The trade war between the United States and China appears to be escalating. The US imposed an additional 25% tariff on US$34 billion of Chinese goods on July 6, and China retaliated with a similar tariff on US imports worth US$29.6 billion. The US may impose an additional 25% tariff on another US$16 billion of Chinese goods in September and perhaps a third new tariff of 10% on another US$200 billion in trade later this year. China’s reaction bears watching.

Both countries have also used other policy instruments in their trade fight. The US, for example, has used the CFIUS1 process to block Chinese acquisitions of certain US companies on national security concerns, while China has withheld regulatory approval of Chinese companies on global mergers that involve US companies.

There are no signs that either country will back down in the immediate future.

The US and China have been engaged in a war of words over trade since 2017 but followed through with tangible actions in 2018. We map out the timeline of actions taken.

Will the US trade deficit really shrink?

On the campaign trail, US President Donald Trump had railed against the trade deficit with China and the “theft” of US jobs and intellectual property by China. Imposing tariffs on Chinese goods seeks to reduce the flow of Chinese imports, move manufacturing and jobs back to the US, and force American consumers to buy domestically made products.

Meanwhile, the shift in China’s trade patterns in recent years – from processing trade to general trade2 – shows that China is slowly moving away from importing goods for processing and export, to importing for domestic consumption. Businesses leveraging the growing Chinese market will still need to set up operations in the country.

Processing trade is driven by low costs and adds very little value in China. Businesses, whose prices are driven up by the US tariffs on China-made goods, will shift production elsewhere where costs are lower and do not attract additional US tariffs.

So, while the US trade deficit with China may reduce in the short term, there may not be significant improvement to the US total trade deficit in the long run.

Will China blink first?

On the surface, US’ demand to close the trade deficit may appear innocuous, and China has signalled its openness to negotiate on this issue, including offering to buy more US goods, cut tariffs on some consumer goods and automobiles, and ease foreign investment restrictions in certain sectors.

Chinese President Xi Jinping has acknowledged that intellectual property protection has an important role in enhancing the competitiveness of the Chinese economy, and promises that China will improve laws and regulations, and boost the enforcement of intellectual property rights.

But, China has also signalled its readiness to fight a trade war. At a press conference on July 5, a Ministry of Commerce spokesperson stated that China will not bow to threats and “blackmail”, nor will its resolve to defend global free trade and the multilateral system be shaken.

The US appears to be taking a leaf from the 1980s playbook of the US-Japan feud. However, some analysts believe that China is in a better position to deal with the situation.

These critics argue that China is not as export dependent and its growth has shifted to domestic demand. Its markets are also more diversified and it is not reliant on the US for security.

Due to existing capital controls, China has a greater command over the stability of its currency, the Renminbi (RMB). Thus, it does not appear likely that China will accept arrangements similar to the voluntary export restraints (VERs) and the Structural Impediments Initiative (SII) that Japan signed with the US.

Furthermore, the US actions and expressed intentions are seen as specifically targeting “Made in China 2025”.3 There is a growing sentiment among the Chinese public that the US actions are taken to hold back China’s economic development and prevent China from moving up the value chain in production and innovation networks. There are even comparisons in China with the “Unequal Treaties” that China was forced to sign during the Qing dynasty in the 1800s. Seen in this light, the Chinese government is unlikely to back down from the US challenge.

Sandwiched between the two trade giants, what can businesses do?

The most immediate effect will be on existing contracts. Businesses should ask the following questions:

1. What are the international commercial terms of the contract? Are the goods supposed to be delivered duty unpaid or duty paid? Who is responsible to pay the import duty, including the additional tariffs, on the goods?

2. What happens if a shipment arrives only after new additional tariffs have been imposed, as there may only be a short warning period between the announcement of a new tariff and its implementation? Who will be liable for the additional tariffs? If there is a delay in the shipping time, would the carrier be liable?

3. Are there provisions in the contract allowing for the cancellation of the purchase order?

It may also be time for businesses to take a close look at their existing contracts or prepare for a re-contract, to build in effective safeguards to deal with further actions that the US and China, and potentially other countries, as the trade war continues.

In the longer term, the trade war between the world’s first and second largest economies may disrupt global supply chains. Multinational companies with operations intricately distributed throughout the US and China may have to rethink and realign their supply chains.

For businesses exporting to the US, this will accelerate the trend of processing trade operations moving out of China to less costly countries (and which do not currently attract additional US tariffs). Conversely, businesses tapping into the vast Chinese consumer market will need to have non-US sources, whether within China or in other countries.

Will the world revert back to a pre-WTO environment where countries sit behind high tariff walls, and globalization becomes a chapter in trade history?

There is little to suggest that the world at large is abandoning globalization; the world is too interconnected now. There is a remote possibility that the US may come to see supply chain realignments as circumventing its China tariff action, and thus erect tariff walls against more and more countries, and eventually the world. However the trade war plays out, businesses should start preparing their contingency plans.