This article first appeared in Forum, The Edge Malaysia Weekly on August 13, 2018 - August 19, 2018

If trade is the engine of world economic growth, then the engine will be shifting to a lower gear soon. This year, the world’s two largest economies — the US and China — embarked on a trade war.

The tools are familiar: imposing tariffs and protecting and building national economies. The future is just as predictable. No country has become poorer by engaging in trade, and a reduction in trade leads to a reduction in national wealth. Is mercantilism back at work?

Sino-American trade relations have deepened over the decades, with China overtaking Canada to become the US’ largest trading partner in 2015. The following year, the US’ goods trade with China reached an estimated US$578.2 billion, while trade in services totalled an estimated US$70.3 billion.

The US imported goods from China worth an estimated US$462.6 billion, accounting for 21.1% of overall US imports, with electrical machinery, toys and footwear among the top categories. In the same year, China was the US’ third largest goods export market, accounting for 8% of overall US exports at a total value of US$115.6 billion. Top export categories included miscellaneous grains, machinery and vehicles.

Despite this growth, relations have been rocky in recent years. In April 2017, the US launched a Section 301 investigation into China’s theft of US intellectual property (IP). Chinese law requires foreign companies to form joint ventures with local firms, forcing foreign investors to transfer vital technology and know-how to their business partners.

While it is difficult to put a definitive number on the monetary value of this IP, a recent report by The New York Times estimates that it adds up to a loss of US$600 billion a year, with China accounting for the majority of all cases. The uncomfortable truth is that business with China is risky, as a partner can easily walk away with IP, as has been seen in numerous past agreements with Chinese firms.

Things worsened in January this year when the US imposed a tariff on imported solar panels, much of which were imported from China. The tariff starts at 30% in the first year before falling to half that figure in the next four years. This was followed by the implementation of a 25% tariff on aluminium and 30% on steel in March.

This provoked a response from China, which slapped a 25% tariff on 128 US products, disproportionately targeting the US agricultural sector. The list included products such as wine and pork, which are among the US’ largest exports to China.

Soon after, the US retaliated by unveiling a list of 1,300 items to be hit by a 25% tariff. Valued at around US$50 billion and targeting industrial goods rather than consumer items, the move was aimed at industries being developed as part of the “Made in China 2025” plan. This is essentially a move to increase local content in manufacturing from 40% to 70%. However, by imposing tariffs on industrial goods, the US will only push China to accelerate this plan, which may well be considered a policy of autarky. Will China burn its ships again?

On July 6, 25% US tariffs on US$34 billion worth of Chinese goods came into effect. China hit back with retaliatory tariffs on the same value of goods. These extreme actions have rattled global markets, with consequences not limited to just China or the US. The Trump administration’s approach to trade disputes — essentially unilateral — may elicit a similar reaction from other countries. These punitive tariffs raise the prices of goods and invoke retaliatory action by other trading partners such as the EU, Canada and Mexico. The International Monetary Fund estimates global growth could drop by as much as 0.5% by 2020, or about US$430 billion in GDP worldwide.

The secondary impact on a number of other countries is a major concern for many export powerhouses that sell goods to China that are used to make products, and are then exported to the US.

Malaysia is one such nation, and its trade-intensive economy makes it likely to be hurt by the trade war. Opinion about the impact of the US-China trade war on Malaysia is split. With the US and China being two of Malaysia’s largest trading partners, a worsening of either economy would lead to greater domestic focus and is likely to hurt exports. In terms of gross domestic product, Malaysia’s exposure to China is about 13%, and to the US, about 8%. In the event of a full-blown trade war, AmBank chief economist Anthony Dass projects that Malaysia’s GDP will be sliced by around 0.5%.

However, some think the trade war could be an opportunity for Malaysia to grow closer to China and the US in terms of trade. Tariffs on American soybean by China may prove beneficial for the Malaysian palm oil industry. However, this demands a shift in consumer demand — from soybean oil to palm oil — which may not happen overnight.

Malaysia is also seen as a competitive alternative to China when it comes to supplying the US with chemical products.

However, the 25% tariff by the US on imported solar panels is sure to hurt the Malaysian solar energy industry, which exports the panels to China.

With China being a huge importer of Malaysian goods, a number of local industries are seen to benefit from the resulting hike in the costs of raw materials and intermediate goods.

The tariffs imposed by the US and China on each other’s exports affect trade worth US$34 billion on each side. The US proposes to increase tariffs on another US$200 billion worth of goods. This is likely to reduce the trade deficit between the US and China, but it is conditional on other economies being substitutes for China. As manufacturing in the US is declining, a reduction in the overall trade deficit may remain elusive.

As for China, the proposed tariffs on US goods may go up to US$50 billion. At this level, China will lose around four million jobs and the US, about 250,000 jobs. Can this escalating trade war be contained?

As multilateral mechanisms such as the World Trade Organisation (WTO) are in place, they should be used to address economic disputes. The WTO must get involved and implement clear decisions with legal standing to prevent a tit-for-tat escalation that may have dire consequences for the world’s economy. At the same time, China should address the concerns about IP rights violation, data privacy and cyber threats.

Finally, as no economic policy can exist in the absence of a political economy, the greater interdependence of nations will follow a strengthening of the liberal democratic order. The current trend of nationalist politics in the West and removal of term limits for the office of the president of China do not bode well.

Leah Saiful and Ali Salman are associated with the Institute for Democracy and Economic Affairs (IDEAS).

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