- Our new estimates based on trade in thousands of individual products suggest that rerouting helped to offset around half of the fall in China’s exports to the US during the first Trump trade war. If the US continues to impose high tariffs on China, despite Wednesday’s court ruling, then rerouting is likely to be just as significant this time. We will be updating our estimates monthly via a new dashboard, allowing clients to track how trade flows are shifting in response to tariffs.
- While yesterday’s court order requires that all US reciprocal tariffs and the 20% fentanyl tariffs on China are removed, we doubt the tariff threat to China has gone away. Even if the Trump Administration fails to overturn the ruling on appeal, it will likely look to levy tariffs on China through other means.
- Section 301 of the US Trade Act could be invoked to justify retaliatory tariffs against unfair trading practices. Or the US could revoke China’s “permanent normal trading relationship” status, which at a stroke would make imports from China subject to an average tariff of around 40%. This would require Congressional approval but a bill to do this has already been proposed in Congress. For now at least, our forecasts still assume an average US tariff rate on China of 40%.
- The economic impact that high tariffs have on China will depend on the extent to which Chinese firms are able to continue to benefitting from US demand by reorienting trade flows through third countries. There are three ways that this could happen.
- The first is offshoring by Chinese manufacturers. Goods that are manufactured using Chinese inputs but that add “substantial” value in the manufacturing process outside of China are subject to the US tariff rate on that third country. But offshoring is likely to be a gradual process, given the uncertainty around the trajectory and longevity of US policy. Factories don’t get built overnight – many Chinese firms may just choose to wait out this administration.
- The second is tariff evasion by outright rerouting. Chinese exporters send goods to countries like Vietnam, where they are repackaged and labelled as “Made in Vietnam.”
- The third is trade diversion. Higher tariffs on Chinese goods boost US demand for the same goods from third countries. If third country producers reorient to meet that US demand, an opportunity will open up for their Chinese competitors in the markets they originally served. The competitive position of Chinese firms will be aided by a fall in the relative price of Chinese goods thanks to the fall in exports to the US and domestic deflationary pressures.
- In practice, it’s almost impossible to differentiate in the trade data between outright rerouting and trade diversion– both show up as an increase in exports from China to third countries and a corresponding increase in exports from those countries to the US. And, while rerouting to evade tariffs is illegal and hence could be targeted by the US authorities, the economic impact of this and trade diversion is equivalent.
- In both cases, China’s trade surplus with the US decreases, and its trade surplus with other economies grows. The narrowing of the US trade deficit with China is offset by an increase in its trade deficit with other economies. Chinese firms suffer some profit losses as price cuts drive down margins, while exporters in other countries see some profit growth driven by stronger US demand.
- Given that there is no substantial difference in the economic impact of the two, we treat them as equivalent. We’ll therefore use the term “rerouting” to refer to both outright rerouting and trade diversion.
- Our new rerouting database allows us to gauge the degree to which rerouting is happening. We’ve used detailed trade data at the product level (HS6 codes) to construct estimates of indirect Chinese exports to the US via Mexico and nine Asian economies.
- The estimates capture the overlap between Chinese exports to these countries and US imports from these countries in any given month. For example, if China exports $10bn of a certain product to Vietnam, and the US imports $15bn of the same product from Vietnam, we record $10bn worth of indirect China-US trade. It is impossible to know for certain if the $10bn worth of goods that China exported to Vietnam are the exact same ones than the US imports from Vietnam, only that they fall under the same product category. Indeed, some of China’s exports to Vietnam will be consumed domestically or re-exported to non-US markets. But, as noted above, the distinction is largely irrelevant from a macroeconomic perspective.
- Rerouting shows up in our estimates as a change in the level of indirect Chinese exports to the US. Our estimates suggest that, since the onset of the first trade war, rerouting via these ten countries has offset almost half of the fall in the share of China’s exports going to the US, with Mexico and Vietnam being the biggest conduits. (See Charts 1 & 2 and explore the data further through our new interactive rerouting dashboard here.) In practice, the scale of rerouting globally (including through Canada and countries in Europe) is likely to be higher.
- Third countries may try to crack down more on outright rerouting this time than during 2018-19. They are facing stronger pressure from the US and, even in the absence of reciprocal tariffs, will be wary of stoking any further US aggression. While they’re unlikely to put themselves at risk of Chinese retaliation by imposing broad-based tariffs on Chinese goods, more stringent customs enforcement seems likely.
- But unless other countries significantly ramp up tariffs on Chinese goods, it will be impossible to prevent Chinese exporters from continuing to indirectly service US demand via trade diversion. Even if some countries do increase tariffs, trade diversion will continue to occur via those with lower tariff levels.
- The upshot for China is that, while its exports to the US will fall sharply if tariffs come back into place, rerouting is still likely to provide a significant offset.
- During the first Trump administration, our data suggest that rerouting via Mexico and key Asian economies offset around half of the fall in China’s exports to the US. Including rerouting via other economies, that number was probably closer to 60%. If higher tariffs are sustained on China, increasing incentives for rerouting, the offset is likely to be as significant this time around.
- If goods from China continue to be subject to a US tariff of 40%, which is still our assumption of where things will settle, direct exports from China to the US would fall by around 45%. Other things equal that would deliver a 1.3% hit to China’s GDP. In practice, our estimates suggest that rerouting and a weaker renminbi will each offset around 0.5%-pts of this. The overall hit to China’s GDP from US tariffs, before taking into account any impact on domestic consumption and investment or offsetting policy measures, would be in the region of just 0.3%. Clients can continue to monitor US-China trade rerouting in real-time through our rerouting dashboard.