By Tariffs have become a hot topic in global economic policy, especially when it comes to China. Originally championed by Trump, tariffs are no longer just a conservative strategy; they’re now a significant part of the Democratic playbook, too.
President Biden, for instance, has imposed even higher tariffs on Chinese goods than Trump did.
With these tariffs likely to persist regardless of who wins future elections, it’s worth exploring how they might impact the world, the future trade relations between the US and China, and probably, your investments.
Tariffs are the key to US-China trade relations
In recent weeks, the debate over tariffs has heated up again. The Biden administration is expected to announce further hikes in levies on Chinese-made items, including electric vehicles, semiconductors, and key minerals.
This comes after multiple delays as the administration reviewed proposed modifications to tariffs originally imposed under Trump in 2018 and 2019. China, in response, has urged the US to lift all tariffs on its goods.
The Chinese government argues that these tariffs are harmful not just to China but to the global economy, and has repeatedly called for their removal in recent diplomatic discussions.
Despite these appeals, it seems unlikely that the US will fully back down from its tariff strategy anytime soon, given the broader geopolitical and economic factors at play.
Why tariffs don’t always work as planned
Tariffs are supposed to make imported goods more expensive, thereby encouraging consumers to buy domestic products instead. But in practice, things are a bit more complicated due to three key reasons:
1. Currency Depreciation: When a country like the US imposes tariffs on another country’s goods, the targeted country’s currency often depreciates.
This currency shift can make that country’s exports cheaper and imports more expensive for its consumers. For example, after Trump imposed tariffs on Chinese goods, the Chinese yuan depreciated significantly.
This depreciation counteracts some of the intended effects of the tariffs, making them less impactful than expected.
2. Circumvention by Companies: Chinese companies are adept at finding ways to sidestep tariffs. For instance, they might relocate production to third countries like Vietnam or Mexico, rebranding their goods as “Made in Vietnam” or “Made in Mexico” to bypass US tariffs.
Alternatively, they could ship components to these countries for assembly, further complicating efforts to restrict Chinese imports.
These strategies dilute the impact of tariffs, making them less effective at protecting domestic industries.
3. Impact on US Manufacturers: Lastly, tariffs increase the cost of intermediate goods—those materials and components that are essential for US manufacturers.
For example, tariffs on steel and aluminum mean higher production costs for American automakers, appliance manufacturers, and other industries that rely on these materials.
This can weaken the competitive position of US companies, both domestically and globally, as they face higher costs and lower profit margins.
Despite these challenges, tariffs are not entirely without merit. They can still play a crucial role in reshaping global supply chains and incentivizing changes in economic behavior, both within China and around the world.
Are tariffs actually nudging China toward economic reform?
China’s current economic strategy heavily relies on overproduction and aggressive export practices. The government subsidizes manufacturers, leading to a glut of cheap products on the global market.
While this has helped China become a manufacturing powerhouse, it has also led to some significant problems.
Chinese companies often operate with razor-thin profit margins, and their massive overproduction leads to mountains of unsold goods and significant corporate debt.
This strategy also suppresses wages and hurts domestic consumption, as companies cut costs to stay afloat.
Tariffs, particularly from major markets like the US and Europe, could push China to rethink this unsustainable model.
By making it harder for Chinese companies to dump excess goods on the global market, tariffs could force China to reduce overproduction and focus more on domestic consumption and sustainable growth.
Interestingly, this is similar to what Japan experienced in the late 20th century.
Japan’s government also promoted manufacturing through aggressive financing, but they balanced this with policies to stabilize prices and prevent overcapacity.
China, on the other hand, has leaned into overcapacity, exacerbating global trade tensions. Tariffs could be the stick that prompts China to adopt more balanced economic policies.
The unintended benefits of tariffs
One of the unintended yet positive consequences of tariffs on China is the potential for economic development in other parts of the world, particularly the Global South.
To avoid tariffs, Chinese companies might move their production to countries like Vietnam, Indonesia, Mexico, or Morocco. This shift would spread manufacturing wealth to these regions, where it is desperately needed.
For instance, according to The Economist, China’s foreign direct investment (FDI) in manufacturing surged to a record $162 billion in 2023, with nearly three-quarters of that going to developing countries .
This trend is already benefiting nations that are significantly poorer than China, providing jobs and fostering economic growth.
From an investment perspective, this shift presents opportunities. Investors might want to look at emerging markets in Southeast Asia, Africa, and Latin America as potential growth areas.
Companies in these regions stand to benefit from the influx of Chinese investment, which could lead to increased production capacity, improved infrastructure, and higher economic growth.
A new phase of globalization?
The broader impact of tariffs on China could be the acceleration of a new phase of globalization. For much of the past two decades, globalization has been characterized by the rise of China as the world’s manufacturing hub.
This has led to significant economic growth in China but also created imbalances in the global economy.
Many countries have become heavily reliant on cheap Chinese goods, while China has accumulated large trade surpluses and wielded considerable influence over global supply chains.
Tariffs could help break this pattern by encouraging the redistribution of manufacturing across different regions.
As Chinese companies move production to other countries, we could see a more balanced global economy emerge, with production spread more evenly across multiple regions.
For investors, this is a key area to watch. Companies that can successfully position themselves during this transition, whether they are local firms or foreign multinationals, could become leaders in the next wave of globalization.
Countries like Mexico and Morocco are already stepping up and meeting some of the relocation demand. Other countries in Europe like the Netherlands or Ireland could perhaps take advantage of such opportunities.
Investing in businesses that are well-positioned in these emerging markets could yield significant returns as these countries move up the value chain.
In conclusion, while tariffs are often seen as a crude and inefficient economic tool, they could serve a strategic purpose in today’s complex global economy.
By pressuring China to rethink its economic model and encouraging the spread of manufacturing to other regions, tariffs could help create a more balanced and sustainable global economy.
It will be interesting to monitor how the next president of the United States will approach the now tensioned trade relations between US and China.
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