- The portion of trade unaffected by tariff has remained hefty, due to inelastic demand.
- The news sensitive high-tech sector represents a relatively small share of trade.
- Reduction of FDI from US and EU is offset by that from HK, which accounted for 75.9% of FDI in 2021.
- 51% of the Hong Kong FDI came from British Virgin Islands, Bermuda, Cayman Islands, and Cook Islands
- Reduction of China’s UST holdings is attributed to both financial and geopolitical factors.
Intensifying competition between US and China complicates long-term business decisions. Deteriorating Sino-US relationship dominates news headline around the clock. That in turn triggers fears of speedy economic decoupling between the two super-powers, heightening risk of sanctions in many sectors, and the rising probability of war in Taiwan Straits.
Limited immediate impact on overall trade relationship with the US
But how deep is the economic impact of these adverse geopolitical developments? China's total trade balance hit a record high of USD878bn in 2022. Overall terms of trade even improved. Trade between the US and China also reached a record high in 2022. Total trade (exports + imports) with the US shot up to USD772.4bn. The growing trade surplus with the US, which reached USD415bn, was mainly driven by products that are not subjected to tariffs, such as computers, phones, and toys. China accounts for over 50% of total US imports for this
Group of products. Shipments of toys (0% tariff), games (0% tariff), and sporting goods (7.5% tariff), for instance, soared by 46.7% in total compared to 2018, which represented almost 70% of imports of this group of products. Computers and phones imports from China rose by 11.8% and 9.7% respectively. Video game consoles rose by 82% according to Peterson Institute of International Economics. Likewise, 60% of US mobile phone and 50% of US computers imports came from China. Inelastic demand for such type of Chinese imports largely offset the decline of imports subjected to tariff.
For products that are subjected to a 25% tariff, such as those on List 1, 2, and 3, the negative impacts of the tariff on Chinese imports were apparent. This group collectively accounted for 34% of US's imports from China last year. For more cost-sensitive products, such as furniture, US importers are now shifting to suppliers outside China. As a result, the share of US’s furniture imports from China plunged from 57% in 2018 to 33% in 2022. Total value also fell by 25.9% to USD16.8bn. A similar trend is also observed in the space of consumer electronics. Chinese-made TV and video equipment plummeted by 70.4% cumulatively, with share of US imports falling from 46% to 16%. For apparel and footwear that are subject to a 7.5% tariff, China's share of US's inward shipment declined from 43% in 2018 to 31%, with total value fell in tandem by 10.0% cumulatively. These statistics reflect some relocations of manufacturing base from China to Vietnam, Cambodia and India are indeed happening for some sectors.
The US Department of Commerce placed a de facto ban on advanced semiconductor exports to China. Such a move immediately affects 95% of AI related products in China. By end 2022, the Biden administration added 36 Chinese companies to the entity list. As a result, exports of US semiconductor to China declined by 21.1% YoY in 2022, compared with +5.7% to the rest of the world. China’s share among US’s chips imports fell from 16% in 2018 to 5% in 2022. In value terms, it fell by 51.6% cumulatively. This means China is also losing the low-end market in the US as well.
The analysis concludes more than 50% of US’s import from China belongs to necessity characterizes by low elasticity of demand. Another 34% is more price sensitive due to tariff distortion, which drove US to import more from elsewhere. Bilateral semiconductor trade predominantly covered by headline news exemplifying geopolitical tensions only accounted for around 6-9% of total US’s exports to China and 1-2% of total China’s exports to the US. The peculiarity of this structure thus cushions sharp trade contraction between the two countries.
Impact on FDI
Has FDI been hurt lately? Last year, FDI increased to USD189bn, up from USD173bn in 2021. Overall FDI inflow rose by 40.1% in 2022 compared to 2018 when the Trump administration firstly launched trade war against China.
Although FDI from the US and EU respectively contracted by 8.2% and 36.4% 2018-2021, investments from other countries continued to pour in. It is important to examine Hong Kong closely because it accounted for 75.9% of China’s FDI in 2021. Investors first set up investment holding companies in BVI, Bermuda, Cayman Island and Cook Island before investing into China through Hong Kong. They collectively accounted for 51% of Hong Kong total FDI inflow in 2021. FDI from the BVI soared from USD36.0bn in 2018 to USD40.0bn in 2021. Cayman Island also improved from -USD1.3bn (outflow) to an inflow of USD15.5bn in 2021 too. FDI from Hong Kong to China rose by 46.5% during 2018-2021. Likewise, China’s FDI from BVI also went up from USD4.7bn in 2018 to USD5.3bn in 2021.
Encouragingly, FDI from AESAN rose by 85.0% amid a tighter trade relationship amongst them. The region accounted for 6.1% of China’s FDI (of which 97.7% of it is from Singapore) or 25.4% of China’s FDI excluding Hong Kong.
From a sectoral perspective, there is no clear evidence exemplifying foreign investors are pulling out of China due to rising US-China tension. In RMB terms, FDI into the hi-tech sector rose by 32% YoY YTD in Feb23. Within it, hi-tech manufacturing soared by 68.9% due to Beijing’s intensifying effort to develop advanced hardware. Hi-tech services, a proxy of software industry investment, also rose by 23.3% despite tremendous conflicts between China and the US on multiple fronts. As far as manufacturing sector is concerned, which accounted for 18.6% of China’s FDI, unsurprisingly fell by 18.1% in 2021 compared to 2018, due to adoption of “China + 1” strategy to relieve supply chain stress during the pandemic. Encouragingly, inflow into sectors such as construction and financing soared by 52.8% and 38.1% respectively.
Absence of a physical entity to displace China as a manufacturing is the reality. China has accomplished economies of scale, horizontal and vertical integration of supply chains, and a highly adaptive hard working labor force. Partial substitutes are available but some lack physical infrastructure, while others lack labor capacity to fulfill demand, notwithstanding production quality of the end products. All the hype about re-shoring and relocation do not make sense from cost competitiveness perspective. It was a viable short-term strategy during the pandemic.
Reduction of UST holdings is systematic
The impact of geopolitical tension on China’s holding of UST is obvious. Since China’s accession to the WTO in 2000, the country successfully amassed tremendous foreign reserves. It rocketed from USD163bn in 2000 to USD3,993bn in 2014, dominated by US Treasuries. At the peak, China’s holding of UST reached USD1,316bn in 2013 before riding on a secular downtrend. The reduction commenced in 2018 when ex US President Donald Trump launched a multi-year trade war with China. The decline was particularly steep when Fed started hiking interest rate sharply in 2022. According to US Treasury data, China’s holding of UST fell to USD859bn in Jan23, a 34.7% fall from the peak. Partial proceeds were recycled into gold reserves, which jumped from 33.9mn oz in 2013 to 65.9mn oz in Feb23. Hong Kong, as the gateway of China’s capital market, also trimmed its UST holding from USD262bn in early-20 to an 8-year low of USD179bn in Sep22.
Ever since US confiscated Russia’s foreign reserve, other major economies have also begun diversifying FX reserves by reduction of UST. Saudi Arabia, the traditional US ally and giant oil producer, also trimmed its UST holding since Feb-22. It contracted by 32.4% within the first 6 months of COVID due to an unprecedented shrink in trade income due to sharp fall of oil prices, thereby hampering financial ability to accumulate UST. A structural downward then began to develop even though oil price rebounded to USD80-120bn per barrel after the Russo-Ukrainian War. By Jan23, the holding is now 40% below its peak at USD111bn. This is likely a reflection of deteriorating diplomatic relationship with US in favor of leanings towards China. The same trend is also applied to Brazil, Latin American countries which have numerous ongoing disputes with the US since 2018.
Japan, Korea, Taiwan, and France, allies of the US had begun trimming UST holdings since early 2022 too. Japan trimmed UST position from the peak USD1,306bn in Feb22 to USD1,076bn. South Korea’s UST holdings also fell from USD132bn in Nov22 to USD103bn. Such group behavior was likely driven by interest rate factor rather than geopolitical forces. Meanwhile, we observed that traditional allies of the US such as UK, Canada and India, as well as neutral states such as Belgium, Luxembourg, and Switzerland continued to accumulate UST holdings irrespective to re-pricing of UST during rate hike cycle.
It appears that the decision to hold UST hinges not only on interest rates but also conditional on geopolitical factors particularly from non-US allies. China’s sharp reduction of UST is a development worthy of closer scrutiny, especially after the Fed has run its rate hike course.
Conclusions
The negative impacts of Sino-US rivalry on China’s trade and FDI are minimal. It makes logical sense because globalization successfully integrated the two economies extensively on numerous fronts. Unwinding them will be costly, notwithstanding unintended geopolitical consequences. The portion of trade that is unaffected by tariff imposition has remained hefty characterized by inelastic demand. The news sensitive hi-tech sector only represents a small share of trade and affects primarily China’s imports. That explains why China’s could run a USD415bn trade surplus with the US last year. FDI that hinges on long term perspective of foreign investors in the mainland economy is still advancing steadily despite daunting challenges in the past 3 years. The reduction of FDI from US and EU interestingly corresponded to apparent increment from Cayman Island and British Virgin Islands as evidenced in Hong Kong’s data alongside official data from China. The reduction of UST by China could be systematically driven by geopolitical factors, which will have some influence on US interest rate over time. This is a concern for the US, as they are reliant on other countries to finance huge budget deficits.
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