to the bankruptcy, they were seeking an additional $1.2 million USD in order to mass produce the watches.
First Casualty: Soybean Farmers
It is almost saddening to see the reporting coming out of the farming belt as the long term damage is already done. There are several factors to take into account to understand that soybean farming in the U.S. is inevitably a permanently damaged market.
We know for a fact that U.S. farmers are hurting from the trade war due to China’s raising of tariffs on several key agricultural products, such as soybeans. Trump has issued a second aid package of $16 billion USD on top of the $12 billion USD aid package from late 2018 in order to alleviate the growing pains for farmers.
Furthermore, an agricultural product like soybeans can be easily sourced elsewhere, due to it being a low skill and low technology industry. Sourcing it elsewhere is exactly what Chinese buyers have done. Brazil overtook the U.S. as the largest supplier of soybeans in the 2012-2013 growing year and there is no reason for this gap to decrease with the trade war in effect.
Farmers may be betting that this business will return to the U.S. when this trade war concludes, but take this into consideration. The Chinese government can use a loophole to buy U.S. soybeans, import them into the country and bypass their own tariffs, then sell those soybeans back to Chinese buyers tariff-free. This option is not being utilized, which is one more signal to the greater scale of change that is occurring. U.S. Soybean farmers are unlikely to ever see this business return and it is time they raze those fields for new crops.
Manufacturing is Expensive
Most people would not understand every single aspect of manufacturing, because most would not need to. Manufacturing in general requires several key factors to take into account.
Many people discussing their trade war have pitted their hopes on the fact that due to rising wages in China, this means that manufacturing will inevitably be forced to migrate to nations with lower wages, such as Vietnam.
Although it is true that some manufacturing has already begun migration, the vast majority cannot shift without major changes and investment.
Considering that in 2014, China had 120 million manufacturing workers in just the formal manufacturing sector, even if the entire population of Vietnam shifted to the manufacturing sector, they would not be able to meet this same demand. To further support the workforce numbers required to manufacture like China does, the average Foxconn factory in China can hire over 3,000 employees overnight.
At this point in time, the sheer amount of workers available in China is not possible anywhere unless India is capable of taking over the industry or China’s industries dissipate across multiple nations.
Automation also threatens this factor as a whole. In May of 2016, Foxconn slashed 60,000 jobs by implementing automation bringing into question the cost effectiveness to invest into automation, which I will get into later.
Workforce numbers are however not the only problem.
Manufacturing an end product does not just happen. It requires a refined material which is refined into a part which is then assembled with other parts to form a finished project. The ability to move those raw or refined materials and finished parts require roads, rail, or ports in order to be imported or exported to where they are needed.
One of the key points to all manufacturing that happened during Vietnam’s ‘Golden Decade’ of manufacturing was preceded by manufacturing companies having to invest into building roads around their factories.
Roads being a prerequisite of manufacturing also means that cement, asphalt, or road building companies need to be invested into. If those finished parts are not being assembled domestically, they need to be transported along those same roads and then as air or sea cargo. What then is the throughput for all of these incoming and outgoing materials and parts of each country?
According to The World Bank, as of 4/24/2019, China accounts for 28.3% of the world’s container port traffic when measured by TEU.
Even if we ignore other measurements, such as imports versus exports, this measurement is a sign of China’s vast throughput when comparing to the world abroad.
Contemplating the issue of logistics further would involve determining whether this is a situation of chicken and egg and that will become the problem for any country where investments into manufacturing or industrial sectors are diverted.
This inevitably ties to the third and most important aspect when considering the manufacturing industry, which is energy. Energy consumption is a key indicator of economic activity because it directly relates to utilization in the industrial sector. To the layperson, this is an oft overlooked aspect that has to be considered when discussing the China-US Trade War.
When workforce costs are prohibitive on the international market, the first solution is always automation. Here you run into another ‘chicken and egg’ situation where the automation has to cost less than if you were to hire a large workforce, but it also requires more energy consumption.
Take into account that the world as a whole generates 25,551.3 TWh of energy per year where China alone accounts for 25% (6,495.1 TWh/year) of that total, the U.S. accounts for 16.8% (4,281.8 TWh/year), and India comes in at third with 5% (1497 TWh/year). [PDF Source: BP Statistical Review of World Energy 67th Edition]
According to the U.S. Energy Information Administration (EIA), of the world’s total energy produced, 54% is consumed by the industrial sector. [PDF Source: EIA.gov Energy Consumption by Sector]
When taking into account the energy produced around the world and the amount of energy utilized in the industrial sector, it is clear that manufacturing in any aspect absolutely requires vast amounts of energy.
If manufacturing is intended, as many hope, to be distributed to new countries, it comes into question whether or not those countries have the energy capabilities to actually onboard those industries.
Manufacturing in a Nutshell
The reality is that even though the U.S. encumbers China at this time, manufacturing does not spring up overnight. Even though many may be putting their hopes on the fact that this trade war will affect China in the long term, it is not possible for these industries to spring up in the short term.
Combining the available workforce, the logistics, as well as the availability of energy means that the ability to migrate these manufacturing capabilities is years down the line.
If the U.S. is capable of stymying China’s endeavors at this time, it does not guarantee that China will inevitably lose its capabilities as the World’s Factory.
Just because the U.S. is putting pressure on China does not mean those manufacturing capabilities are going to migrate overnight to other countries because the reality is that those countries could not ontake those manufacturing capabilities even if they wanted to.
Unlike the soybean industry, much of what comes out of China requires investments that may take years to develop. This is of course taking into account whether or not those investments have guaranteed returns.
President Trump’s term is not forever. Whether investment into the necessities of manufacturing is beneficial to the investor of such endeavors is very much up in the air.
If you have never heard of it, Yiwu is a city in China that is renowned even domestically in China as the wholesale capital of the world. You can find anything and everything in Yiwu. Take a look at this video to get an idea of the absolute vast amount of goods available.
From the video, you can see that the goods produced in China encompass goods you may not have even imagined. Even if it is Christmas decorations year-round, these manufacturers have already established their factories, the molds necessary to press their goods, they have the workforce to man their production lines, and they have the electricity necessary to run those production lines.
The amount of time and investment required to move these industries in the scale necessary to replace China as the World’s Factory carry not only the herculean task of doing so, but also the risk of being completely unnecessary.
China’s government is much more monolithic than that of the United States. There are no guarantees as to how long these tariffs can last, whether during or after the term(s) of President Trump. If China’s industries are strong enough to outlast these tariffs, this creates a risk for any potential investors that seek to invest into the infrastructure necessary in other countries.
This brings us to an interesting point.
One Belt, One Road
China itself is actually investing vast amounts of money into the type of infrastructure required to make manufacturing possible outside of China.
We have a lot of surplus equipment for making steel, cement and pleat glass for the Chinese market. This equipment is of good quality. We want companies to move this excess production capacity through direct foreign investment to ASEAN countries who need to build their infrastructure. These goods should be produced locally where they are needed. -Li Keqiang
According to the Lowy Institute’s report by Peter Cai as well as quotes from CCP officials, one of the oft-stated goals of the OBOR initiative is very much to transition manufacturing sectors out of China.
Even if your opinion of the OBOR initiative is not a positive one, it is irrefutable that building railways, power plants, and ports are very much the exact infrastructural needs that are important to an industrial sector.
The Hurt is Spreading
Making this trade war about trade is an impossible feat. Of course we know that there are many more accusations besides a trade deficit. Allegations of forced technology transfers and theft of intellectual property are also some of the highlighted justifications for this trade war.
Regardless of the motives, the trade war is causing pains around the globe and although it is impossible to determine ‘winning’ for anybody, there are many realities we can view.
Prices Will Rise in the U.S.
If we take into account the difficulty of migrating manufacturing elsewhere as well as the fact that China is already so well placed to manufacture so much of these goods, there is nowhere else for many of these goods to come from.
The reality of the China-US Trade War is that when prices rise and no alternative source is available, the trade deficit will actually increase as more money ends up being spent by American consumers.
..China produces 99% of the fireworks you use at home and 75% of the fireworks the professionals use.
These price increases are expected across numerous industries. Walmart has stated that although they will try to keep prices down, increases are on the way as a result of the trade war. Another reported sign of this as actually being a consumer tax is that washing machine tariffs will cost U.S. consumers about $1.5 billion USD a year. Ironically, a product we use to celebrate American liberty and freedom will also see prices increase as a result of tariffs. After current stock levels of fireworks in the U.S. are depleted for the July 4th holiday, firework prices will inevitably increase as China produces 99% of the fireworks you use at home and 75% of the fireworks the professionals use.
Manufacturing is Not Coming Back to the US
It just is not possible for the vast majority of manufacturing industries to return to the United States and this goes beyond the cost factor, although that is a major contributor to the issue.
As shoemaking jobs disappeared, so did the support network for the industry. Suppliers of things like the little metal eyelets and colorful leather followed the industry overseas. Many shoe factories turned into warehouses and offices.
A story reported by NPR going over the decline of shoe manufacturing in the United States as well as failed attempts at its revival highlight much of the same problems already discussed. The failure of a manufacturing industry is a cascading effect, where any missing or too expensive part of the process can topple the next thereby causing the industry to fall like dominoes.
All is Fair
The China-US Trade War is seeing both countries utilize their arsenals. For example, the Chinese Yuan devalued against the US Dollar as the trade war ramped up and it has fluctuated along with trade talks.
This means that even if Chinese sellers have to sell their products at a reduced price, when they convert their US Dollars back into Chinese Yuan, they are much less likely to have lost spending power at home.
The US blacklisting of Huawei and China’s threat on the export of precious metals are just a few examples. In the broader spectrum, the United States may have taken a bigger bite than it can handle. If China was the only target of US punitive tariffs, the story could be very different. However, as seen from the recent tariff hikes on U.S. goods by India, the playing field is far from even. The United States has shot across the bow of many nations, including many allies. This alienation very much puts the U.S. at a disadvantage unless it can close many of these deals quickly. There is also the loss of potential business as China is seen doing the opposite of the United States by further cozying up with its trade partners.
Regardless of whether you are for or against this trade war, it is important to look at it from a broader perspective. The damages from this war will not go away because it ends. Much of the damage is permanent and players in the battle are pushing that permanence to their advantage. Whether the U.S. is able to gain its stated goals or if China is able to survive these punitive damages is something nobody can predict, but there are plenty of factors that can sway favor in one direction or the other.