Winners and losers from the trade war - Capital Economics
Emerging Asia Economics

Winners and losers from the trade war

Emerging Asia Economics Focus
Written by Gareth Leather

The trade war between the US and China so far appears to have had a small negative impact on most of the region, although some countries, most notably Vietnam, look to be benefiting as US demand has shifted away from China towards alternative suppliers. While the upcoming G20 meeting may bring a truce, there is a risk that the situation ultimately escalates much further. In the event of a full-blown global trade war, a number of the region’s economies would be tipped into recession, while no part of Emerging Asia would escape unscathed.

  • The trade war between the US and China so far appears to have had a small negative impact on most of the region, although some countries, most notably Vietnam, look to be benefiting as US demand has shifted away from China towards alternative suppliers. While the upcoming G20 meeting may bring a truce, there is a risk that the situation ultimately escalates much further. In the event of a full-blown global trade war, a number of the region’s economies would be tipped into recession, while no part of Emerging Asia would escape unscathed.
  • Since the US started raising tariffs on Chinese goods, exports from the rest of Asia to China have fallen back sharply. Although the main reason for this fall has been a downturn in the electronics sector, the trade war has also played a role. Countries in Asia are key suppliers of intermediate goods that are processed into finished goods in China before being shipped off to the US.
  • However, many countries in the region have received an offsetting boost as US demand has shifted away from China towards alternative suppliers. We estimate that for Vietnam a surge in exports to the US has more than made up for the decline in exports to China. For Korea and Taiwan, the big increase in exports to the US has broadly offset the decline in exports to China. Other countries in the region received no such offsetting boost to their exports.
  • There are also the effects on financial markets, business confidence and investment to consider. Equity markets across the region have tended to drop back sharply whenever Trump has announced an extension of the trade war. Further falls are likely if Trump proceeds with his threat to impose 25% tariffs on the remaining US$300bn in goods the US imports from China. But given that Asian households don’t hold much of their wealth in shares (Hong Kong is the key exception), swings in equity prices don’t have much impact on household spending and saving patterns.
  • Investment growth has also slowed sharply across the region since the trade war began. But we are wary of assigning much of this to the trade war. Last year’s monetary policy tightening cycle, which saw interest rates increased in a number of countries, played a role. The slump in demand for electronics products, which has led to a sharp fall in investment in plant and machinery was another factor. The upshot is that while these indirect effects are difficult to quantify, their impact will not have been significant.
  • Looking ahead, there is a risk that the latest tariffs on China are just the start of a broader shift in US policy away from free trade. America’s bilateral trade deficit with Taiwan, Korea and Vietnam has increased markedly since the start of the trade war last year, and it is possible that these countries will be the next in line if Trump decides to escalate tensions further.
  • US tariffs on electronics would be the most damaging to the region. Meanwhile, Korea would be the most vulnerable if the Section 232 investigation into US imports of motor vehicles and parts paved the way for new tariffs. There would also be significant spill-overs to Hong Kong. Although the city state has a very small manufacturing sector, its port and logistics businesses would be affected by a slump in trade.
  • If rising US protectionism eventually led to a global trade war, the region’s most open economies like Malaysia and Singapore could be tipped into recession. Higher trade barriers would also damage the region’s long-term potential growth rate. They would reduce productivity growth in the tradable sector and hamper the transfer of technology and know-how. While the gains from globalisation made over the past two or three decades by emerging economies would not be reversed, the process of convergence would be slower.

Winners and losers from the trade war

Escalating trade tensions between the US and China pose a major threat, but also an opportunity, to the economies of the rest of Asia. In order to assess the likely impact of an intensification of the trade war, this Focus is split into three main parts. It starts by analysing the impact of the US-China trade war so far on the rest of the region. It then considers the implications for Emerging Asia of a broader rise in protectionism, which sees US import tariffs extended to the rest of Asia. Finally, it looks at the impact on Asia of a full-blown global trade war.

Hopes of a breakthrough likely to be disappointed

The upcoming meeting between Presidents Trump and Xi at the G20 summit has raised hopes of a US-China trade deal but, as things stand, we think it is more likely that the trade war will ultimately escalate further.

There is, admittedly, a reasonable chance of some type of truce at the summit on 28th-29th June. But this would probably be temporary. While the US-China trade war has ebbed and flowed over the past year or so, the broad trend has been a ratcheting up of trade protection measures between the two countries. Our working assumption is that all US goods imports from China will become subject to a 25% tariff rate by early next year, with China likely to respond with some counter measures. (See our China Update, “Preparing for a long trade war”, 6th June.)

Chart 1: Chinese Exports by Destination ($, % y/y)

Source: CEIC

Counting the cost so far

In order to evaluate the likely impact of such an escalation, it helps to look at the effect of the measures that have been introduced so far. In the first five months of this year, Chinese exports to the US have underperformed exports to the rest of the world by a significant margin. (See Chart 1.) We estimate that this has knocked around 0.3%-points from Chinese GDP. (See our China Update, “Four implications of the re-escalation in trade tensions”, 6th May.)

Since the tariffs were introduced, exports to China from other parts of Asia have dropped off sharply. (See Chart 2.)

Chart 2: Exports by Destination ($, % 3m y/y)

Sources: CEIC, Refinitiv, Capital Economics. *excludes China

The drop in exports to China is mostly due to a slump in demand for technology products. A key factor behind the drop in electronic exports has been a shift in the inventory cycle. (See our Update, “Slump in technology exports to weigh on Asian growth”, 30th January & Chart 3.) A slump in demand from data processing and cloud computing centres may also be playing a role, and it is notable that exports of memory chips are performing less well than sales of other electronic components.

Chart 3: Emerging Asia Exports ($, % 3m y/y)

Sources: Refinitiv, Capital Economics

Weaker growth in China has probably also been a factor. Our China Activity Proxy, which we think is a better gauge of economic activity than the official GDP figures, suggest the economy grew by just 5.2% y/y in April, down from nearly 6% around the middle of last year. (See Chart 4.)

Chart 4: China GDP & China Activity Proxy (% y/y)

Sources: CEIC, Capital Economics

However, the trade war has probably played a role too. Asian countries are exposed to the trade war due to their integration into Chinese supply chains. The total value-added from Taiwan embedded in Chinese exports to the US is equivalent to around 1.8% of Taiwan’s GDP. The share for Malaysia, Singapore and Korea is only slightly lower. (See Chart 5.) Given the underperformance in Chinese exports to the US, we estimate that the trade war will have knocked around 0.1-0.2%-points from GDP growth in these countries.

Chart 5: Origin of Value-Added in China’s Exports to US (% of country’s GDP, 2017)

Sources: Comtrade, OECD TiVA, Refinitiv, Capital Economics

That said, some of these countries have received an offsetting boost as US demand has shifted away from China towards alternative suppliers. Exports to the US from Taiwan, Korea and Vietnam of the goods subjected to US tariffs jumped after the duties were introduced. (See Chart 6.)

Chart 6: US Imports (October-April, % y/y)

Sources: ITC, Capital Economics

An important question is whether this is a genuine shift in production or whether Chinese firms are simply rerouting their production for minimal processing before they are shipped to the US. The pick-up in China’s exports to Vietnam, Korea and Taiwan suggests that there may be a small amount of re-routing going on. (See Chart 7.)

Chart 7: Trade (US$bn, 3m average)

Source: Refinitiv

However, this increase in exports from China has not matched the surge in exports from Korea, Taiwan and Vietnam to the US. This indicates that even if there is some re-rerouting taking place, it does not account for all of the increase in exports to the US.

Financial markets and business investment

There are also the effects on financial markets, business confidence and investment to consider. Equity markets across the region have tended to drop back sharply whenever new tariffs have been announced. (See Chart 8.) The MSCI Emerging Asia index is down by just under 20% since the US first imposed tariffs on solar panels and washing machines in January of last year. Further falls are likely if Trump carries ahead with his threat to impose 25% tariffs on the remaining US$300bn in goods the US imports from China.

Chart 8: MSCI EM Asia (Ex. HK)

Sources: Bloomberg, Capital Economics

Sharp falls (or rises) in stock markets can affect the real economy via wealth effects. In other words, because falling asset prices cause household wealth to decrease, consumer spending slows, and vice-versa. On the face of it at least, there appears to be good evidence for the existence of such effects across Emerging Asia. Chart 9 shows a fairly close relationship between equity prices and retail sales in Thailand. The correlation is relatively close in other parts of the region too, including Hong Kong, Taiwan and Korea.

Chart 9: Thailand Retail Sales & Equity Market (% y/y)

Source: Refinitiv

However, we’re sceptical that there is a strong causal link between equity prices and consumer spending. Instead, both have tended to react in the same way to changes in global macroeconomic conditions. (For more, see our Emerging Markets Update, “Market turmoil unlikely to cause EM growth to slow via wealth effects?”, 28th June 2013.)

What’s more, there is little reason to think that equity prices have a large impact on regional wealth since Asian households don’t hold much of their wealth in shares (Hong Kong is the key exception).

Investment growth has also slowed sharply across the region since the trade war began. (See Chart 10.) But we are wary of assigning much of this to the trade war. Last year’s monetary policy tightening cycle, which saw interest rates increased in a number of countries, will have played a bigger role.

Chart 10: Investment (weighted regional average, % y/y)

Sources: Refinitiv, Capital Economics

The slump in demand for electronics products is also a factor. It has led to a sharp fall in investment in plant and machinery. (Chart 11 demonstrates this for the case of Korea.) It is also worth noting that investment was slowing well before the first tariffs were introduced.

Chart 11: Korea Semi Conductor Exports & Facilities Investment (% y/y)

Sources: Refinitiv, Capital Economics

The upshot is that while these indirect effects are difficult to quantify, we don’t think their impact will have been too big.

Overall impact varied but small

Putting all of this together, we think the overall effect of the trade war to date has been small for most countries. For the region’s less open economies such as Pakistan and Indonesia, the impact has been negligible. For Malaysia, Singapore, Thailand and the Philippines, we think the net effect of the trade war so far will have been to knock only 0.1-0.2% from GDP.

However, some countries do appear to be benefiting. In particular, Vietnam, with its low labour costs, political stability, and its close integration into the supply chains of southern China, has seen exports to the US surge since the trade war began. We recently raised our GDP growth forecast for this year from 6.0% to 6.5% to reflect the improved prospects for the export sector. (See our Chart Book, “Who is winning the trade war?”, 29th May.) Meanwhile, we estimate that big increase in exports to the US has provided a boost to Taiwan and Korean GDP which is roughly equivalent to the hit to GDP growth from the fall in exports to China.

Further escalation

If Trump proceeds with his threat to impose 25% tariffs on the remaining US$300bn in goods the US imports from China, it would also have a relatively small economic impact. In order to minimise the impact on US consumers the Trump administration initially targeted goods for which China has a relatively low global market share. It will be more difficult to shift to alternative suppliers for the remaining goods, implying a smaller decline in Chinese exports. On balance, we think that hiking the 10% tariff to 25% will knock 0.2% off Chinese GDP, while a 25% tariff on the remaining goods would lead to a further 0.3% drop. This implies the direct effects for the rest of Asia should also be relatively small, and probably in the range of 0.1-0.3% of GDP.

However, some countries are likely to experience an offsetting boost if, as we anticipate, tariffs cause firms to shift their production away from China. The experience of the trade war so far suggests that firms can start to shift production pretty quickly.

Chart 12: Share of US Imports of Mobile Phones (% of total)

Source: ITC

Between them, China, Korea, Vietnam and Taiwan account for approximately 99% of mobile phones exported into the US. (See Chart 12.) Korea, Vietnam and Taiwan are well-positioned to gain market share if tariffs are introduced on Chinese exports to the US. In the short term it is likely that China will remain the biggest supplier of mobile phones to the US for some time to come. However, even a relatively small drop in China’s overall market share could make a big difference to smaller economies in the region. The benefits to the rest of the region will be even bigger if a prolonged trade war leads to the large-scale relocation of production of these products from China.

There could also be gains from a shift in Chinese demand away from US suppliers, though countries from other regions are generally better positioned to benefit. Brazil has seen a surge in imports of soybeans to China since the trade war began. Further ahead, China may buy more aircraft from Airbus rather than Boeing, and encourage students seeking an overseas education to go to Australia or the UK rather than the US.

Is India the next China?

As the trade war between the US and China has intensified, more attention has focused on the possibility of whether India could pick up the baton from China, and become the next global manufacturing powerhouse. Not only are wages in India much lower than in China, but India is the only country in the world that can match China in terms of the size of its population.

Prime Minister Modi has made decent progress in raising infrastructure spending and improving the business environment, both of which should boost the competitiveness of the country’s manufacturing sector. We are hopeful that progress in these areas will continue. (See our India Focus, “Five more years of Modi”, 24th May.)

However, we are less optimistic about the chances of wide-ranging labour and land reform being enacted, without which India will struggle to develop a manufacturing sector to rival places such as China or Vietnam. Mr Modi demonstrated in his first term that he was not willing to implement politically-contentious measures, and it is highly unlikely that this will change now, especially as reforms to labour and land markets would prove unpopular among a large section of the electorate that has just voted the BJP back into power.

Policy response

Policy easing will help cushion the blow even further. Most governments in the region have loosened fiscal policy over the past year to help offset the drag from weak export demand. The strong fiscal position of most countries in the region means policy could be loosened further. (See Chart 13.) A further escalation of the trade war would increase the likelihood of further monetary policy easing. So far this year, the central banks of India, the Philippines and Malaysia have cut interest rates. We expect further easing in all three, as well as in Korea and Indonesia.

Chart 13: Budget Balance (% of GDP, latest)

Source: IMF

What if there is a broader rise in US protection?

So far we have just considered the impact of a bilateral trade war between the US and China. But there is a risk that tariffs on China signify a broader shift in US policy away from free trade. America’s bilateral trade deficit with Taiwan, Korea and Vietnam has increased markedly since the start of the trade war last year (see Chart 14), and these countries could be the next in line if Trump decides to escalate tensions further.

Chart 14: US Bilateral Trade Balance (12 month sum, US$bn)

Source: Refinitiv

Chart 15 shows the OECD’s estimate of domestic value-added embodied in US imports for a range of emerging markets, measured as a share of their GDP. In the event that tariffs were expanded to cover US imports from all countries, Emerging Asia looks especially vulnerable.

Chart 15: Origin of Value-Added in US Total Imports
(CE Estimates, % of GDP, 2017)

Sources: OECD TiVA Database, Refinitiv, Capital Economics

The overall impact would obviously depend on which products were targeted by tariffs. Table 1 shows the products that constitute the largest exports to the US for a range of Asian countries. US tariffs on electronics would be the most damaging to the region.

Table 1: Domestic Value Added in US Goods Imports
(% of GDP, latest)

Country

% GDP

Key Sectors

Taiwan

7.2

Electronics, Chemicals

Singapore

6.8

Electronics, Chemicals

Malaysia

6.8

Electronics, Chemicals

Vietnam

5.5

Textiles, Food, Electronics

Korea

4.6

Electronics, Vehicles

Thailand

4.5

Electronics, Food

Philippines

3.4

Electronics, Food

China

2.8

Electronics, Textiles

Japan

2.7

Electronics, Vehicles

India

2.5

Chemicals

Hong Kong

1.4

Electronics

Sources: OECD, Capital Economics

Meanwhile, Korea and Japan would be the most vulnerable within the region if the ongoing Section 232 investigation into US imports of motor vehicles and parts paved the way for new tariffs. (See Chart 16.) In a scenario in which a 25% tariff caused demand for US imports of autos and parts to fall by 25%, we estimate that the loss in export revenues would be equivalent to 0.2-0.3% of Korean and Japanese GDP. (See our EM Update, “Impact of US auto tariffs limited to a few countries”, 14th May.)

Chart 16: Exports of Autos to US (% of GDP, latest)

Sources: Intracen, IMF

Hong Kong does not produce many manufactured goods, and so the direct effect of an intensification of the trade war, provided the focus remains on merchandise goods, should be relatively small. That said, there would still be significant spill-overs to Hong Kong (and Singapore) via their services sectors. (See Chart 17.) The sub-sector that would be hit hardest is transport and storage services, as both economies serve as major transhipment hubs for the region.

Chart 17: Services Value Added in US Imports
(CE Estimates, % of GDP, latest)

Sources: OECD TiVA Database, Refinitiv, Capital Economics

Another sub-sector would be financial services, given that both economies play key roles as financial intermediaries in trade transactions involving the US and the region.

The Philippines would be the biggest loser if Trump followed through on his threat to punish American companies that outsource jobs abroad. The Philippines has a thriving business process and IT outsourcing sector, which last year brought in revenues equivalent to around 10% of GDP. India, where receipts are the equivalent to about 4% of GDP, could also be hit.

What about a global trade war?

Our Global team has already considered the impact if rising US protectionism led to a global trade war and a complete breakdown in the post-war global trading system which involved all governments imposing a blanket tariff of 25% on all imports. (See our Global Focus, “The damage from a global trade war”, 9th July 2018.) In a global trade war, the most significant costs would come from the relocation of resources by businesses seeking to minimise the cost of the tariffs. This would result in a loss of efficiency as economies of scale and specialisation were reversed.

The disruption would be concentrated on manufactured products, particularly those made in complex supply chains. Our Global team estimates that the relocation costs would be in the order of 2% of world GDP. To this they added an estimate of the impact of uncertainty on business investment of 0.5% of GDP. That brings us to an estimate that the trade war would result in a total reduction of world GDP of around 2-3%-pts, probably spread over a period of two to three years.

The damage would be spread unevenly around the world, but the disruption would be concentrated in open economies that produced a lot of manufactured products, particularly those made in complex supply chains. On this basis, it is likely that countries in Asia would be especially hard hit.

Chart 18 shows our estimate of the likely hit to GDP for Emerging Asia over the next three years. In the cases of Malaysia and Singapore, a trade war would push them into a recession, but even for China and India, the impact would still be significant.

Chart 18: Damage from a Global Trade War*
(% of GDP)

Sources: OECD TiVA Database, Thomson Reuters, Capital Economics

*Based on all governments introducing a 25% tariffs on all goods imports

Higher trade barriers would also damage the region’s long-term potential growth rate. They would reduce productivity growth in the tradable sector and hamper the transfer of technology and know-how. The gains from globalisation made over the past two or three decades by emerging economies including China would not be reversed. But future convergence would probably be slower. Accordingly, it would be much harder for poorer Asian economies such as Vietnam, Philippines, India and Indonesia to emulate the success of some of the region’s richest economies such as Taiwan and Korea, where openness to trade has been key to their success in moving up the value chain, developing globally competitive manufacturing sectors and achieving high standards of living.

The long-run consequences would be even bigger if the world also maintained barriers to trade in services and information, to foreign direct investment, and to migration. In this case, there may be a much bigger global downturn, or indeed a long period of stagnation.


Gareth Leather, Senior Asia Economist, +44 20 7811 3916, gareth.leather@capitaleconomics.com

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