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What is a trade war? The US-China spat explained

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The trade war starts now. How will China react and what does it mean for Australia?

Barring an eleventh-hour change of heart from Washington, Friday 6 July is the day US tariff hikes kick in on a huge range of Chinese goods.

The Chinese are expected to retaliate in kind. So what does that mean for the global economy, and for Australia? 

What is a trade war? 

When a country raises taxes on another nation’s imports in order to protect its domestic industries, and the other nation retaliates with its own tariffs, that can escalate into a trade war. 

The idea is tariffs make imported goods more expensive and therefore less attractive to domestic consumers, so they will instead buy local, protecting local jobs and industries. 

Xi Jinping, Donald Trump
Chinese President Xi Jinping and US President Donald Trump in Beijing in 2017.
Getty Images

Most economists say that this sort of tit-for-tat process of protectionism hurts economies: whatever the political motivations, ultimately everyone loses economically from a trade war. 

What happens when the tariffs come in?

No one knows how bad it could get. Many economists argue that protectionist policies significantly worsened the Great Depression of the 1930s. 

The volume of US-China trade affected by the planned 25 per cent tariffs is not that high, at about four per cent, but “there’s no doubt there’s a very significant conflict stirring, and nobody really knows what the consequences of this are going to be,” said Alan Oxley, chairman of the trade-focussed APEC Study Centre at RMIT University and a former Australian diplomat.  

The US tariffs will cover thousands of Chinese goods, many that are key high-tech components like semiconductor chips for TVs, cars, computers or smartphones. China is threatening to retaliate with tariffs on a range of US agricultural products and cars. 

'Everybody loses'

Economist Dr Yixiao Zhou from Curtin University in Perth has tried to predict what will happen in a US-China trade war. She modelled three scenarios: the US puts tariffs on Chinese goods; China retaliates in kind; and an all-out trade war where both countries extend the tariffs to imports from all nations. 

In all three scenarios, she told SBS News, the global economy is hurt; global trade volumes contract, global GDP shrinks, and most countries’ per capita disposable income shrinks. 

But if only the US raised tariffs, bilateral trade between China and the US would shrink by one quarter, but US per capita disposable income would actually rise by US$204 per person per year, based on the modelling Dr Zhou did with University of Western Australia Professor Rod Tyers. 

If, as seems likely, China retaliated with its own tariffs, or if it transitioned to an all-out trade war, then the disposable income of citizens in the US, China, Australia and the EU – all the regions covered in the modelling – would drop. 

Because China’s average per capita income is only about a quarter of the US, any drop in per capita income would hit China harder. That means, Dr Zhou says, that Beijing has the biggest incentive to negotiate. 

“Economically no one will win; but politically it depends on the dynamics down the track, which country is seen to dominate, or get what it wants. It’s about politics and emotions, not just economics, so it can become highly uncontrollable.”

She argues that the core of the trade conflict is rivalry between the US and China for technological supremacy, which is not going away any time soon. 

What does it mean for Australia? 

Dr Zhou calculates Australians would lose US$198 per person per year, among the worst nations hit after China, if China retaliated with tariffs against the US. It would be far worse if the tariffs applied to all countries. 

A rise in global protectionism is generally bad news for Australian economy even if the tariffs don’t directly apply to Australian goods, because it is open and trade-exposed. If global trade volumes shrink, the manufacturing sector in China will shrink and therefore demand for Australia’s major exports – resources – shrinks too. 

There could be benefits for Australian farmers if China started buying agricultural products from Australia (like soybeans) that it used to buy from the US. 

But inflation and interests rates would rise globally with any major tariff imposition, so consumers in Australia, like elsewhere, would be hit with the double blow of higher-priced goods and heavier mortgage repayments, she says. 

That is why foreign minister Julie Bishop has expressed hope that the US and China will take their dispute to the World Trade Organisation to be settled before it hits global standards of living.  

“Free and open trade and investment is of great benefit to our country and the world,” she said when the tariffs were announced on June 16. 

Why is the US doing this?

US President Donald Trump argues that US-China trade is unfair. He points to the trade deficit – the US bought $347 billion more in goods from China than it sold to it in 2016 – and to Chinese requirements for foreign investors to hand over intellectual property.

He believes that trade wars are “good” and “easy to win”. This is a view that, Mr Oxley says, is “quite radically off the mainstream”. 

“If you’re asking me to predict how Trump will behave, I don’t think anybody can answer that,” Mr Oxley said. “He doesn’t understand the economics of the trade-investment relationship and is not interested. But there is growing concern among the international community that he may do some considerable damage to the trading system. 

“On the other hand, he has actually put his finger on some of the features of the way in which China has been managing its economy. The Chinese know they have to make further changes, like increasing legal protection for foreign suppliers of services and foreign investors.”

Dr Zhou agrees that some of the US demands are for reforms that China intends to make in its own interests anyway, offering some hope of de-escalation in the longer term. 

The US is asking China to open up its financial sector to international investors and to strengthen intellectual property protections, both of which China must eventually do anyway because it wants to continue to grow its economy and to internationalise its currency, she says. 

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