Chinese Retaliation in Trade War May Include Tariffs and Customs Hassles, Experts Say

While the Chinese have not levied tariffs on U.S. aircraft, the top manufactured good China imports from the U.S., that could change if President Donald Trump follows through on his May 5 threat to hike 10 percent tariffs to 25 percent, one expert believes. Edward Alden, a trade expert and professor at Western Washington University, said that the Chinese have been seriously negotiating for five months, and if the U.S. walks away, they will hunker down for a long, protracted trade war. They could levy tariffs on airplanes, increase customs hassles for those U.S. firms exporting goods to China and create geopolitical trouble for the U.S.

The president of the U.S.-China Business Council, which represents U.S. multinationals with operations in China, agreed that China would retaliate if tariffs were hiked. He doesn't know precisely how, but said they are willing to be creative in their approach, since most U.S. exports are already facing increased tariffs. "The Chinese were taken aback by the comments from the president and are trying to determine how to interpret them," Craig Allen said. "Good progress was being made and there seemed to be a landing zone in sight, but suddenly the tables have shifted. And I think it is unclear to our Chinese friends why that is so."

Dustin Daugherty, head of North American business development at consulting firm Dezan Shira & Associates, said that it's possible that Trump's tactic will work in getting Chinese negotiators to be conciliatory. Dezan Shira advises U.S. companies that locate facilities in Asia, and Daugherty said because Trump’s announcement was so recent, he hasn't seen much reaction from clients who conduct business in China. “But certainly there is increased worry,” he said.

A temporary impasse in U.S. and China trade negotiations rather than a quick deal or further trade war escalation appears to be the most likely scenario in the near future, said Merill Lynch China economists Helen Qiao and Xiaojia Zhi in a May 6 research note. That was written before U.S. Trade Representative Robert Lighthizer told reporters that the tariffs will be hiked at 12:01 on May 10, and the Federal Register notice would be published on May 7.

Although such an impasse "may well be the plan, it leaves China in a difficult position not to respond with a firm stance," they said. That's because " President Xi Jinping has won more credit lately by promoting the ongoing trade negotiations as part of the overall opening-up plan for the country," said Qiao and Zhi. "However, if the high-profile potential tariff hike materializes in a few days, Chinese policy makers will have to come up with some form of counteraction to avoid losing policy credibility at home."

The economists see three possibilities for the trade talks. The base assumption is that the trade talks will not show major progress in the near future because "the urgency of reaching a trade deal has declined modestly in the past few months, supported by better economic growth and market performance in both countries." While both sides see a deal as a good outcome, "even if the tariff hike does not materialize this week, the two sides could exchange harsh rhetoric on each other in the media and suspend official trade negotiations for a month or two, before returning to the negotiation table formally in the following quarters," they said.

A less likely scenario is that the two sides reach a deal quickly, said the economists. Despite the flare-up, "the two sides could still be communicating and exchanging terms and condition," they said. There may also be some renewed demand for deal after all the work that been completed, Qiao and Zhi said. The other scenario is that the trade war intensifies, they said. "In this most bearish case, the US tariff hike will be met with China’s retaliation in the form of tariff hikes (especially on US made cars) and import diversion (such as buying soy beans from Brazil)," they said. "These small tit-for-tat trade skirmishes could risk developing into an outright trade war on a grander scale. Such uncertainty will likely add to market volatility, as investors start to worry more about growth stability in China and inflationary pressure in the US."

Phil Levy, a former George W. Bush economist on trade, teaches at Northwestern University's business school, and he said one of his classes worked on penciling out if it makes sense for GE Healthcare to continue manufacturing advanced medical equipment in the U.S. because of Section 301 tariffs. "The pain is not just going to come from Chinese retaliation," he said, describing how an escalating trade war could affect the U.S. economy. He said while a lot of businesses can manage the cost of a 10 percent tariff, if they believe a tariff will be at 25 percent for years, they may consider moving factories to Canada, where there are no tariffs on their Chinese manufacturing inputs. Levy said in GE's case, the major competitor was a German company, which had no pricing pressure from tariffs, so if GE tried to raise prices, it would lose market share.

The location decision, he said, "all came down to how long do you think those tariffs are going to be there?