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US-China trade tensions
- In response to US trade policy uncertainty, China is replacing exports with investing overseas and growing trade with EM
- China is cementing its centrality in global supply chains through component exports and high-tech manufacturing
- Trade tensions could accelerate China’s domestic economic reform; major US-China currency agreement unlikely to occur
Six lessons from Japan’s experience
Adapting to trade policy uncertainty
How might China react to US trade policy uncertainty under Trump 2.0? Drawing on insights from the US-Japan trade conflict during the 1980s, we offer six thoughts on the trajectory of US-China economic relations in the year ahead.
First, to offset the impact of US tariffs, Chinese firms may increasingly utilize overseas direct investment to shift production either closer to end-consumers or lower-cost third markets. This move is reminiscent of Japanese automakers who built up auto plants in the US and Thailand throughout the 1980s to 1990s, helping transform Thailand into ‘the Detroit of Asia.’ China could have a similar impact on the electrification of ASEAN’s auto industry if sufficient investment is poured into local production.
Second, although some manufacturers have diverted final assembly out of China due to geopolitical tensions, we believe that the country’s centrality in global supply chains has actually grown since Trump’s first stint in the White House due to its rise as a provider and exporter, rather than a user and importer, of components in manufacturing. Yes, other emerging economies are producing more goods for Western consumers, but China is increasingly performing the higher value-added and harder-to-replace role of providing the components for those goods.
Third, while Japan relied heavily on US consumer markets, which absorbed nearly 40% of Japanese exports during the mid-1980s, China today is far less reliant on trade with the US. Not only is China’s direct exposure to the US significantly lower (15% and declining), but its share of global trade continues to rise, especially with emerging market regions such as ASEAN, Latin America, and the Middle East.
China’s trade with emerging market regions continues to rise
Fourth, elevated external trade risks could inadvertently help the Chinese economy by being a catalyst for stronger property stabilization measures, more forceful fiscal and monetary easing, and deeper structural reforms. More immediately, significant stimulus will be required to cushion China’s growth as exports take a hit this year. Over the long run, China may well seek to rebalance income distribution towards households for consumption, either through higher wages or a stronger social safety net (e.g., hukou reform), to avoid the stagnation experienced by Japan during its ‘Lost Decades’ marked by low growth and persistent deflation.
Fifth, could President Trump—who is vocally in favor of a weaker US dollar—pursue a currency grand bargain with China similar to the 1985 Plaza Accord, which significantly depreciated the US dollar in relation to the Japanese yen, British pound, French franc, and West German mark? That appears unlikely: Japan’s experience of a subsequent property bubble and collapse serves as a cautionary example, and one that Chinese officials have closely studied and will be keen to avoid.
Finally, Japan’s experience offers two lessons for US-China technology competition today. First, trade restrictions often cannot hide the reality of economic competitiveness. For instance, voluntary export restraints did little to slow Japan’s ultra-competitive automotive and memory chip exports, or save struggling US producers, during the 1980s. Second, global leadership in advanced manufacturing can suddenly shift when incumbents fail to adapt to paradigm shifts. China has built up strengths such as EVs, batteries, robotics, and renewable energy. Only time will tell whether Chinese firms are able to adapt and compete when the next technology paradigm shift arrives – but recent advancements in areas including artificial intelligence and semiconductor packaging suggest they certainly appear to be keeping pace with global competitors for now.
The next few years are likely to be a critical period of evolution for China’s trade and economic relationship with the rest of the world. While Japan’s past experience may not provide all the answers, it is certainly a valuable study guide.
To hear more from Fred and Justin on this topic, please listen to a special edition of the Under the Banyan Tree podcast. To learn more about HSBC Global Research, including how to subscribe, please email us at AskResearch@hsbc.com.
