Scaling the extent of Chinese Trade Deflection and Trade Retrenchment into the EU during the first US-China Trade War
ZEITGEIST SERIES BRIEFING #44
Should the next US Administration raise sharply import tariffs on Chinese goods then there is a risk that some Chinese shipments will be deflected to other economies. Voices inside Europe call for pre-emptive increases in import tariffs to forestall such trade deflection. This briefing identifies and scales trade deflection of Chinese products to Europe during the first US-China Trade War. American tariffs can also cause trade retrenchment, where lost sales in the US market cause Chinese firms to benefit from fewer economies of scale and so retreat from EU markets. We show that both effects influenced Chinese exports to the EU during 2018 and 2019. However, the products involved were concentrated in a small number of HS chapters and, as far as the amounts of trade involved, largely offset each other. For the EU the ripple effects of this Trade War were contained.
Pressures for pre-emptive import tariffs
Donald Trump’s election victory last week raises the prospect of significantly higher tariffs on imports from China. In turn, this has led to fears that Chinese exports will be deflected to other economies, including the European Union. Already, fears about potential trade deflection are being used by some to justify immediately raising import barriers against Chinese goods.
Evidently, some prefer to speculate about the extent of future trade deflection. Instead, we prefer to identify and scale incidences of trade deflection witnessed during the first US-China Trade War before COVID-19 disrupted trade flows.
Trade retrenchment is possible too
In the interests of balance, we also identify and scale instances of trade retrenchment over the same timeframe. Such retrenchment occurs when exporters hit by tariffs suffer a double blow: lost sales in the protected market (here USA) reduce the benefits exporters derive from economies of scale, impairing their competitiveness overall—resulting in lost sales in third markets (here the EU). Scale is central to the business model of many exporters.
Policy relevance
In principle, both trade deflection and retrenchment are possible. Some see trade deflection as problematic because it puts import-competing firms in third markets under additional competitive pressure. Trade retrenchment can be problematic because security of supply to third markets may be jeopardised.
Detecting import anomalies
While trade deflection increases exports to third parties from the tariff-targeted country, trade retrenchment reduces them. This difference is central to identifying anomalous import patterns into the European Union from China during the early years of the US-China Trade War. Specifically, our goal here is to determine how frequently the then 28 members of the European Union experienced these two effects during 2018 and 2019 after the US starting raising tariffs on Chinese imports essentially across-the-board.
The empirical approach taken here is described in the box on page 3. Critical to our approach is to assess whether Chinese exports to the EU in 2019 are much larger or much smaller than their likely level had their rate of growth during 2012-17 been sustained. Correcting for such organic growth (that is, correcting for expanded sales in Europe unrelated to the Trade War) is important. That way, analysts don’t incorrectly attribute all of the observed changes in Chinese exports to the EU to American tariff changes.
We confined our analysis to the 74 6-digit HS codes where China exported more than a billion US dollars of goods to the USA in 2016 and 2017. Why? A de minimis threshold is needed to ensure there were enough Chinese exports to the US to be deflected in the first place.
The greater the departure of actual 2019 import levels from that level expected had trend import growth continued, the higher the confidence that we have found an anomalous trading pattern that could be linked to the Trade War (see Figure 1). We use 5% and 10% thresholds to sort between cases of normal trade, trade deflection, and trade retrenchment.
Figure 1: Visualising trade deflection and trade retrenchment.
How often? How much trade at stake?
When identifying cases of trade deflection and retrenchment, requiring a 10% departure from pre-Trade War import growth is more restrictive than insisting on a 5% departure. Using the 10% threshold, we identified trade deflection in 25 of the 74 HS codes. Ten cases of trade retrenchment were also found. Together, this implies that US tariffs on more than half (39 out of 74) of the big-ticket product lines that China exported to the United States did not result in trade disruption in the European Union. Neither trade deflection nor trade retrenchment are inevitable.
In products where it was found, on average trade deflection raised Chinese exports to the EU by 22% above trend, while trade retrenchment reduced Chinese exports by 15% on average. The 25 instances of trade deflection increased Chinese exports to the EU by approximately $15 billion; the cases of trade retrenchment reduced Chinese exports by around $12 billion (Table 1).
On net, the knock-on effect of US tariffs on Chinese bilateral exports to the EU was to increase the latter by just $2.8 billion. Compare that total to the hundreds of billions of US Dollars in overall goods imports by the EU from China in 2019. Or to the $46 billion in increased Chinese goods exports to the EU between 2017 and 2019.
Relaxing the threshold for detecting trade deflection and trade retrenchment does not change the findings by much (again see Table 1). For sure, the instances of trade deflection increase from 25 to 36. However, the total value of imports associated with this form of trade disruption rises from $14.8 billion to $16.0 billion. Therefore, the most commercially significant cases of trade deflection were identified using the more restrictive 10% threshold. The same finding arises when comparing the thresholds used to identify trade retrenchment.
Overall, the amount of EU imports from China affected by trade deflection is a little larger than that affected by trade retrenchment. The net impact of US import tariff hikes on Chinese exports to the EU was very limited---accounting for just 7.1% of the change in total exports from China to the EU between 2017 and 2019. These effects are a sideshow in commercial terms. The fundamental market forces driving EU-China trade proved far more significant than ripple effects from the US-China Trade War.
Table 1: Extent of Trade Deflection and Trade Retrenchment into the EU in 2019.
Granular findings
We also share sectoral- and product-level findings. Table 2 shows how concentrated trade deflection and retrenchment is across “chapters” (essentially sectors) of the United Nations Harmonized System of product categories.
Almost all the instances of trade deflection into the EU market during the first US-China Trade War occurred in 3 sectors: machinery and mechanical appliances, in electrical machinery and parts, and in furniture. Trade deflection in road vehicles was confined to one product line. In sum, the trade deflection created by President Trump’s (first) Trade War with China created at most localised increases in import competition. Such trade deflection was not a broad-based threat to European manufacturing.
If anything, trade retrenchment was even more concentrated, affecting principally product lines in two sectors. Even more granular findings for each of the 74 HS codes examined in this study can be found in the Annex Table.
Table 2: HS chapters where Trade Deflection and Trade Retrenchment occurred.
HS codes identified using 10% threshold.
Policy implications
President Trump’s last Trade War involved imposing high tariffs on large swathes of Chinese products. During the recent presidential election campaign, he threatened to single out Chinese exports for even higher tariffs, raising fears about future trade deflection.
Last time around the EU did not pre-emptively raise import barriers to prevent a “flood” of Chinese exports onto its markets. That was wise as this analysis shows the flood never happened. For sure, Chinese exports to the EU rose but, in most cases, roughly in line with pre-Trade War trends. Consequently, instances of trade deflection were infrequent and the amounts of trade involved marginal.
Moreover, cases of trade retrenchment that reduced Chinese exports to the EU meant that the net impact on the bilateral trade balance with China was negligible.
The notion that sharp US tariff increases presage massive Chinese-induced disruption on European markets should be set to one side. European living standards are predicated on its openness to external trade. Speculation about trade deflection should not be allowed to drive EU import policy.
Box: Technical details—identifying cases of Trade Deflection and Trade Retrenchment.
The goal is to identify and scale instances of trade deflection and retrenchment of Chinese exports to the European Union following the imposition by the United States of sizeable import tariffs on Chinese goods in 2018 and 2019. A prerequisite for trade deflection and retrenchment on a significant scale to EU markets is that a sufficient quantum of Chinese goods are exported to the United States in the first place. Using COMTRADE with 2012 HS codes, we found 74 6-digit HS codes where China exported to the United States more than $1bn of goods in 2016 and 2017, the years immediately before the first US-China Trade War. The products associated with these 74 HS codes were the focus of our analysis. In 2017, China exported to EU $203.9 billion of goods in these 74 HS codes, equivalent to 55% of all EU imports from China during that year.
For each of the 74 HS codes we calculated the cumulative average annual growth rates (CAAGR) of Chinese exports to the EU from 2012 to 2017. These CAAGR were used to forecast HS code by HS code the total value of Chinese exports to the EU in 2019 had the 2012—17 growth path continued. This yielded the counterfactual level of exports, equivalent to point C in Figure 1. Next, for each HS code, we checked if the observed value of Chinese exports in 2019 was 5% higher or lower than the counterfactual value. If higher, this was deemed to be a case of trade deflection (point D in Figure 1). If lower, a case of trade retrenchment was identified (point R in Figure 1). The calculations were repeated for a more restrictive 10% threshold. The results for each HS code are summarised in the Annex Table. Note that 20 HS codes have negative CAAGR.
This approach essentially attributes significant deviations from the trend growth path to either trade deflection or retrenchment. Note the following, however. On the methodology above, buyer shifts in favour of Chinese goods of sufficient scale could wrongly indicate a case of trade deflection, meaning the results report here overstate the frequency and scale of trade deflection. Buyer shifts away from Chinese goods would overstate the number of trade retrenchment cases. We are not in a position to verify if buyer shifts occurred. During 2018 and 2019 the Chinese Yuan was stable against the Euro, making it unlikely that this factor influenced the results.
Annex Table: Results for each of the 74 HS codes examined in this study.
Notes: (1) Items shaded in the CAAGR column indicate HS codes with negative Chinese export growth between 2012 and 2017; (2) Entries shaded light or heavy red are instances of trade deflection, entries shaded green are instances of trade retrenchment; (3) Cells shaded in the last column refer to anomalies estimated to involve more than a billion US dollars of trade in 2019.
Simon J. Evenett, an international trade economist, is Professor of Geopolitics & Strategy at IMD Business School, Switzerland. He is also Founder of the St. Gallen Endowment for Prosperity Through Trade, home of the independent monitoring initiatives Global Trade Alert, Digital Policy Alert and the New Industrial Policy Observatory and Co-Chair of the World Economic Forum’s Global Futures Council on Trade & Investment. Fernando Martin is an Associate Director at the Global Trade Alert and leads the Analytics team.