In a shocking move, the United States has just slapped a 100% tariff on Chinese electric vehicles, igniting fears of a new and potentially devastating trade war. This follows the 2020 Trump-China trade deal that ended a two-year period of escalating tariffs and restrictions. But now, with the EU considering it s own tariffs against China, and China vowing to retaliate, the question arises:

has the West just started a second trade war?

While leaders like the EU’s von der Leyen have made it clear that a second trade war is not the intention, she also indicated that the EU will likely follow the US soon and introduce new tariffs to compensate for China’s giant subsidies to strategic sectors like batteries, renewable energy, and electric vehicles. Even more worryingly for China, nations that should on paper be friendly towards China, like Brazil, which is part of the BRICs, and Thailand, which is part of China’s belt-and-road initiative, have already followed the US and announced new tariffs on Chinese goods.

But, if China wants to essentially subsidize the energy transition in the rest of the world, why is that such a bad thing? Could it be that all of this is just political maneuvering to appear tough on China, while in reality nobody wants to repeat Trumps trade war?

To answer these questions, I’ve dived into the latest research by economists and journalists, and uncovered that it’s not really Western and Chinese rivalry that will determine whether or not this will escalate into a trade war. What really matters is how China will choose to solve its economic crisis at home.

But, to explain why, we first need to a quick recap of

How we got here

Essentially, I think there are three pieces of historical context that we need to be able to understand if we want to find out whether or not we are on the brink of a second trade war. The first is China’s ‘unfair’ rise as a manufacturing superpower. The second is the first US - China trade war, that lasted from 2018 to 2020, and the third is China’s recent economic slowdown and how it responded by increasingly subsidizing its industries.

Okay, first, let’s talk about China’s ‘unfair’ rise to become the manufacturing superpower that it is today. As I discussed in my longer video about why China’s growth miracle is no longer working, China essentially followed the same growth model that nations like Japan and South Korea did before it, which is that it first transformed from an agricultural economy to a manufacturing based economy, which allowed it to level up its technology. However, crucially, this transition was not just about opening up to the world, as China allowed its industries to develop with a lot of government support, while it had high tariffs and other restrictions in place to protect it from foreign competition. At the same time, the country got relatively good access to Western markets, which for a large part, allowed it to get rich.

This is something that Western powers agreed to at the time, not just for China, but for developing nations in general because the consensus was that free trade was good. But, that in order to develop, poor nations should be allowed to have some trade barriers against competition from industrialized nations so that their industries could develop.

In fact, Western economists in the 1990s were so enamored with the benefits of this arrangement, in which the Chinese got rich, while Western consumers got cheap products, that they tended to forget that, while the on average everyone benefits from free trade, there are still some groups that loose out a lot. In the case of China’s development, the losers were mostly blue collar workers in the American industrial heartland that, subsequently came to be known as the rust-belt. Indeed, as this graph by IMD professor Richard Baldwin shows, manufacturing jobs in the USA nosedived, while at the same time they grew a lot in China.

This brings us to the second part of how we got here: the backlash and the first US-China trade war.

In response to these job losses, many of these blue collar workers propelled Donald Trump to win the Republican primary, and later the general election on an anti free-trade message, especially against China, stating rather subtly that

“we can’t continue to allow China to rape our country, cause that’s what they are doing.”

where he was referring to their ‘unfair’ trade policies like higher tariffs and other restrictions on US products that were still in place, even though China was now much richer. Trump believed that this was causing the US to have giant trade deficit with China, and that is was largely responsible for deindustrialization in the US. So, when he got elected, Trump started the first US-China trade war by raising tariffs across the board on products ranging from steel, to solar panels.

Indeed, as you can see here in this graph from the Peterson institute, tariffs from China on US products were initially quite a bit higher, and then as Trump started increasing them, China responded each time by raising them even higher, continuing for roughly 2 years until they signed a trade deal to ease some measure, but mostly just left tariffs in place as they were. Also, note here that both countries left their tariffs against other countries roughly the same throughout this period.

But, did the Trump trade war work? Well, while we cannot know for sure, US exports to China certainly seem to have slowed down compared to their previous trajectory.

However, in spite of what mr. Trump wanted, it actually seems like China decoupled more from the West than the other way around. For example, as you can see here in this graph, in 2002 China still relied for over 50% on exports to the US, Japan, and EU. But, now that percentage has dropped to around 35%, and has even been overtaken by exports to friendlier, Asian nations that are part of China’s Belt-and-Road project.

Of course, this makes more sense if you take into account that China aimed to become less dependent on the West already before Trump was elected. They just did it in a more subtle way than Trump did because, rather than relying on Tariffs, China decided to reduce its dependence on foreign imports by heavily subsidizing its own strategic sectors like cars and energy when it introduced its ‘made in China 2025’ program in 2015.

Indeed, as this chart shows the Chinese government spent billions on its emerging electric vehicles from 2009 to 2017, 2018, 2019, 2020, and then significantly more in 2021, as its economy started to slow down through direct subsidies, and more subtle sales tax exemptions, R&D expenditures and government procurements. However, as you can see here, subsidies to Chinese electric vehicles got a big bump in 2021, which brings us to the final part of how we got to the second trade war, and that is China’s economic slowdown.

You see, in 2021, the financial collapse of China’s Evergrande property group made clear that China’s property bubble had finally burst. A property bubble that had helped China to continue grow rapidly after the country got too big to rely on exports to the West alone. Along with the drag of Covid lockdowns, it was the bursting of this property bubble that made China’s leaders realize they needed a different growth model.

However, in spite of most Western and Chinese economists recommending that China should switch to promote the service sector and local consumption, China’s leadership had different ideas, and reverted back to its old model of pushing manufacturing by increasing subsidies massively. What’s more, as you can see in this graph the Chinese state started ordering its state run banks to start lending more and more to its factories, despite local Chinese demand for their goods going down.

This is I think the most crucial recent development if we really want to understand the second trade war.

As I discussed in my video about China’s slowdown, economies tend to grow by focusing first on agriculture, then on manufacturing, and then on services. The reason why countries need to make that final switch to services is because this is where, in a modern economy, most of the jobs will be. If you do not make that switch, you will end up with high unemployment, and, perhaps even more importantly, your population will not earn enough to buy all of the manufactured goods you are producing.

So, what to do then with all of these manufactured goods that your own population cannot afford? Well, you can export them o f course! Sure, this model worked very well for China in the past. However, this old strategy cannot work today because China’s industries are just so incredibly massive that just a slight increase in production cannot be absorbed by Chinese consumers results in a massive flood of cheap exports to the rest of the World.

And, indeed, this is exactly what we are seeing today, Chinese youth unemployment is very high, Chinese local demand has stagnated, and yet, the Chinese state is now heavily encouraging more industrial production. The inevitable consequence is that cheap Chinese exports are now flooding the world.

But, hold on a minute, why is that a bad thing? If the Chinese government wants to subsidize electric vehicles, batteries, and solar panels, it would effectively mean that the Chinese tax payer subsidizes these goods for the rest of the world. But, if you think about it, if China wants to subsidize our energy transition, wouldn’t that be great! Wouldn’t cheaper electric cars and energy products help solve the cost of living crisis much of the world is going through? Yes, it would!

So, then

Why does the world reject more subsidized Chinese goods?

Essentially, I’ve identified three main reasons why countries are imposing tariffs to stop the influx of cheap Chinese goods

The first argument is that increased tariffs are needed to protect local jobs and profits, especially in the car market. For example, some have made the case that Joe Biden has just introduced these tariffs now to win favor with potential working class voters in mid-Western states like Michigan and Ohio where a lot of cars are made. Similar many have argued that European car giants like French-Italian company Stellantis, Germany’s Volkswagen, and France’s Renault, are now in mortal danger due to China’s dominance in the electric vehicle sector.

China’s threat to local profits and jobs could also explain why a host of developing nations, ranging from Asian neighbors like Thailand to China’s BRICs partner Brazil have already announced new tariffs against China. You see, given that China got rich by exporting to the rich world, countries like Brazil, Bangladesh, Vietnam, and India are now looking to replicate that success. However, for that to work, they need the Chinese consumer to buy their manufactured goods, and they do NOT need subsidized Chinese manufacturing, which will prevent them from leveling up their economies by moving into manufacturing.

However, I do not think that this is now the main reason that Western countries are worried. Indeed, contrary to what you might have expected, Europe’s car bosses have lobbied against the ta riffs because they fear a Chinese retaliation. What’s more, the American car industry has faced stiff competition many times, first from Europe, then from Japan, and then from Korea, and it never before felt the need to introduce 100% tariffs.

So, could it be that, just as with the first trade war, Western countries are worried about their trade deficit with China. After all, if you run a trade deficit for too long, this could cause a currency crisis. Well, no, I don’t think this is what the West really cares about today, given that the US China trade deficit is at its lowest in years. On the European side, while the EU’s trade deficit with China has certainly grown, it currently is running a trade surplus with the rest of the world. So, its trade deficit shouldn’t really be a big concern.

Instead, I think the third argument —national security— is now the real reason the West is afraid of cheap Chinese goods. After all, both Europe and the United States now consider China a ‘systemic rival’ t hat has made it clear it wants to displace the American order and now quietly supports a major war on the border of Europe. A rival that could turn into a true enemy if it ever decides to invade Taiwan, which the U.S. is likely to protect. Now, as we have seen in Ukraine, if that happens, the West would be completely screwed if it completely depended on Chinese goods for its energy production, such as batteries or solar panels. What’s more, after several hacking incidents, and reports of China installing back doors into various of its export products like Huawei phones, the West likely doesn’t want to become completely dependent on Chinese EVs, which are basically giant smart phones on wheels, that could be operated remotely. I mean just imagine that, in case of a war over Taiwan, China suddenly shuts down 50% of cars driving around in the West. Finally, given that civilian factories, like those for cars and electronics, have historically often been transformed into military factories in case of a war, it would be a Chinese dream if it could get the West to de-industrialize as much as possible. As you can imagine, these are all national security scenarios that Western officials simply cannot risk.

So, to sum up, China’s policies of trying to return to a manufacturing led economy has led to a flood of exports to the rest of the world. However, rather than welcoming this with open arms, the world feels threatened by it. Developing nations feel threatened by this because it blocks their development via the export-led growth model that China itself successfully used. On the other hand, advanced Western nations feel threated by it because they now view China as a geopolitical rival, and they’ve seen with Russia that it is unwise to depend too much on a potentially hostile country.

So, now that we know how we got here, and why the world feels so threatened by subsidized Chinese exports, I think we can now answer the main question of this video

Is this the start of a second trade war?

Well, sadly, despite the fact that neither Chinese, American nor EU officials want a full-blown trade war, I still think it is likely that this will escalate further, simply because China’s leaders now seem committed to returning to its old growth model of manufacturing and export based growth. However, because China is now so big, the world cannot absorb all of this excess Chinese production. The West does not want to depend on a potentially hostile country for crucial goods after its experience with Russia. This means that as its markets close, more and more Chinese manufactured goods will flood emerging markets. But, while China had hoped BRICSs and Belt-and-Road countries can take the place of the West and become the prime customer for Chinese industries, these countries are unlikely to allow this because it robs them of a chance to get rich through manufacturing themselves.

So, unless the Chinese see the light and switch their growth strategy to a more sustainable model, I fear likely that a second trade war is essentially what we are facing. Indeed, a first development has already been that China announced shortly after the new US tariffs t hat it would retaliated against Western chemical exports and that it would likely raise its own Tariffs on Western cars to 25%.

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