Tariffs and Trade

Trump launched the trade war in his first term to much bombast, grabbing headlines as he and his team announced the death of globalization. But compared to the current trade war, Trump’s previous trade conflict was barely a skirmish. During the president’s first term, tariffs averaged a mere 20 percent and were only implemented in his second year following months of Sections 232 and 301 investigations.

In contrast to his earlier relative restraint, Trump came swinging right out of the gate in his second term and had far less respect for legal proceduralism. Trump’s April “Liberation Day” tariffs invoked the International Emergency Economic Powers Act to avoid a prolonged investigation, despite the Act being reserved for national emergencies. The initial Liberation Day tariffs on China amounted to 54 percent, but a tit-for-tat quickly escalated to a peak of 145 percent, which Xi Jinping responded to by imposing 125 percent levies on American goods. While both countries quickly backed away from the cliff of a de facto trade embargo, US tariffs averaging around 57 percent remained in place after the Liberation Day back and forth.

This recent meeting led to a reduction of tariffs of 10 percent, bringing the average down to 47 percent. This minor de-escalation is unlikely to undo the major changes to global trade flows wrought by the second stage of the trade war. Between April and June, bilateral trade between the United States and China fell by $41 billion, a 23 percent year-over-year decline. As Chinese exporters have retreated from the United States, they’ve found replacement markets in Europe and Asia, a shift which doesn’t appear to be mere transshipment to the United States through third-party countries.

There’s good reason to think that these countries won’t be able to act as a long-term replacement to the United States given their lower purchasing power and reluctance to absorb China’s massive trade surpluses. And despite the downturn in trade, the United States and China still form the largest bilateral trade relationship in the world. Nonetheless, the 10 percent reduction still leaves a massive tariff of 47 percent and Trump’s trigger-happy use of this economic sanction means that this number can skyrocket at any time. We should expect further delinking of bilateral trade going forward.

Economic Sanctions Through the Entity List

Although tariffs have attracted far more attention, the “Entity List” has been an even more impactful weapon in American economic warfare. The Entity List is published by the Department of Commerce and includes foreign individuals, institutions, and businesses that are subject to strict trade and sanctions requirements. All firms, including non-American ones, are required to obtain licenses from the US government to export to parties on the Entity List and face large fines or imprisonment for violating these restrictions.

The Entity List entered center stage of the US-China conflict in May 2019, when Trump added Chinese tech giant Huawei to the list, cutting it off from wide swaths of American hardware components, software, and intellectual property. The Trump administration swiftly followed up with an expansion of the list in October, justified by China’s human rights violations against Uyghurs in Xinjiang.

The United States took another swing at Huawei in August 2020 with the expansion of the Foreign-Produced Direct Product Rule (FDPR). These rules give the United States extraterritorial control of the trade of foreign-produced goods if they use American technology, regardless of whether they ever touch American borders. Given that almost all advanced semiconductors require US tech at some point, the FDPR was an assertion of American control over the entire semiconductor supply chain.

The Biden administration continued Trump’s trend of economic sanctions on China, but in a more targeted manner. Specific companies that were seen as assisting Russia’s invasion of Ukraine were added to the Entity List. Most importantly, Biden started an all-out onslaught on China’s semiconductor industry in 2022, unveiling progressive rounds of new chip export restrictions all the way up to his last week in office.

September marked the latest escalation of US export controls with the announcement of the “Affiliate Rule,” which would have added tens of thousands more organizations to the Entity List. While US government officials may have seen this as simply closing loopholes, the new rule infuriated China and likely provoked the People’s Republic’s newest rare earth mineral export controls. Luckily, this meeting saw a truce where both sides agreed to delay their respective export controls for a year. While avoiding a major escalation is cause for celebration, this truce is only temporary and doesn’t undo any of the already draconian sanctions implemented earlier.

The continued expansion of American sanctions has inflicted damage to Chinese companies, but also motivated the People’s Republic to move toward technological autarky. The Chinese government’s newest five-year plan doubles down on its commitment to technological self-reliance. Necessity is the mother of innovation and Huawei has been forced to create domestic alternatives now that it’s been cut off from American tech. Losing access to Android’s operating system motivated Huawei to accelerate development of its alternative, HarmonyOS, which now holds a larger market share than AppleOS in China.

Although Joe Biden’s chip export controls were meant to halt China’s progress in advanced semiconductors, they may have done the opposite. The Chinese state had long wanted to promote a vertically integrated Chinese chip supply chain, but faced resistance from domestic tech companies who wanted to source from the best Western suppliers. The United States essentially helped the Communist Party of China to achieve what it could not do on its own: force Chinese tech companies to source from their own domestic suppliers. Without access to Western chip suppliers, China’s semiconductor ecosystem has developed rapidly over the past few years. Domestic firms that were initially passed over for their superior Western competitors suddenly gained huge demand from Chinese tech giants. China’s semiconductor ecosystem is still far from the cutting edge, but American sanctions have made it far more resilient and self-sufficient.

Rare Earths

From electric vehicles to fighter jets, rare earth elements (REEs) are essential inputs for almost all modern technological goods. Although REEs are actually geologically abundant, China has a near monopoly on the refinement processes that make rare earth raw ore usable in industrial production. With an eye to Washington’s powerful economic sanctions regime, Beijing has sought to build its own by leveraging this crucial supply-chain bottleneck.

Beijing’s first use of REE sanctions was against Japan in 2010. But the power of this economic weapon has reached globally significance in recent years. In response to Trump’s early April Section 232 tariffs, China imposed export licensing requirements on several REEs, forcing firms to go through an onerous application process to acquire imports. These controls quickly created supply-chain shocks that shut down factories. The conflict was resolved by Trump backing off from some of his tariffs and China granting REE export licenses to non-military American firms. However, these licenses only last six months and are set to expire soon.

REE sanctions again reared their head in early October, just a few weeks before the Trump-Xi meeting. In response to an expansion of American export controls, China unveiled new REE export controls that were vastly more aggressive than anything seen previously. These new far-reaching sanctions could require Chinese approval for the trade of any goods containing even trace amounts of Chinese REEs, even if that trade doesn’t involve Chinese companies or cross Chinese borders.

In the most maximalist interpretation, this could give China veto power over all global trade of technological goods. These recent export controls were China’s most extensive use of economic sanctions to date. Not only could they apply to a sweeping range of goods, they take a page from the American playbook by allowing Xi to regulate trade between countries beyond China’s borders.

The meeting yielded a one-year pause on these new REE controls. Because of these controls’ breadth, it’s not surprising that China backed down. The broadness of the sanctions meant that many other countries were caught in the crossfire. In some cases this vulnerability has reinforced resolve to reduce reliance on China. This backlash was clearly not anticipated by the People’s Republic, which responded with multiple statements that moderated their tone. In addition, it’s unlikely that Beijing could actually enforce these export controls, given their far-reaching nature and China’s relative lack of experience in exercising this kind of economic weapon.

But despite this temporary ceasefire, the West has been moving quickly to cover this glaring supply-chain vulnerability. Early on in Trump’s second term, the Department of Defense took an equity stake in MP Materials, an American-based rare earths company, in a bid to revive the United States’s rare earth production capacity. Australia’s Lynas is similarly contributing to reducing dependencies on Chinese REEs. In addition, some companies are looking to find engineering solutions to reduce the need for REEs altogether. It’s unclear how successful these efforts will be given the long atrophy of Western REE production capabilities and the geological scarcity of certain specific REEs. In the same way that American sanctions on semiconductors motivated China to consolidate a self-sufficient supply chain, Chinese export controls may revitalize the West’s REE industry.

Despite the ongoing hostilities between the United States and China, the current truce is welcome, although it only represents a small easing of the rising tensions that have developed between the two nations over the last several years. Despite Trump’s characterization of the meeting as a “twelve out of ten,” the few concessions he wrung out of Xi — minor changes to port fees and soybean tariffs lobbied for by America’s farmers — are relatively inconsequential.

China and the United States halted plans to impose the most major economic sanctions, but this is only a temporary retreat. It’s unclear if even this short one-year truce will actually hold. Trump’s capricious nature means that the agreement could be blown up over any perceived slight. Nothing in the discussions touched the fundamental tensions created by America’s attempt to retain global primacy, China’s industrial and trade policies, and conflicts over Taiwan and the South China Sea.

US-China relations remain on a dangerous path, with each side moving to insulate itself from the other. There’s nothing in the Trump-Xi summit that indicates that this downward trajectory will change. At best, we can hope that the economic war doesn’t escalate into a real one.