Investigating the impact of a trade war on Chinese and U.S. economies


The potentially “devastating” trade war between the U.S. and China has dominated headlines in recent weeks. On July 9, Germany and China renewed their commitment to free trade with $23.5bn worth of commercial agreements. The next day, Washington threatened new tariffs on $200bn worth of Chinese goods. What is often left out of this story is the potential role played by Beijing’s investment in foreign infrastructure, the Belt and Road Initiative (BRI), which will build $900bn worth of highways, ports, rail networks and bridges in more than 70 countries.

The countries where the Silk Road will be revived, cover a wide geographic, cultural and economic range, from Germany to Kazakhstan to Singapore.

Trump claims he is determined to end what he perceives as China’s unfair trade policies, such as currency manipulation and export dumping. America’s economic dominance has been challenged; declining growth is experienced as stagnant wages and dying industries. To what extent this is due to Chinese growth and trade is a different matter. As early as 2015, 350 of the U.S.’s leading economists, including MIT’s Daren Acemoglu, said Trump’s views on trade ignore “the reality of technological progress and the benefits of international trade.”

WikiTribune collected the World Bank’s economic indicators for China and the U.S. from 1980 onwards. Gross Domestic Product (GDP) and its composition gives us an idea of how the two economies have developed over this period of time. Combining the facts of the past with IMF predictions of growth, current account balance and government debt, we can place the BRI within the context of the evolution of the two economies. If China is the world’s factory, what can a trade war do to its economic well-being? Will the BRI successfully re-orient its exports?

Gross Domestic Product (GDP)

A country’s economic size is primarily measured by GDP. The U.S. remains ahead of China when measuring production in terms of U.S. dollars, but China has been catching up over the past 30 years. If the two measurements are taken at Purchasing Power Parity, which accounts for the fact that a dollar has different buying power across borders, the Chinese economy surpassed the U.S. in 2014.

In the same year, China took the lion’s share of the world’s productivity. This is depicted in the graph below.


Since the 1980s, China has experienced high levels of growth, almost double those seen in the U.S. Both experienced a drop in output after the 2008 financial crisis. Even though both economies rebounded, it is expected that GDP growth will slow over the next five years. China’s growth rate has faded in recent years, but remains positive. China is predicted to continue increasing its output, unlike the U.S.

The expansion of GDP has yet to trickle down to the Chinese population, as output per capita shows. Even at purchasing power parity (PPP), the American worker produces 3.5 times what his or her Chinese counterpart does. High levels of GDP associated with low levels of GDP per capita can be interpreted as a red flag for inequitable development.  What is more, low household income precludes high levels of consumption, which can act as a driver of GDP growth.

GDP composition


Economic theory tells us that as countries’ GDP per capita increases, employment moves from agriculture, through manufacturing and into services. The U.S. made this transition a while ago. As it got richer, financial and productive capital was accumulated, which boosted manufacturing, increasingly adding value to manufactured goods. Eventually, it withdrew from goods into services which often face constant demand and less price volatility.  The model is not always accurate. In India, services now make up 60 percent of employment, despite the fact that the industrial sector has remained constant.

As the graph above shows, China’s employment follows the same three-sector model to a large degree. Employment in agriculture has been steadily declining as a share of GDP, whilst the services sector is growing. The U.S. is increasingly a service-based economy, as has been it has been for several decades. If the three-sector model continues to apply in China, as the trend indicates, the distribution of employment will converge with the United States, towards a service-based economy.

But discrepancies appear when comparing the drivers of GDP. Household consumption, government spending, investment and net exports all help finance production. Government spending has remained relatively constant at about 15 percent of GDP since 1980. Household consumption accounts for two-thirds of production in the American economy. Since the millennium, Chinese households have been reducing their spending. By 2016, they only accounted for a third of production. Investment, on the other hand, has seen a slow but steady increase, outpacing the U.S. by almost 40 percent.

Chinese consumers are saving more and more of their income, so they are spending less on consumer goods. Overall, China’s gross domestic savings is at least triple that of the U.S. Savings do not fuel production in the short term, but can provide security in the long term.

Trade

The final component of GDP is trade. If a country imports more than it exports, it is using up its own currency. At the same time, it is funding the development of overseas industries.

The U.S. has been running a current account deficit since the 1970s. Its trade is withdrawing from rather than adding money to its domestic market. The last time China spent more money on other nation’s production than its own was in the 1990s.

How does the Belt and Road Initiative fit in?

China’s BRI project largely operates through a series of loans to governments around the world. The infrastructure that China is helping finance will be funded by loans to governments and paid back with interest.

In Pakistan, for example, a $1.26bn deep-water sea port is under construction at Gwadar.  Located in western Pakistan, it will be the final stop in the China-Pakistan Economic Corridor, a 3,000 km project starting from the Chinese city of Kashgar. The cost to Pakistan is the Chinese ownership of the port for the next 43 years. In addition, 90% of profits will be collected by the leaseholders, the state-owned China Overseas Port Holding Company. A Special Economic Zone has been designated around Gwadar port and 85% of its profits will go to China Overseas Port Holding Company.


According to China, BRI will provide access to markets all around the world and a number of developing nations will be given an opportunity to increase their trade revenue.

The IMF predicts that public debt in BRI countries will decrease in the next seven years, while American and Chinese debts will see a rise. The BRI is a risk to China as well, since it is itself borrowing money at an increasing rate to fund this project. Its growth is expected to remain high until 2023, albeit slower than in previous years.

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