In just over a month since the change of government in the United States, two rounds of 10% tariffs have been imposed on Chinese imports, and another 34% differential and reciprocal tariff rate is about to take effect on April 9, which, when combined with the previous two rounds, will reach 54%. At the same time, the tax-free treatment for small parcels imported from mainland China and Hong Kong will also be terminated on May 2.

Affected by the sudden tariff shock, China’s exports to the United States are likely to decline this year. The market is concerned that this will reduce China’s trade surplus with the United States, and in turn reduce China’s overall trade surplus, which will drag down economic growth due to external demand. However, judging from the experience in 2019, the tariff shock may not necessarily be reflected in a decline in China’s overall trade surplus. Rather, it may affect or reflect China’s economic performance through both exports and imports, even as the surplus may expand. In this regard, we need to prepare early and turn pressure into motivation to accelerate economic transformation and policy adjustments.

In 2019, external demand bucked the trend and contributed to growth

During Trump’s first term in office, in early April 2018, the U.S. threatened to impose additional import tariffs on China based on the results of Section 301 investigations. Since then, the China-U.S. tariff conflict has escalated, and the U.S. has imposed 10% to 25% tariffs on a total of about $370 billion worth of Chinese imports in four batches on July 6, August 23, September 24, 2018, and September 1, 2019.

Trump’s 1.0 tariffs triggered a “rush to export” effect in 2018. According to Chinese statistics, during that year, China’s exports (in US dollars, the same below) grew by 9.9%, an increase of 2.0 percentage points over the previous year. Among them, exports to the United States grew by 10.8%, 0.9 percentage points higher than the average export growth rate. During the same period, as China’s imports grew by 15.8%, faster than export growth, the import and export surplus decreased by 16.4%, of which the trade surplus with the United States increased by 16.7%.

In 2019, as the “rush to export” effect subsided after Trump’s tariff measures, China’s exports grew by 0.5%, 9.4 percentage points lower than the previous year’s growth rate. Exports to the United States fell by 12.9%, 13.4 percentage points lower than the average export growth rate. During the same period, as China’s imports fell by 2.7%, lower than export growth, the import and export surplus increased by 20.0%, of which the trade surplus with the United States fell by 8.9%.

From the perspective of the “troika” of the expenditure method, in 2018, due to the narrowing of the trade surplus in goods, external demand (including the trade balance of goods and services) turned from a positive contribution of 0.32 percentage points to a negative contribution of 0.59 percentage points to real economic growth. In 2019, due to the widening of the trade surplus in goods, external demand turned to a positive contribution of 0.75 percentage points, an increase of 1.34 percentage points over the previous year. During the same period, the driving effects of final consumption expenditure and capital formation fell by 0.91 and 1.13 percentage points respectively compared to the previous year; real gross domestic product (GDP) grew by 6.1%, a slowdown of 0.7 percentage points compared to 2018.

The aforementioned tariff impact mechanism is: additional tariffs suppress Chinese exports → drag down export-related Chinese investment and employment → affect Chinese residents’ income and consumption → investment and consumption suffer → affect Chinese imports → expand China’s trade surplus in goods → enhance the role of external demand in China’s growth, but domestic demand is weak.

This corresponds to the fact that in 2019, the export delivery value of industrial enterprises above designated size in China (in RMB, the same below) grew by 1.3%, a decrease of 7.2 percentage points in growth rate compared to the previous year, and a decrease of 4.4 percentage points compared to the average growth rate of industrial added value, which was 2.3 percentage points higher than the previous year. Manufacturing investment grew by 3.1%, a decrease of 6.4 percentage points compared to the previous year, and a decrease of 2.3 percentage points compared to the average growth rate of fixed asset investment, which was 3.6 percentage points higher than the previous year. Private manufacturing investment grew by 2.8%, a decrease of 7.5 percentage points from the previous year and 0.3 percentage points lower than the average growth rate of manufacturing investment. For the whole year, the average urban survey unemployment rate was 5.15%, 0.22 percentage points higher than the previous year; the average urban survey unemployment rate in 31 major cities was 5.08%, 0.30 percentage points higher than the previous year.

This year may repeat the situation in 2019

Last year was an election year in the United States. After Trump was elected, Chinese companies rushed to “export as much as they can” since November last year and before Trump’s inauguration on January 20 this year, out of concerns about the tariff threats.

According to Chinese statistics, in the first 10 months of last year, with the exception of February, the year-on-year growth rate of China’s exports to the United States was lower than the national average growth rate. However, from November last year to January this year, the growth rate of exports to the U.S. was higher than the national average for three consecutive months, with an average increase of 4.1 percentage points. In February this year, the growth rate of exports to the U.S. fell below the national average of 6.9 percentage points. Whether this is a sign of the fading of the “rush to export” effect remains to be seen. In the first two months of this year, China’s exports grew by 2.3% year-on-year, while imports fell by 8.4%, and the trade surplus expanded by 36.9%.

As mentioned earlier, the U.S. has so far imposed a cumulative 54% tariff on Chinese imports (including the soon-to-be-imposed differential and reciprocal tariffs). Therefore, although the differential tariff rate imposed on China under Trump’s reciprocal tariff policy is only moderately high (the median differential tariff rate is 31%), the cumulative tariff is still slightly higher than Lesotho’s highest differential tariff rate of 50%. This will undermine China’s export competitiveness, leading to a contraction in exports to the U.S. and, in turn, a reduction in the trade surplus with the U.S.

In fact, Trump’s April 2 executive order already granted him the authority to further raise the reciprocal tariffs in the event of continued deterioration in U.S. manufacturing capacity and output. In other words, unless Trump’s trade policy changes course, as long as the China-U.S. trade imbalance does not improve or even worsens, he has the authority to raise the differential rates of China’s reciprocal tariffs.

However, as seen in 2018 and 2019, changes in the trade surplus with the United States do not determine the increase or decrease in China’s overall trade surplus. At that time, China’s trade surplus with the United States accounted for 92.4% and 70.2% of China’s total trade surplus, respectively, and last year that proportion fell to 36.4%. This year, it is possible that the story of 2019 will repeat itself and skip that of 2018.

First, this time the tariff measures against China have increased significantly and will be implemented quickly. Last time, it took Trump a year and a half to raise the average tariff rate on Chinese goods imported into the United States from 2.7% to a maximum of 15.4%, and it was lowered to about 12.5% after January 2020. Trump issued a tariff threat in early April 2018, giving Chinese companies a longer response time. This time, however, more than two months after Trump officially returned, the 20% tariff has already been implemented, and the 34% differential tariff is about to be implemented, leaving a relatively short time window for Chinese companies.

Second, the target of this tariff conflict is more extensive. Last time, it was mainly trade friction between China and the United States, while other economies were encouraged to negotiate through trade friction. This time, not only China is targeted but also Canada and Mexico, which have seen 25% tariffs imposed. Mexico has been an important destination for Chinese companies to relocate their industries in recent years. In the list of differential and reciprocal tariffs announced by Trump, all ten ASEAN countries except Singapore are on it, with Vietnam, Indonesia and Malaysia having differential tax rates of up to 46%, 32% and 24% respectively. This will curb Chinese companies’ indirect exports to the United States. At the same time, it is not impossible that some countries may impose tariffs on Chinese imports in exchange for tariff reductions from the U.S. side. In addition, the uncertainty of Trump’s trade policy will exacerbate the downward pressure on the global economy and weaken the growth momentum of world trade. According to the latest forecast by the Organization for Economic Cooperation and Development (OECD) in mid-March, the global economic growth rate is expected to slow from 3.2% in 2024 to 3.1% and 3.0% this year and next year. Previously, the agency predicted that the global economy would grow by 3.3% this year and next year.

Third, this time the tax base of Trump’s tariffs has been further expanded. Last time, the U.S. only imposed tariffs on a cumulative total of $370 billion worth of Chinese goods, equivalent to nearly three-quarters of the value of Chinese imports to the U.S. in 2017, according to U.S. statistics. This time, tariffs have been imposed on all Chinese imports, and even small tax exemptions have been cancelled. At the same time, last time the U.S. only imposed additional tariffs of 25% and 10% on steel and aluminum respectively. This time, the U.S. has not only imposed an additional 25% tariff on steel and aluminum, but also a 25% tariff on automobiles and their parts and components. Tariffs on specific goods such as semiconductors, pharmaceuticals, and timber are also on the way. The U.S. has made it clear that these tariffs are not subject to “reciprocal tariffs” and are cumulative. Of course, since Trump has generally raised taxes on imports from other countries and regions, this will help partially offset the impact of raising taxes on Chinese imports on China’s exports to the U.S.

In the end, Chinese imports may face greater downward pressure this time. Currently, China’s domestic effective demand, especially consumer demand, is insufficient, and prices have been running at a low level for a long time. The trade tensions will, in the short term, shrink China’s production possibility frontier. All other factors being equal, this will exacerbate the imbalance between domestic supply and demand, further suppressing import demand. At the same time, about 80% of China’s annual imports are intermediate goods, and a considerable proportion of these are related to exports (for example, imports related to processing trade account for about 1/6 of annual imports). If there is no export market, related imports will also shrink significantly.

In addition, China’s countermeasures against the United States, such as increasing import tariffs and implementing export controls, will also reduce China-U.S. imports and exports.

In summary, under the unexpected tariff shock, this year China may experience a slowdown in exports but an even greater slowdown in imports, just as it did in 2019, and the trade surplus in goods will increase against the trend. Judging from the “troika”, the driving effect of external demand on economic growth may not decline but increase, but it will affect related investment and consumption through imports and exports, which in turn will affect overall economic growth.

This will force China to accelerate its economic restructuring and adjustment

The success of China’s reform and opening-up over the past 40 years is certainly inseparable from the peaceful development of international environment, but China’s achievements in economic and social development have never relied on external gifts and handouts. The current adverse effects brought about by changes in the external environment have deepened, allowing us to completely abandon luck and illusions and turn the pressure of external suppression and containment into a driving force to focus on doing our own things well.

One, accelerate the construction of a new development pattern. The Chinese government proposed the construction of a new development pattern as early as 2020, and it was included in the report of the 20th National Congress of the Communist Party of China at the end of 2022, and in the “Resolution of CPC Central Committee on Further Deepening Reform Comprehensively to Advance Chinese Modernization” in mid-2024. Trump 2.0’s tariff storm is still evolving, and it is difficult to say that the China-U.S. economic and trade relations have already overcome the most difficult stage. This further highlights the necessity and urgency of constructing a new development pattern. While focusing on developing the manufacturing industry and expanding effective investment, we must also pay attention to developing the service industry and strive to boost consumption. By increasing counter-cyclical adjustments, especially implementing a more proactive fiscal policy, it will help to hedge against the impact of external uncertainties, increase aggregate social demand, and promote the economy to return to a reasonable range. But in the final analysis, we must further comprehensively deepen reform, promote the construction of a unified national market, focus on unblocking the bottlenecks in the economic cycle, further create a favorable development environment for all types of business entities, strengthen policy support for enterprise innovation and creation, and enhance the internal driving force of economic development. In order to gain time against various uncertainties, policies should be introduced and implemented as soon as possible, rather than later. Policy coordination should be strengthened to create synergy. In addition, in the face of the rise of anti-globalization, we must adhere to the “dual circulation” of opening-up. By steadily promoting institutional openness, autonomous and unilateral openness, we will further leverage the advantages of China’s ultra-large market, use the “big circulation” to drive the “dual circulation”, and promote the high-quality co-construction of the “Belt and Road” mechanism.

Second, transform the development model of foreign trade. For a long time, China’s foreign trade exports have pursued a marketing strategy of low profit margins and winning by price, which has shaped the position of Chinese products in the global industrial chain and supply chain. The tariff storm will affect the international price competitiveness of Chinese products. China’s foreign trade exports can only shift from price to quality, optimize the structure of trade in goods, increase the added value, technological content, brand awareness and reputation of products, and form customer loyalty, in order to have stronger bargaining power and make overseas buyers bear more of the tariff costs. At the same time, it is also very important to comprehensively rectify the “inward-looking” competition that is more inefficient the harder you try, especially vicious price competition, and to regulate the order of foreign trade operations. In this regard, it is necessary for enterprises, industries, markets and the government to work together, and to be self-disciplined as well as be disciplined by others.

Third, strengthen the people’s livelihood as an orientation of macro policies. At the end of July last year, the Politburo of the Central Committee of the Communist Party of China (CPC) meeting clearly proposed that the focus of economic policies should be shifted to benefiting people’s livelihood and promoting consumption, which marked the beginning of the shift in China’s macro policies. At the end of September, the Politburo meeting decisively deployed a package of incremental policy measures, which promoted a significant economic rebound, effectively boosted social confidence, and resolved major risks in an orderly manner. At the beginning of March, the government work report of the National People’s Congress and the Chinese People’s Political Consultative Conference once again emphasized the need to strengthen the people’s livelihood orientation of macro policies. In the past, China’s macro policies focused more on “investing in things” and expanding government investment. Now, more resources need to be invested in people and their livelihoods, to create a virtuous cycle of economic development and improvement of people’s livelihoods. At present, China’s foreign trade is under short-term pressure, and macroeconomic policy is indispensable as an important trade relief tool. We must combine the short and long term, strengthen inclusive, fundamental, and bottom-up livelihood construction, and steadily improve the level of public services and social security. Greater efforts must be made to stabilize and expand employment, and employment support plans must be implemented in key areas, key industries, and at the grassroots level in urban and rural areas, as well as for small, medium, and micro enterprises. In particular, efforts must be made to subsidize employment in industries and enterprises that are more heavily impacted by tariff shocks, unemployment insurance, and re-employment skills training. It is also necessary to strengthen dynamic monitoring of low-income populations and regularize assistance and support, improve the hierarchical and classified social assistance system, and ensure the basic livelihood of people in difficulty.

The above-mentioned tasks are what China has long wanted to do, not stopgap measures to deal with external shocks. Now that the external environment is becoming more complex and severe, China will be forced to accelerate relevant reforms and adjustments. The government work report points out that China has significant institutional advantages, including a huge market, a complete industrial system, abundant human resources, and many other favorable conditions. It also has long-term planning, scientific regulation, and an effective governance mechanism that coordinates top to bottom. There is also plenty of room for growth through demand upgrades, structural optimization, and kinetic energy conversion.

This is where our confidence and foundation lie in being able to effectively prevent and resolve various external shocks. Of course, the road ahead will be difficult, and it will require everyone to work together to forge ahead. Because everyone is a protagonist on the new journey of Chinese-style modernization, every contribution is precious, and every ray of light shines brightly.