Category: China

How will new US administration policies affect economies in Asia and the Pacific, and how should they respond? 

To gain insight into these questions, ADB recently completed two studies based on different global models—one strong on macroeconomics and one strong on trade—to estimate the magnitude of likely effects. 

The first study examines the impact of the US imposing aggressive policies including 60% tariffs on the People’s Republic of China (PRC) and 10% tariffs on everyone else, reduced US immigration, and expansionary US fiscal policies. 

The second study focuses only on the impact of tariffs. It assumes 60% tariffs on Chinese imports and examines different tariff scenarios for the rest of the world: 10% versus 20% tariffs, tariffs across the board versus exemptions for countries with free trade agreements with the US, and equal retaliatory tariffs versus no retaliation.   

What do we learn from these exercises? 

First, the negative effects on the Chinese economy will be relatively modest even with 60% tariffs. The first study, using a macro model, finds that growth slows by just 0.3% per year during the four years of the new administration, and the trade model predicts much smaller impacts thanks to opportunities to redirect trade to other countries and smaller impacts on global output than in the macro study. The impacts will be even less severe if the US only imposes additional tariffs of 10% as has been recently announced, even though further review of US trade imbalances could lead to more tariff increases later in the year.

One reason for the modest impacts of high US tariffs is that the importance to the Chinese economy of exports to the US (both direct and indirect) has fallen steadily, now accounting for just 3% of the country’s GDP.

Evidence from President Trump’s first term shows that the PRC was able to redirect exports to other countries and that the cost of US tariffs was largely borne by US consumers and firms.

Second,  the effects on other Asian economies will be mixed, with some economies even expected to grow faster thanks to new export opportunities to the US to replace goods previously exported to the US from the PRC.

Opportunities from trade diversion also were evident during the first trade war between the US and the PRC, benefiting export-competitive economies such as Viet Nam. 

The recent shift observed in foreign direct investment (FDI) in strategic sectors away from the PRC and toward other Asian economies, especially in Southeast Asia, is likely to be reinforced.   

Despite these trends, it would be a mistake to assume that US tariffs on the PRC have zero-sum impacts that hurt the PRC and help other Asian economies. This is because in recent years the Chinese economy has become increasingly linked to other economies in the region through trade and investment despite geoeconomic fragmentation globally. 

Thus,  slower Chinese growth hurts other economies by reducing demand for imports, and reduced Chinese exports to the US hurts economies that supply capital equipment and inputs to Chinese exporters, most notably the high-tech economies in East Asia including the Republic of Korea and Japan. 

Also, if higher US tariffs on imports from the PRC help other Asian economies to attract more FDI and increase exports to the US, Chinese firms can still share in those benefits by increasing their outbound FDI and increasing exports of intermediate inputs to those economies. Indeed, such patterns of investment and trade have already become evident, especially in Southeast Asia.

The trade study also finds that economies with trade agreements with the US will benefit if they are exempt from US tariff increases while tariffs are imposed on their competitors without such trade agreements. Most economies in the region lack trade agreements with the US and so would be negatively affected by such a differentiated policy. 

Finally, economies in the region should be cautious in considering whether to respond to higher US tariffs with tariffs of their own. Higher import tariffs increase the price of imports which can contribute to inflation, make goods more expensive for domestic consumers, and increase the costs of production for producers that rely on imported intermediate inputs. 

 Perhaps of greater importance for Asian economies than tariffs is the impact of the new administration’s policies on US inflation and interest rates.

All the announced policies—to increase tariffs, reduce immigration, and extend and perhaps increase tax cuts—are likely to be inflationary, which is expected to lead to higher US interest rates for longer periods of time. These expectations are already evident in the shift in the structure of US bond yields since the US election. Despite much progress by many Asian economies to reduce reliance on US-denominated debt, financial conditions in Asia remain quite sensitive to US interest rates and to inflation news when Fed policy is data dependent as it is now. 

Higher US rates reduce the scope for Asian central banks to lower interest rates and support growth in the region. They increase debt sustainability risks for economies with high debt levels denominated in US dollars. 

Given higher US interest rates, our macro model predicts that currencies in the region will depreciate relative to the dollar.

However, we do not expect weaker currencies to lead to higher inflation overall because our macro model finds that the higher interest rates and trade costs associated with US policies will reduce global GDP and demand for commodities, which will lead to lower global energy and food prices.

In recent years, developing economies in Asia have demonstrated tremendous resilience to large shocks associated with the pandemic, commodity prices, and geoeconomic fragmentation.

This is due to sound macroeconomic management by most governments in the region. Moreover, despite global geoeconomic fragmentation, governments have maintained their commitment to open trade and investment, which has strengthened regional economic integration.

This impressive track record means the region is well placed to maximize opportunities for inclusive growth and remain resilient to future shocks, including unexpected policy directions of the new US administration.