The worsening US-China trade war might cost the world much more than US$430 billion of lost GDP
Aidan Yao says the US-China trade war threatens to be a drawn-out affair, pulling down the global economy. The IMF has put the cost of the conflict at 0.5 per cent of world GDP, but there might be more serious consequences ahead
Politically, it is difficult to see how things could turn around in the near term. After having taken such a tough stance in front of domestic and international audiences, neither side can realistically back down without a significant loss of face.
Where Trump is concerned, it is not obvious he wants to relent, even if he is given a chance to do so in a face-saving way. Since China bashing has worked well for his popularity, Trump may even find it opportune to show more hostility towards China, with the midterm elections looming large.
For President Xi Jinping, making sure China stands up to the bullying of the US could be critical to preserving national pride.
Watch: Are Chinese less willing to buy US goods?
These political considerations are important hurdles to deal-making in the near term, and it might be difficult to end the impasse until after the November elections. What is worrying is that this political game of chicken could take the world economy down a very dangerous path.
An all-out trade war could cost the US economy almost 0.5 per cent of gross domestic product once the domestic and international feedback effects are considered. A nasty financial market reaction could cause more damage to the US economy, raising the cost to almost 1 per cent of GDP over the next 24 months.
Such a shock will deal a severe blow to investors’ confidence, and in turn, drive a substantial correction in Chinese asset markets. Once again, the combined impact of real economic and financial shocks is likely to be significantly larger than what standard economic modelling implies, because the technique does not capture financial shock very well.
The trade war will also be seriously contagious, spreading beyond the two involved parties. The global supply chain and financial markets are major transmission mechanisms that can propagate the shock across the world economy. While everyone will suffer, Asia will take the worst hit, given its high degree of supply chain integration with China’s manufacturing and assembly operations.
Let’s hope cooler heads will eventually prevail and an economic train wreck can be avoided.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers