U.S.-China spat won't spark a global recession

Many people liken the trade war between the United States and China to the situation triggered by the Great Depression, when the world's major economies competed with one another to raise import tariffs and threw the global economy into severe turmoil. They are wrong.

When an importing country hikes its tariffs, businesses in the exporter country incur losses either when they are unable to pass the cost of higher tariffs sufficiently on to the consumers or when they see the volume of their sales decline due to higher prices. But unlike the days when the whole process from production of parts to the manufacturing of finished products was completed within national borders, today parts made in a certain country are typically shipped to another to be assembled and traded from there.

For example, China imports parts and components from Japan, Taiwan, Thailand and so on to build the finished products that it ships to the U.S. If the product is priced at $10,000 and the aggregate value of the imported parts amounts to $9,000, the damage incurred by China will only be its added value of $1,000.

In the case of the Great Depression trade war, many countries imposed steep tariffs on imports from all other countries. This time, however, the U.S. has imposed the heavy tariffs only on Chinese products, and China did so solely on imports from the U.S.

Today, the global supply chain has become more flexible due to the increased parts trade. Even when the trade route linking China and the U.S. gets hampered by the tit-for-tat exchange of tariffs, companies can still ship parts to Southeast Asia to be assembled there and then export the products to the U.S. or China. The country that used to export parts to China will face no problem since it can now ship them to Southeast Asia instead. In a sense, U.S. President Donald Trump is contributing to Southeast Asia's economic development.

Likewise, consumers in an importer country can get supplies from other trade routes free of tariffs. Of course, when there are no other suppliers and it's difficult to shift production elsewhere, companies will have no choice but to import from the exporter even if that means paying additional tariffs. In this case, consumers in the importer country that raised the tariffs and businesses that use the imported products and materials will be heavily affected.

In the Great Depression turmoil of the global economy, GDP growth in the U.S. plunged from 5 percent in 1929 to minus 15.1 percent in 1932 -- a 20.1 percentage point downturn. Japan's economy experienced a 10.4 percentage point decline -- from 1.7 percent growth in 1929 to a 8.7 percent fall in 1930.

On the other hand, the International Monetary Fund estimates the current U.S.-China trade war will push down global GDP by a mere 0.2 percent over the long term. And while both the U.S. and Chinese economy are forecast to decline by roughly 0.5 percent, there will be no impact on Japan and the European Union (and some positive effects on Japan are expected over the short term).

The essence of the U.S.-China trade war is a free trade agreement in reverse. A free trade agreement, in which the signatories mutually reduce or abolish import tariffs and protect investments in one other, discriminates against nations that do not take part in the accord. On the contrary, in the U.S.-China trade war, both the U.S. and China raise their tariffs solely against each other. Therefore, other countries that can export to both the U.S. and China stand to benefit from their relative tariff advantage.

In other words, it is equal to the U.S. having free trade agreements with all countries except China -- and China doing the same with all other countries but the U.S. It is U.S. and Chinese businesses and industries that will be discriminated against, and jobs will be lost in both countries.

The Chinese tariffs on U.S. soybeans inflicted heavy damage on American farmers, while Brazil managed to increase its exports significantly. The U.S. automobile industry sustained dual damage from higher production costs due to the steel and aluminum tariffs imposed by Trump and the higher tariffs imposed by China. Therefore, BMW and Daimler, which used to ship vehicles built in U.S. plants to China, are shifting the production of their China-bound cars to countries like Thailand. Meanwhile, Japanese automakers benefit from their relative tariff advantage.

What if the trade war becomes protracted?

There are two schools of thought in the U.S. via-a-vis China: Trump's view of prioritizing cuts to the U.S. trade deficit with China on one hand, and the arguments of anti-Chinese hardliners that China must be stopped in its bid to achieve high-tech hegemony by stealing U.S. technology. If China proposes to increase its purchase of American farm products, Trump might agree to end the trade war since it would likely reduce the U.S. trade deficit. However, others in the U.S. administration put priority on addressing structural problems in China's economy, such as intellectual property protection, cuts to subsidies to domestic industries and reform of state-owned enterprises.

But these are issues on which Beijing cannot easily compromise, since they concern the power structure of the Communist Party-led regime. A wide and insurmountable divide lies between the two countries, and it's difficult to find a solution acceptable to both sides.

If the trade war becomes protracted for the above-mentioned reasons, the damage to the world economy will likely be larger than has been calculated by the IMF. But still, it is the U.S. and China -- the parties fighting the trade war -- that will bear the brunt of it. The impact on the Japanese and European economies won't be that serious. They may even benefit from the reverse FTA effect over the short term.