Why the US Trade Agreement Will Slow China’s Economy

Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow

The response of the global financial markets to the trade agreement reached between the United States and China has been very positive, probably excessively so given the relatively limited size of the agreement reached.

The positive thing about the agreement is that it allows a truce — at least partially — in the strategic competition between China and the United States. This truce comes at a key moment for both President Donald Trump and President Xi Jinping for different reasons. China cutting tariffs in half on U.S. goods will serve President Trump as he aims to show that he has managed to take China on before the U.S. presidential election.

President Xi desperately needed to improve investors’ confidence in China’s economy to pave the way to generate enough growth in 2020 to reach President Xi’s widely advertised objective of doubling China’s income in only 10 years.

The China dream (also named the Nation’s Rejuvenation) needs 5.7% GDP growth in 2020, which could probably have been reached with the better sentiment following the agreement reached on the Phase 1 deal. But as President Trump reminded the world in Davos, the U.S. has been the main beneficiary of the deal, as existing tariffs on Chinese imports will not be dismantled, and China will need to import as much as the equivalent of $200 billion in goods from the U.S. A large trade diversion will be created to satisfy the import amount and is the main reason China may be considered a loser of the Phase 1 deal.

Additionally, for China, any positive sentiment that the deal generated around the Chinese economy has now vanished as a consequence of the coronavirus outbreak.

Such a massive increase in imports from the U.S. can only be guaranteed by substituting Chinese imports from other parts of the world. The trade diversion generated from such a substitution will not only hurt Chinese consumers, but also other key exports to China. For the $50 billion of agricultural and energy products, the losers are generally the emerging economies.

For the $80 billion in manufacturing products, the main losers are Germany and, to a lesser extent, South Korea…