Trade war expediting the evolution of China's economy

Trade war expediting the evolution of China's economy
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The addition of $200 billion in additional tariffs on goods emanating from China signals an escalation of the trade war as a widening list of products are added to the list.

In response, China’s leaders have signaled their intent to reciprocate by increasing the number of American products that it will target for additional tariffs.

It is unclear as to how far China can go as it plays this game of tit-for-tat. China’s total imports from the United States are lower than the $200 billion levied by the Trump administration.

Future retaliatory action on the part of China may include a combination of tariff and non-tariff barriers as well as other yet-to-be-announced countermeasures.

A recent article in the Wall Street Journal described the changes occurring in the Chinese economy as a result of the trade war and how present circumstance has led companies to adapt and respond in new and creative ways.

An unintended consequence of the trade war may be an acceleration of changes that were already taking place within China.

Many manufacturing companies in China operate on thin margins. Labor, material and operating costs have been steadily rising. China’s traditional advantage in labor costs no longer holds true, as the cost of labor has increased, and demographic factors include a rapidly ageing population.

There are places in Asia where labor costs are but a fraction of what it costs in China. As a result, manufacturing is becoming a losing game in China, as the laws of diminishing returns start to set in.

Chinese firms have been known to be relentlessly attentive to costs. Finding ways to squeeze costs is necessary for survival. A 10-20-percent tariff represents a shock that will have a serious impact on their viability.

Chinese companies are not standing still as the trade war with the United States escalates. Many are initiating bold action to prepare for a changed world. To confront increased tariffs, Chinese firms are finding ways to strip away costs to adjust to the new realities.

Such measures include labor substitution as well as relocation. The former involves the use of automation and robotics while the latter includes the establishment of new factories in countries such as Vietnam.

In order to remain competitive, companies in China are ramping up the purchase of machinery, robotics and automation. To capture greater efficiencies, the substitution of machines for labor is one of the ways in which Chinese firms can increase productivity.

For manufacturing processes that aren’t easily subject to automation, such firms are looking to move to places such as Vietnam where labor costs are a fraction of what prevails in China. The additional benefit of moving abroad is that the product will no longer be “made in China” but “made in Vietnam” and thus not subject to American tariffs

History is replete with such actions and reactions. Constraint is the catalyst that leads to adaptation and innovation. The next chapter of China’s economic story may very well be tied to the activities of Chinese firms doing business outside of China.

The trade surpluses that China currently enjoys may shift to places such as Vietnam, Cambodia, Indonesia, Myanmar and Sri Lanka as these states become focal points for Chinese investment.

Arthur Dong is a professor at Georgetown University's McDonough School of Business. He specializes in legal and business engagements between China and the United States.