The Global Impact of the U.S.-China Trade War

This past September, U.S. imposed new tariffs of 15% on Chinese goods such as tools, clothing, and electronics. A retaliatory Chinese response targets U.S. imported soybeans, crude oil, and medical supplies. (1)

Small US companies felt a direct, negative impact. More importantly, the escalating trade war has a wide global effect. The rippling effect arrived at Asian industrial giants, as well as European export-oriented factories. Tariffs between China and U.S. are elevating both product and operation cost for multinational companies, forcing them to search for methods of maintaining a current expenditure level instead of passing all additional burden to the customers. However, uncertainty about future development of the trade war makes good judgement and outlook extremely difficult. Plus, managers have little slack in their global supply chain, leaving few options. Other than that, the dispute between the U.S. and China has caused a substantial disruption to the global trade system. An unsolved dispute and the developing uncertainty have fueled market caution. Large factories find themselves seeing a significant drop in new orders from overseas buyers. Challenges on both costs and new orders make a weaker performance of the global manufacturing industry a reasonable observation. (1)(2)

Purchasing Managers’ Index (PMI) is an indicator of the economic health of the manufacturing sector. A PMI is compiled by surveying purchasing managers in the manufacturing sector across the target location. A PMI of 50 indicates a balanced sentiment going forward. In other words, an equal amount of respondents are reporting positive and negative results. A PMI goes below 50 indicates a contraction of the manufacturing sector. (3)

Europe as a continent is not widely affected, but Germany, serving as the continent’s exporting powerhouse, has felt a lot of pain. In December 2017, Germany PMI is at a level of 63.2 after experiencing an increase every month, over the whole year period. But the start of the trade war between U.S. and China has been dragging it down since the beginning of 2018. In August 2019, Trump’s speech about plowing toward with Europe for a new trade war caused a further hit on the measurement which is reported at 38.2 in September. As a major global supplier of machinery and equipment, Germany export manufacturing goods that are used to support further manufacturing activities by their buyers, which makes Germany especially vulnerable when facing a global lag of manufacturing. (1)(2)(4)

Japan’s September data shows that capital spending by the country’s manufacturers fell 6.9% in the 2019Q2, the first decline in two years. A substantial component of the contraction is contributed by companies suffering a nearly double-digit plummet in exports to China. Overall, Japan’s PMI fell below 50 in May this year and hits its new low at 48.5 in October. South Korea, at the same time, reported a 21.3% decrease YoY in exports to China this August, which drives a 13.6% export decline in total. (1)

Both Japan and South Korea have found tariff impact to be particularly demonstrative in high-tech parts and materials purchased by factories in China. For example, Chinese factories use Japanese auto parts and South Korean semiconductors to manufacture finished goods, most of which are exported to the U.S. Chinese orders of Japanese auto parts and South Korean semiconductors face significant cuts, corresponding with the decline of China’s finished goods exports to the U.S. Surveys of purchasing managers in Taiwan and Indonesia also pointed to declines in manufacturing activity in August, with a similar cause. (1)

The widely observed negative impact, especially amongst suppliers can be explained by a concept called the Bullwhip Effect. By definition, it refers to increasing swings in inventory in response to shifts in customer demand as one moves further up the supply chain. Here, the shift in demand is not created by consumers, but instead, by an unexpected policy change. (5)

Using this model, it is very important to identify China’s position in the global supply chains of the particular products on which the tariffs focus. Chinese food industry does get hurt, but the majority of the impact was held and absorbed within the Chinese border. This is because, in the food industry, China is near the upper end of the supply chain. Chinese farmers grow the raw materials that are later processed and exported. There is no sizable foreign supplier for the Chinese food industry who is exposed to a proportional damage.

The case becomes considerably divergent when shifting the spotlight to electrical machinery and machinery industry which are the two most vitiated industries. China can be perceived as the last production workstation in these two industries – it assembles the components together into finished products. This means that there are a wide range of suppliers at the upper end who are significantly exposed. Suppliers of these two industries also tend to lock in long-term agreements with buyers to maximize efficiency, meaning they generally lack flexibility to adapt.

These two import categories are both gigantic. The former is the top category by amount, accounting for $152 billion, 25% of the total U.S. imports of Chinese goods, and the latter is right after the former, at 20% worth $117 billion. The colossal volume directly indicates the expansive damage that will be spread out globally. What makes the situation even worse is the fact that electrical machinery and machinery were the first two categories to be shot in the trade war because of their significance. Without any explicit sign, the trade war caught almost all managers off guard. A huge change in order amount within a month is almost outside their control to ameliorate. (6)(7)

Citations

1. Simon, Ruth, et al. “U.S.-China Trade War's Global Impact Grows.” The Wall Street Journal, Dow Jones & Company, 2 Sept. 2019, https://www.wsj.com/articles/u-s-china-trade-wars-global-impact-grows-11567466809.

2. Omeokwe, Amara, et al. “Slowing Trade Hits Global Manufacturing.” The Wall Street Journal, Dow Jones & Company, 1 Oct. 2019, https://www.wsj.com/articles/global-trade-set-for-weakest-year-since-crisis-11569924455

3. Chappelow, Jim. “Purchasing Managers' Index (PMI) Definition.” Investopedia, Investopedia, 7 Sept. 2019, https://www.investopedia.com/terms/p/pmi.asp.

4. “Germany Manufacturing PMI.” Germany Manufacturing PMI | 2019 | Data | Chart | Calendar | Forecast | News, https://tradingeconomics.com/germany/manufacturing-pmi.

5. Bray, Robert L., and Haim Mendelson. "Information transmission and the bullwhip effect: An empirical investigation." Management Science 58.5 (2012): 860-875.

6. “The People's Republic of China.” United States Trade Representative, https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china.

7. “The US-China Trade War: A Timeline.” China Briefing News, 12 Oct. 2019, https://www.china-briefing.com/news/the-us-china-trade-war-a-timeline/.