- U.S.-China trade tension is rising amid political rhetoric, U.S. efforts to relocate supply chains from China, and technology decoupling.
- While Phase 1 is in trouble with China well behind in its purchases of U.S. imports, both sides have strong incentives to stick with the deal for now.
- A fudge on trade should help support one bright spot in Asia's nascent COVID-19 recovery, which is the resilience of the technology sector.
Add a flare-up in the U.S.-China trade relationship to risks. The U.S., along with other countries including Australia, is questioning China's handling of the coronavirus, from its sharing of information to trade policies related to medical equipment and supplies. China has defended its actions and suggested that mismanagement explains the outbreaks outside its borders.
The dispute has implications for growth. U.S. officials have remarked that COVID-19 has encouraged them to redouble efforts to reduce supply-chain dependency on China. President Trump has suggested that the U.S. government could impose additional tariffs on Chinese imports as the "ultimate punishment" for China's handling of the coronavirus. The U.S. has continued to tighten rules governing the transfer and trade of technology products.
Renewed tension comes as the "Phase 1" trade deal agreed to late last year is already in trouble. China committed to purchasing an additional $200 billion of imports from the U.S. during 2020 and 2021. However, imports so far this year are tracking well below levels consistent with this target. The deal includes a "disaster clause" that seems to cover events such as global pandemics, but this is toothless in substance. China has yet to use it.
Clearly, the timing of renewed trade tension could not be worse. One bright spot in Asia's nascent COVID-19 recovery has been the resilience of the technology sector, both in terms of trade and final demand. Technology supply chains have recovered quickly and the prospect of a "new normal" of home working, online shopping, and health tech has lifted demand. The tech sector has become a key driver of China's economic cycle and, by extension, for economies across the region.
Incentives are strong on both sides to keep Phase 1 alive for a while yet. A large trade-related hit to market confidence would set back the COVID-19 recovery. If this leads to a fudge on trade, for now, Asia's tech revival will remain on track. However, the threat of higher tariffs and the intensifying technology cold war could yet disrupt technology trade and investment, de-powering what still promises to be an engine for recovery in 2020.
Phase 1 Trade Deal Was In Trouble Before COVID-19
China committed to buy an additional $200 billion of U.S. goods and services over the two years through 2021 when it signed up to Phase 1. The point of departure was taken to be 2017, the year before the trade war broke out, when imports of U.S. goods and services totaled $186 billion. This would entail a swing toward U.S. imports of about 1.4% of China's GDP.
The purchase commitment was already a tough ask. Phase 1 set annual targets for both 2020 and 2021. Let's assume, instead, that China scaled up its purchases gradually to keep things simple. Starting from the level at the end of 2019, imports would have to grow by a little more than 6% per month for two years (see chart 1).
Imports in 2019 were unusually depressed as China began to reduce its reliance on the U.S., so a fairer comparison might be 2017. Using this as our starting point, China would still need to grow its U.S. imports by about 4% every month. That might not sound like much but let's put that in dollar terms. China's purchases would have to more than triple from about $8 billion to over $30 billion per month by the end of next year.
China's goods imports are not yet on a path consistent with Phase 1. Imports are already running well below 2019 levels, never mind 2017. It's not clear to us why U.S. imports to China have dropped this year--both absolutely and relative to the rest of the world--in the face of tremendous political pressure from the U.S. to increase exports to China. It's possible that the COVID-19 outbreak has thrown this initiative off track.
During the first quarter, U.S. data suggest that China's imports this year were running over $7 billion (or 25%) below the same period in 2017. Imports can be lumpy--think of soybean harvests and aircraft--so this will not follow a smooth line. Still, China's purchases are off to a slow start.
China also faces challenges scaling up its purchases of U.S. services. In 2019, China imported $56.7 billion of U.S. services, about 1% above the level in 2017. Phase 1 commits China to buying $38 billion more in U.S. services over 2020 and 2021 combined, using the 2017 import level as a base line. This means that service imports from the U.S would need to grow by about 2.4% per month and, by the end of 2021, be about 70% higher than the level at the end of last year.
China's Imports Of U.S. Goods Drops Below Trend
The deal specifies how China should allocate its goods purchases. Of the additional $162 billion (netting out services), China is committed to spend at least $78 billion on manufactured goods, $52 billion on energy, and $32 billion on agricultural goods.
China's purchases of U.S. products so far this year are running below levels in either 2017 or 2019 (see chart 2). The gap is large for soybeans, transport equipment, and energy. China is still buying sophisticated manufactured products, such as electrical and specialized machinery, at rates higher than we have seen in the past. This might be because China has fewer alternatives to U.S. products for specialized equipment.
Phase 1 'Disaster Clause' Means It's Time To Chat--That's It
COVID-19 makes China's task of meeting its Phase 1 commitments harder. China's big buyers of U.S. imports, including airlines, manufacturers, and power producers, are unlikely to scale up their purchases with the economy still healing from COVID-19. There may be more scope to lift purchases of soybeans, especially if China's livestock industry recovers as swine flu recedes. But the overall point is that imports normally rise and fall with GDP, and China's GDP over the next two years will be much lower than anyone thought possible when the trade deal was signed.
China could trigger the deal's disaster clause, which appears to cover a situation such as a global pandemic. However, this is not a "force majeure" type of clause. In its entirety it reads that, "In the event that a natural disaster or other unforeseeable event outside the control of the Parties delays a Party from timely complying with its obligations under this Agreement, the Parties shall consult with each other."
In other words, if either party is hit by a global pandemic it seems like a good time for a chat. That's it. There appears to be no obligation for either party to accommodate changes to the deal if it does not agree. The U.S. Trade Representative last week noted that "[Both sides] agreed that in spite of the current global health emergency, both countries fully expect to meet their obligations under the agreement in a timely manner."
Let's All Try Harder And Declare Victory
The most likely outcome is a fudge. China steps up its purchases of U.S. products, particularly those with political resonance in America such as soybeans, but still falls short of the overall deal. The U.S. acknowledges progress and declares victory. Kick the can down the road and talk about "win-win" outcomes and "the best deal ever." Focus on healing the economy from the COVID-19 shock.
Even this compromise will come with political noise that could damage confidence and impose real economic costs. As fears about tariff hikes wax and wane during the consultations, financial conditions could tighten as investors price in the risk of a bad outcome. Firms may go even slower on investment plans hampered by COVID-19. As the old saying goes, nobody wins a trade war.
If China Starts Buying American, Global Markets Will Be Disrupted
Incredibly, the deal notes that "purchases will be made at market prices based on commercial
considerations." Economics 101 tells us that if we fix the quantity, we must accept whatever price that implies. Common sense tells us that, unless we buy more of everything, favoring one supplier will hurt competitors. Fulfilling the deal will mean trade disruption and diversion.
China will not add U.S. purchases worth more than 2% of GDP over two years on top of its existing import bill and worsen its trade balance. Total imports reflect the level and composition of demand and the real exchange rate. Changing these two would require profound changes in policies that are unlikely to be consistent with China's most important objectives--full employment, stable prices, and financial stability.
If China will not import much more than it would have otherwise done, it will have to switch suppliers. In the long run, this may not matter. Net global demand will not change, prices will be unaffected. A soybean is, after all, a soybean. Still, trade diversion is likely. Suppliers in other countries will need to find new markets, negotiate new terms, and arrange new supply routes. This will add costs and complexities to a world recovering from COVID-19.
China's Trade Diversion
Trade tension has already caused trade diversion. Chart 3 shows average monthly imports into China from the U.S. and the rest of the world since the end of 2017 compared with the average level in 2017. In peacetime, imports typically rise in the same direction for both the U.S. and the rest of the world. Unless the U.S. becomes much more or less competitive, its shares in China's imports should be fairly stable.
Chart 3 shows that in some cases such as vegetables (including soybeans), vehicles (including aircraft), and to a lesser extent plastics (often specialty polymers), China is importing more from the rest of the world and less from the U.S. In others, including chemicals, metals, and fuel, we see a similar pattern but U.S. imports have stalled rather than declined.
The timing of purchases also points to trade diversion. This is reflected in the monthly pattern of purchases, again relative to 2017 average levels, for vegetable products (including soybeans) over the past two years (see chart 4). Starting with the northern hemisphere harvest in 2018, higher-than-average purchases from the rest of the world coincide with lower-than-average purchases from the U.S.
There is a similar pattern for fuel imports (see chart 5). Starting in late 2018, when purchases of fuel from the rest of the world picked up, those from the U.S. declined relative to 2017 averages.
Trade diversion should show up in falling U.S. import shares. Indeed, since the trade war broke out, China has reduced the U.S. share of its imports from almost 9% to just 6%, with the U.S. share dropping for key products (see chart 6).
China will need to switch its purchases of some imports to the U.S. and away from other trade partners, especially in soybeans, manufactured goods, and energy. If China's total imports remain steady, then the share of U.S. products will have to almost double over the next two years. Brazilian soybean farmers, European aircraft manufacturers, and Russian oil drillers may need to find new markets.
These charts are not definitive proof of trade diversion because we do not know what trade patterns might have been in the absence of a trade war. However, we think it suggests a change in behavior within China that has benefited alternative suppliers.
It Is Still Technology Not Trade, Decoupling Not Soybeans
Trade and tariffs are important but not the most important issue. We have long thought that, from an economic perspective, technology not trade is the core issue in the U.S.-China relationship (see "The Great Game And An Inescapable Slowdown," Aug. 29, 2019). Technology has been and will continue to be the key driver of growth in China. It is at the heart of intellectual property, market access, and level playing field debates.
Even as the trade truce held, the U.S. has continued to tighten the screw in its technology policies toward China. One tool of choice is the executive order, which has been applied recently to restrict technology and investment flows with China in the telecoms and power infrastructure sectors. Another is the Export Administration Regulations, which were broadened to include a wider range of products that could be used in military applications .
Our point here is that, whatever happens with the Phase 1 trade deal, we should not lose sight that the long-term dynamics of the U.S.-China economic relationship remain unchanged. Technology is becoming more important for growth (everywhere) and the U.S. and China are on a path toward decoupling.
Testing Asia's Tech Cycle Resilience
Putting aside the long-term challenges from U.S.-China decoupling, a renewed flare-up in trade tensions could test Asia's nascent tech sector recovery. Bright spots are hard to find but Asia's tech cycle is one of them. There has been a clear turn in the exports of technology products from three regional powerhouses: Korea, Singapore, and Taiwan (see chart 7). This is due to resilient supply and demand.
First, fears of serious tech supply chain disruptions stemming from COVID-19 have been misplaced. Second, demand for technology may benefit as a result of COVID-19 as firms and households gear up for more online activity in the "new normal." Global IT spending will decline 4% in 2020 with slight outlook deterioration across all technology segments, we expect (see "As Global IT Spending Falls, Tech Ratings Pressure Rises," April 29, 2020). Compared with many other sectors and given the hit to corporate cash flows and household incomes, this presents stellar outperformance.
The tech cycle is important for recovery even though the service sector will play the key role in this recession. As a share of value added, the importance of tech varies across the region and is highest in Taiwan, Korea, Singapore, Malaysia, and China. For China, the domestic supply chain feeding tech has also grown, so a rebound could ripple across the manufacturing sector. A U.S-China trade fudge should help keep the tech recovery on track and this will be a key part of Asia's recovery in 2020.
Trade Deal In Trouble, Swerving Likely, But Technology Still Key
The Phase 1 deal is in trouble. China is unlikely to meet its commitments to increase its purchases of U.S. imports by $200 billion. Still, a flexing of terms is likely at least for a few months. China should commit to pick up the pace of purchases and the U.S. will claim some progress is being made. As China buys more U.S. imports, some markets may be disrupted as non-U.S. suppliers get squeezed out. Agriculture and energy markets look exposed.
Additional damage to market and business confidence should be limited and the outlook, while highly uncertain, is little affected for now. With a Phase 1 easing, Asia's technology sector can continue to lead the recovery from the COVID-19 sudden stop. China, Korea, Malaysia, Singapore, and Taiwan will benefit most.
We should not lose sight of the bigger game being played, however. Technology de-coupling of the U.S. and China continues unabated. This flies under the radar of financial markets but this will matter much more than tariffs for Asia-Pacific's trading system and long-run growth across the region.
- As Global IT Spending Falls, Tech Ratings Pressure Rises, April 29, 2020.
- Economic Research: China Credit Spotlight: The Great Game And An Inescapable Slowdown, Aug. 29, 2019
United States Federal Register, "Expansion of Export, Re-export, and Transfer (in-Country) Controls for Military End Use or Military End Users in the People's Republic of China, Russia, or Venezuela--A Rule by the Industry and Security Bureau." April 28, 2020
This report does not constitute a rating action.
|Asia-Pacific Chief Economist:||Shaun Roache, Asia-Pacific Chief Economist, Singapore (65) 6597-6137;|
|Asia-Pacific Economist:||Vishrut Rana, Asia-Pacific Economist, Singapore (65) 6216-1008;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: email@example.com.