With moderate economic adviser Gary Cohn exiting the White House, and President Donald Trump reportedly mulling broad curbs on imports from China, fears of a 1930s-style trade war are spiking. Indeed, for the past several months, a potential U.S.-China trade battle has ranked as one of the key macro investment risks of 2018. Given Trump’s predilections and China’s leverage, however, the conflict to come may look very different than most are imagining.
For one thing, it’s important to remember that we’re nowhere near Smoot-Hawley territory yet. When that legislation was enacted in 1930, tariffs were applied to over 20,000 different goods, and direct retaliation by key U.S. trading partners exacerbated the damage. So far, the Trump administration has or has threatened to impose tariffs on just four goods. And while the White House is reportedly considering casting a wider net, an across-the-board penalty still seems unlikely.
What’s more, China probably wouldn’t counter with hefty new duties on all U.S. goods. China’s greatest leverage over its trading partners isn’t in broadly restricting trade per se, but in inflicting tactical pain on companies that operate in China or are highly exposed to the Chinese market.
Think about how China reacted to South Korea’s decision to deploy a U.S. missile-defense system on the Korean Peninsula in 2016. Seeking to change minds in Seoul, Chinese regulators all but shut down the Chinese operations of Lotte Corp., the Korean conglomerate that was set to provide the land where the missiles would be stationed. The company paid a harsh price: Between mid-March and mid-September 2016, its share price fell by almost 40 percent.
In addition to targeting Lotte, Chinese customs officials disrupted imports of Korean cosmetics, confectionaries and cell phones. The Chinese tours of K-pop stars were abruptly canceled and authorities temporarily banned Chinese tour agencies from offering trips to South Korea. Those moves produced similar nosedives in specific equity prices. Korea’s largest cosmetics company, AmorePacific Corp., saw a 58 percent drop in operating profit at the height of tensions in the second quarter of 2016. Shares of Korean Airlines Co. Ltd. fell 24 percent from early July to mid-October last year.
Yet, none of China’s actions had a lasting impact on South Korea’s overall economy: GDP expanded by 2.7 percent in 2016, up a touch from 2.6 percent in 2015. Overall trade with China held up just fine as well. True, South Korean exports to China contracted by 9.4 percent year-on-year in the first three quarters of 2016. But total Chinese imports shrank by a roughly similar 8.3 percent during the same period.
China is likely to take a similar tack with U.S. companies. While that means the likes of Apple Inc., The Boeing Co. and General Motors Co. will be in the crosshairs, overall imports of American goods — especially key commodities — may not suffer sharp declines. Chinese officials figure that by restricting the sales of specific goods and generally disrupting business operations — as opposed to raising barriers to broad categories of imports — they can convince well-connected U.S. firms to make enough noise in Washington, D.C. to convince the Trump team to back off.
That may leave a select group U.S. multinationals caught in the middle. With the “globalist” camp of White House advisers shrinking, companies may be loath to cross a more combative Trump. But, with China fast becoming the largest market for many of them — if it isn’t already — they’re equally unwilling to offend Chinese regulators. Government relations teams at multinationals in China have been gaming out this scenario for months. The response from Chinese officials: We don’t want to punish you, but we may have no choice.
In such a scenario, the share prices of individual companies would be affected much more severely than the pace of growth in either the Chinese or U.S. economy: This is a micro, rather than macro threat. The announcement of steel tariffs by the Trump Administration last week produced a similar result. The likes of AK Steel Holding Corp. and United States Steel Corp., two U.S. steel companies, rose by 9.5 percent and 5.7 percent, respectively. Meanwhile, steel consumers such as General Motors Co. and Ford Motor Co. saw their stock prices dip by 4 percent and 3 percent, respectively.
To be sure, a sustained across-the-board tariff aimed directly at China — something Trump threatened during the 2016 campaign — would up the ante and require a vociferous response from the Chinese. So far, though, that idea doesn’t seem to be the administration’s preferred course. Until that changes, China will seek to fight a tactical trade war that imposes collateral damage on vulnerable companies, rather than throwing global commerce into turmoil.
Andrew Polk is a founding partner of Trivium/China, a Beijing-based research firm. He was formerly director of China research at Medley Global Advisors and chief economist at the Conference Board’s China Center.