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The US Department of Commerce’s recent decision to launch an investigation into Chinese solar panel manufacturers is a new marker of the friction between the US and China.
The US Department of Commerce’s recent decision to launch an investigation into Chinese solar panel manufacturers is a new marker of the friction between the US and China. Seven American solar-equipment manufacturers have claimed that their Chinese counterparts enjoy an unfair cost advantage in the form of subsidies.
This dispute is part of a long-standing belief, especially in the US, that China should allow the value of the renminbi to rise in order to rebalance the global economy. Two months ago, the US Senate approved a measure that would impose additional tariffs on Chinese goods, threatening retaliatory sets of protective measures from both countries. It’s interesting to figure out who the winners and losers will be should these trade disputes between the US and China continue to escalate.
China is America’s third-largest export market, behind Canada and Mexico, accounting for 7% of US exports as of August 2011. If the US imposes additional tariffs on Chinese goods, China will almost certainly retaliate, perhaps by focusing on the largest import categories.
America’s biggest exports to China in the first eight months of 2011 were waste and scrap ($8 billion, 12% of total exports), soybeans ($5 billion, 8%), aircraft and related items ($4.2 billion, 6%), automobiles and light vehicles ($3 billion, 5%), and semiconductors ($3 billion, 5%). In the short run, China could stop importing and substitute many of these products.
China recycles 90% of its scrap — 15% of which is imported — to produce steel. Because of the constraints imposed on real estate development by Beijing, the demand for steel, and scrap, is likely to flatten and even fall. China will therefore manage to produce the steel it needs without relying on US imports. It will either impose fresh tariffs or conduct inspections that will de facto slow the entry of scrap into the country.
China, the world’s biggest consumer of soybeans, will be hard-pressed in the short run to replace the US, the world’s biggest producer of soybeans, as a supplier. Any action that might lead to food price inflation will not be taken lightly. As China’s soybean production is constrained by land availability, the alternatives would be to import from Brazil and Argentina, which accounted for 27% and 16% respectively of China’s soybean supply in 2010.
Although production is growing faster in Brazil and Argentina, replacing US supplies would require either that Brazil increases its exports to China from 31% to 70%, or that Argentina triples its exports from 21% to 66%. Both are unlikely, so China seems unable to eliminate its soybean dependence on the US.
Chinese airlines have entered into contractual commitments to purchase tens of billions of dollars of aircraft, mainly from Boeing. Beijing may delay those purchases, but it will force their cancellation only in extremis. The government could exert pressure on automotive joint ventures to source locally, and through inspections, making it tough to import vehicles and components. Given the importance of the Chinese market, the auto majors would have to be responsive to these demands.
Semiconductors cannot be easily substituted, but most are assembled into electronic products for multinational companies and end up as exports, often to the US. While China will need to manage this impact, it could use tariff and non-tariff levers to reduce semiconductor imports by 20%.
In the first eight months of 2011, the value of US imports from China touched $255 billion, the top categories being business and consumer electronics ($77 billion, 30% of the total), apparel and footwear ($32 billion, 13%), and toys ($9 billion, 4%). Most of these imports went to American multinational giants.
Take the iPhone, perhaps the most famous “Made in China” product. The Chinese export value of a 16-GB iPhone 4S is $196 per unit. However, according to IHS iSuppli, Chinese producers add only $8, or 4%, to the cost. Most of the value added goes to companies in Japan, Korea, Germany, and the US, which supply IP and components. Imposing an import tariff on iPhones will likely hit American Apple consumers with higher prices, and create a “grey” market for them.
Many consumer electronics items made in China are not easy to produce elsewhere, at least in the short run. Bangladesh, Mexico, Vietnam, and other developing countries simply don’t have the workforce to step in. In the case of other Asian markets, such as India, ports and airports will be major bottlenecks.
The manufacture of apparel and shoes could move quickly out of China, though. There are alternative sources — India, Bangladesh, South Africa, and other nations — that can scale up rapidly. The two industries have traditionally switched supply sources rapidly in order to preserve margins, so additional tariffs could result in a decline in Chinese imports. As it is, exports of these products have fallen from 18% to 13% of China’s US exports over the last decade.
Given the complexities of global production networks, less can be substituted by the two countries than many people think. Still, consumers in both China and the US, as well as multinational companies that manufacture goods in China, will be hit hard should the two governments choose to embark on a trade war.
About the Authors
Gordon Orr is Chairman, Asia, at McKinsey & Company, based in Shanghai.