2.1 Overview of United States-China Trade War
The U.S. and China are the leading powers in the world when it comes to economies. Since China’s economic growth is soaring under globalization, the Goldman Sachs had estimated that China would surpass the U.S. in late 2020s. It leads to those trade actions, involving international trade prospects amid rising U.S.
protectionism (Steinbock, 2019). The “American First” further became the catchword for protectionism rising in recent years to oppose the exports-leading trade policies by China. After the withdrawal from the Trans-Pacific Partnership (TPP) and the intention of NAFTA renegotiation, the direction had been tilted toward the country specific tariffs.
In the second half of 2018, China and the United States have been confronting a trade conflict when the Trump administration implemented tariffs lists on approximately $360 billion of U.S. imports from China. To respond to the protecting trade policy of the U.S. with retaliation, averaging tariffs of 16% has been imposed by China on $161 billion of U.S. exports (Amiti et al., 2019). These competitively retaliating tariffs policies are commonly addressed as “trade war”.
Table 1, organized from the Office of the U.S. Trade Representative, shows the comprehensive time of release and implementation as well as estimated trade value from China for the four tariffs lists conducted by the Trump administration. Note that the tariffs rates of the third list were changed, and part B of the fourth list was suspended.
The U.S. trade action lists are announced consecutively between June 2018 and August 2019. The first tariffs list (L1) specifically for China began in June, 2018, with additional 25% tariffs rates estimated for $34 billion of imports value. The second tariffs list (L2) of additional 25% tariffs rates have $16 billion of imported China goods.
The third list of tariffs implementation started in September, 2018 with 10% tariffs
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(L3_10) on $200 billion of China imports. The tariffs rates were modified to 25%
(L3_25) in May, 2019. The fourth list (L4) with 15% tariffs implementation took place.
However, the truce was made at the G20 conference in Dec, 2018. Although the goods in part B of the fourth list will not be subjected to the tariffs, the additional 15% of tariffs with a total trade value of approximately $120 billion are imposed on the China-import goods in part A of the fourth list (L4A) effective in September, 2019. The rates of tariffs were reduced from 15% to 7.5% on Feb 14, 2020 after a Federal Register notice was issued by the United States Trade Representative (USTR).
The policy aims to encourage American people to consume and purchase American products by making imported goods much more expensive. Under the trade war, thousands of products from China are the target of the tariffs lists. In the first and second lists (L1& L2), the affected products in terms of value are mainly machineries, electronics, and transportation products. However, since the total value of these lists are subtle compared to the last two lists (L3& L4), the effect of list 1 and 2 could be expected to be smaller. For the third list (L3), even though it was imposed only for an additional 10% of tariff at the beginning, the rate was further modified to 25%, expanding the possible effect considering the value of imports. The main products affected in tariff action list 3 are: telecommunications equipment, printed circuit board (PCB) for computer, central processing Unit, home appliance and vehicle parts according to the United States International Trade Commission (USITC). The tariff list 4 mainly imposed an additional 15% tariffs on agricultural products, semiconductor, machineries, vehicles, and general products, such as clothing, shoes, and textile, with an import value of $39 billion, and the cost will transfer to consumers.
The increases in prices for domestic (U.S.) consumers and the distortion of welfare induced by the increasing cost is not the only effect raised by the imposition of the tariffs lists. Other countries could also possibly benefit from the detouring trade because
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of the increased cost induced by the tariffs lists. Those products subjected to the tariffs lists from the U.S. could avoid the imposition through the change of the origin. In Taiwan, if you want to change the origin of the product to “made in Taiwan”, it must go through substantial transformation3 before re-exporting. In other words, the product that Taiwan has more advantage in brings more opportunity of gaining interest through the effect of trade deflection and creation. In addition, since the air liberalization and relative advantages are different across countries, the category each country may benefit from will be different as well. According to a research, Taiwan was the largest beneficiary of the trade deflection effects of United States tariffs on China, accounting for additional exports to the United States of almost US$ 4.2 billion in the first half of 2019. The increase is largely on the office machinery and communication equipment (Nicita 2019). It gives the implication that the trade war may draw benefits for different combinations of products among countries, if the products in the lists are mostly the major exporting products of Taiwan.
The fundamentally and conventionally theoretical model provides us an understanding of how imposition of tariffs affects the price of foreign goods and further decreases the demand of foreign imported goods.
2.2 The Theoretical Model of Trade Deflection and Creation
The trade deflection originally is defined as an effect by redirection of imports from a third country through a low-tariff partner member of a free-trade area (FTA) to the destination country intending to take advantage of the tax differentials between the member and non-member countries (Shibata, 1967).The redirection effect not only
3 Substantial transformation means an increase of 35% in added-value or a complete change in 6-digits HS code, according to the Import Origins Identification Standard.
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Figure 1 presents the concept of trade deflection and creation effects. Using the U.S. antidumping (AD) data over the period of 1992-2001 to match with the Japanese product-level export value to third countries (EU), in this case, Bown and Crowley (2007) found a 5-7% increase in Japanese exports to non-U.S. trade partners. They mentioned four different kinds of effect as the result of increase antidumping tariff:
1) Trade destruction
2) Trade creation via import source diversion 3) Trade deflection
4) Trade depression
Here, I focus on trade deflection and creation effects. In Figure 1, country A, B and C are the U.S., China, and Taiwan, respectively. When the U.S. implemented tariffs barriers, such as the tariffs lists, China may not want to directly export their product subjected to additional tariffs rates. Therefore, China will deflect those products to other countries, such as Taiwan, to avoid the imposition of additional tariffs. The increase of the imports from China to Taiwan, is trade deflection effect. On the other hand, Taiwan has to export those products to the U.S., hence, the exports from Taiwan to the U.S. will increase. Thus, this increased effect on exports is trade creation effect. However, the data in this study has a difficulty to differentiate the trade flow with the purpose of avoiding additional tariffs from the general trade flow. As a result, it is still questionable whether trade deflection and creation effects are truly caused by the distortion of trade flow.
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In the statistical data from the Bureau of Foreign Trade of Taiwan, China is the top trade partner holding 22.68% of total trade value, 27.19% of export value and 17.47%
of import value of Taiwan between April, 2010 and November, 2019. As for the U.S. in the same period, it holds the third place of trade partner to Taiwan, accounting for 11.184% of total trade value, 11.759% of export value and 10.52% of import value.
Under the U.S.-China trade war, the channel for the firms to avoid the country-specific imposition for imports from China is to divert the destination for the goods to a third country thereby fleeing the additional tariffs. By diverting to another destination, the third country could be benefited by both trade deflection and creation. In this research, the focus is on Taiwan, one of the closest trade partners of China.