US tech focus suggests risk of broader confrontation

Last week's US trade and investment measures targeting China focused on technology. China will respond, but we expect it to remain relatively restrained, and－barring major escalation－the macroeconomic damage in 2018-19 should remain manageable.

However, the technology focus of the US measures suggests the risk of a broader economic and technological confrontation.

Planned US tariffs and investment restrictions are meant to hit China in response to what the United States sees as unfair technology and intellectual property practices. The US aims to impose tariffs on $50 billion worth of Chinese exports to the US, with a focus on the advanced sectors that China has previously identified as ones in which it wants to become a global leader.

In response to earlier US tariffs on metals, China plans to impose tariffs on $3 billion of US exports to China, targeting agricultural and food products, while calls for further measures in response to the most recent US moves have proliferated. However, Beijing also continues to call for dialogue.

On March 22, US President Donald Trump ordered the United States Trade Representative Robert Lighthizer to prepare concrete action targeting China, including raising trade tariffs. This follows a Section 301 investigation by the Office of the USTR into policies and practices pursued by China that it claims constitute intellectual property theft and forced technology transfer. Trump also ordered the Treasury Secretary to explore restrictions on Chinese investment in the US.

The USTR declared in a fact sheet that he will propose additional 25 percent tariffs on Chinese exports with annual value "commensurate with the harm caused to the US economy", referring to an estimate of that harm of "at least $50 billion per year". The USTR also launched a dispute at the WTO "to address China's discriminatory technology practices".

Lighthizer told the Senate Finance Committee that the industries he "will recommend for tariffs are mainly those that China has identified in its Made in China 2025 plan as areas in which it wants to become a global leader: new advanced information technology; automated machine tools and robotics; aerospace and aeronautics equipment; maritime equipment and high-tech shipping; new-energy vehicles and equipment; modern rail transport equipment; agricultural equipment; new materials, biopharma and advanced medical products".

A few hours after the US announcement, China's Commerce Ministry said it plans to impose tariffs on about $3 billion worth of US exports. This was in response to the earlier US plans to impose tariffs on steel and aluminum, from which, by now, many other steel-exporting countries have obtained exemptions. China's tariffs include a 25 percent one on US pork imports and recycled aluminum, and 15 percent tariffs on US steel pipes, fruit and wine. China will also pursue legal action against the US at the WTO, while also calling for dialogue to resolve the dispute.

The amount of Chinese exports that the US aims to impose additional tariffs on would equate to about 10 percent of China's total exports to the US, which is nearly 2.2 percent of China's total exports, or 0.4 percent of GDP. The tariff rate of 25 percent is as we assumed before.

The relatively modest scale is because, the large share of US imports from China that is US-branded and/or features the significant involvement of US companies in the supply chain constrains the range of existing Chinese exports to the US at risk of major US trade restrictions. The Chinese exports most at risk of protectionist measures by the US are those that compete with US-based production and are produced via Chinese or Asian supply chains with little involvement of US firms.

Indeed, the USTR is targeting the advanced sectors that China－using homegrown technology－aims to become a global leader in, rather than the large amounts of often US-branded information technology, consumer electronics and telecom products that China exports to the US. Lighthizer noted that the list does not include consumer items "that should not be on there".

As indicated by recent action and comments, China will surely respond, as it does not want to appear weak vis-à-vis the US. But we continue to expect its response to be relatively restrained, with targeted measures rather than broad ones.

The economic impact of the scale of trade measures that the US is aiming for, with proportionate retaliation from China and some negative impact on confidence, is modest. The $50 billion scenario would reduce China's GDP growth by about 0.05 percentage points in 2018.

Moreover, despite the high-profile announcements, it will take some time before the US measures will be introduced. And the process leaves ample room for discussion and negotiation on the amount and types of goods targeted.

However, there are risks of much more serious trade friction. During the announcement of the memorandum, President Trump said this measure will be the "first of many", underscoring the risk of escalation. Our research shows that, with more comprehensive trade restrictions imposed by the US and China (and the US eventually also leaving NAFTA), the overall economic impact on China, the US and the global economy would be substantial. The cumulative impact on the level of China's GDP in 2018-20 would be 1.6 percent. Collateral damage would be substantial, especially in Asia; while in Europe, Germany would be affected the most.

Also, the US focus on aspects of China's policies on technology and the USTR's explicit targeting of the advanced manufacturing sectors that China wants to become a global leader in points to the risk of a broad economic and technological confrontation between the two countries. This focus suggests that the risks of some kind of technological cold war have risen, even though the strong economic interaction between the two countries should constrain the extent of cold war-type actions.

Louis Kuijs is head of Asia Economics at Oxford Economics.