Donald Trump and Xi Jinping will soon decide if they want to engage in a trade war. In this issue of Sinology, we explore the options available to both leaders. A key conclusion is that if either side chooses war, the impact on the Chinese economy and on the majority of listed Chinese companies will be quite modest, because it is not an export-driven economy.
Not Your Father's Chinese Economy
Before I discuss the battlefield choices Trump and Xi may make, I want to emphasize that forecasts that a trade war will seriously damage the Chinese economy and its listed companies are based on an outdated understanding of that country. The ongoing rebalancing of the Chinese economy has already made it far less dependent on trade and more focused on domestic demand, which should mitigate the impact of a trade war with the U.S.
The Chinese economy is no longer export-driven. Net exports (the value of a country's exports minus the value of its imports) account for only 2% of China's GDP, down from a peak of 9% in 2007. In contrast, domestic consumption now accounts for the majority of China's economic growth and more than half of its GDP. 2017 was the sixth consecutive year in which the consumption and services share of China's GDP was larger than the manufacturing and construction share.
Because Trump would be fighting a trade war without the support of America's allies, the impact on China's exports would be relatively small. Last year, Chinese exports to the U.S. accounted for only 19% of total Chinese exports.
On a micro level, I believe much of the impact of Trump's import taxes will not be borne by Chinese companies; about two-thirds of the 25 largest exporting companies based in China are foreign-owned. Moreover, one-third of the value-added from all Chinese exports actually accrues to firms from other countries, including U.S. partners such as Japan, South Korea, Taiwan and Germany, as well as to U.S. companies.
And, at Matthews Asia, we are focused on Chinese companies selling goods and services to Chinese consumers—the largest and fastest growing part of the economy. The impact of a trade war on earnings growth of these companies should be modest. Across all of our strategies, less than 5% of our China holdings have significant exposure (greater than 15% of total revenue) to the U.S. market. As a result, the impact of a trade war on our strategies should be modest.
Donald Trump's Smart Choice
There are many reasons why Trump may decide that his interests are better served by closing a deal with Xi to gain better market access and protection of intellectual property (IP) than by a trade war.
Tariffs are not an effective way to pressure Beijing to change, as China's economy is not export-led and the pain will be largely absorbed by foreign firms. The largest category of Chinese goods targeted by the initial Trump tariffs is computer and electronic products, but 87% of those are produced by multinationals, according to the Peterson Institute for International Economics.
China will clearly retaliate with reciprocal tariffs on U.S. goods, with a list designed to inflict pain on Trump supporters, which could help Democrats take control of the House in November. Of the 2,742 counties with employment in the industries targeted by Beijing's retaliation list, 82% of those counties voted for Trump in 2016, while just 18% voted for Hillary Clinton, according to analysis by the Brookings Institution.
Soybeans are high on China's retaliation list, and it is worth noting that 24 Republican Members of Congress represent districts which account for about 60% of the total U.S. soybean crop.
U.S. equity markets have already responded negatively to talk of a trade war, so actual conflict could have a significant impact on the valuations of the many companies which are doing well in China. General Motors sells more vehicles in China than it does in the U.S., and China accounts for about 20% of GM's global earnings. Boeing delivers more aircraft to China than to the U.S. China contributes roughly 15% of global earnings for firms such as Apple, Nvidia, Dolby and Tesla.
A trade war would jeopardize the many jobs at American factories and farms created by almost 600% growth in U.S. exports to China since that country joined the World Trade Organization (WTO) 16 years ago, including a 1,000% jump in agricultural shipments. Even imports from China create many American jobs. A 2011 study by the Federal Reserve Bank of San Francisco concluded that, “on average, of every dollar spent on an item labeled ‹Made in China,' 55 cents go for services produced in the United States. In other words, the U.S. content of 'Made in China' is about 55%.”
The president must also be concerned that an angry Xi Jinping may be able to scuttle a denuclearization deal between Trump and Kim Jong Un.