How Might China Manage Trump’s Tariff War

China has taken a tough stance against US President Donald Trump, matching the last two rounds of US tariffs with tariffs of its own. The US tariff on goods from China is now 145%, while China’s is 125%. Why does China take such a position, and are there any off-ramps that would allow it to mitigate the costs of a prolonged trade war?

There are three plausible reasons why China has responded this way so far. First, Chinese leaders may believe that negotiation at this stage will not produce a satisfactory outcome. They regard the US approach as akin to a kidnapper: any concession could just invite more hostage taking. After all, China already abstained from responding in kind to two earlier rounds of incremental (10%) US tariffs, on February 1 and March 3, and that did not prevent Trump from adding another 34% levy on April 2.

The Chinese can see that Mexico and Canada are also being hit with new US tariffs, even though they agreed to Trump’s first-term demand to renegotiate the North American Free Trade Agreement. Similarly, following the first Trump administration’s tariffs on China in March 2018, the Chinese agreed to purchase more from the US, only to be met by even higher tariffs on a wider range of goods. Although they acceded to the unfavorable terms of the so-called Phase One Agreement in December 2019, the US retained 20% tariffs on Chinese goods.

The Chinese also consider it unfair for the US to refuse to sell them goods that they really want – such as advanced semiconductors and other technology-intensive products – while compelling them to buy more of the goods (soybeans) that they could obtain at a better price elsewhere. Is it any surprise that they would try a different strategy this time?

A second reason concerns “face” (as in “saving face”), which is important in Chinese culture. The Chinese may suspect that Trump looks down on foreign leaders who come to beg for lower tariffs. After all, he recently boasted that foreign governments were “kissing my ass.” At the same time, Trump is known to admire foreign leaders who exhibit toughness.

US Treasury Secretary Scott Bessent wants to persuade the Chinese with the following logic: You should capitulate, as you are in a weaker position than the US, because the US can tariff more of its goods than vice versa. But this argument may have backfired, by reminding Chinese of the British position during the 1839-42 Opium war. The message then was: Our guns have a much longer range than yours, so why don’t you just capitulate and buy our opium?

Finally, the Chinese may worry about an unfavorable spillover effect from making concessions to the US. Since the high US tariffs could cause Chinese producers to divert some of their exports to other markets, many other countries are already considering their own additional tariffs on Chinese goods. A tough response to the US thus could function as a deterrent against such moves.

China is hoping that the turmoil in US financial markets will persuade Trump to change course. But its strategy could also trigger further US escalation. The bipartisan anti-China sentiment in Washington may be strong enough to allow the administration to stay the course, even if it proves painful to US households and firms. Moreover, losing access to the US market may add pressure to an already weakening Chinese economy.

So, are there off-ramps in this game of chicken? One option is for China to follow the Europeans in offering zero tariffs on US goods, as well as committing to policy reforms to reduce other market-distorting barriers if the US does the same. China could even propose a third-party monitoring mechanism – such as a panel of experts appointed by other World Trade Organization members – to ensure compliance.

A second option is to reinforce trading relations with other countries as leverage. Since many are concerned about Chinese export diversion from the US market, China could promise an import diversion: goods that it used to buy from US producers can now come from other countries. China is already the world’s second-largest importing country, and it could well claim first place if the US follows through with its “reciprocal” tariffs on the rest of the world. Thus, any country that introduces higher export barriers against China could risk losing a crucial export market.

China can also reduce its trade barriers on goods from other countries, as it did during the first Trump administration, and it could do a better job of advertising its International Import Expo. While most countries have export-promotion agencies, China may be unique in having a major state-sponsored exhibition devoted to imports. In the current context, the expo could promote more imports from countries that refrain from erecting new barriers.

Third, to reduce its trade surplus, China needs to find more effective ways to boost domestic consumption. A fundamental reorientation of its saving-consumption balance would require structural reforms to its social safety net, financial system, and gender balance, implying a multiyear process. While China could pursue macroeconomic stimulus in the short run, recent efforts have had only mixed results. What China really needs is much more aggressive monetary easing combined with fiscal measures that include temporary sales-tax cuts and consumption subsidies.

There is a very small chance that the US would accept an offer of zero-for-zero tariffs, at least for now. But a combination of trade reform, macroeconomic stimulus, and other structural measures to boost consumption and reduce net exports should be on the table anyway. Such an approach would be good for both China and the world economy, regardless of what the US does.