Lose-lose scenario for Europe from ongoing China-US negotiations

While there is no clear winner from the US-China trade tensions, the way in which the negotiations between the US and China are shaping up does not bode well for the European Union (EU). If China were finally to massively increase its imports from the US to buy back its future, it needs to substitute imports from other parts of the world, leaving missed opportunities borne by US allies, especially the European Union. Further, should China offer the concession that the US has requested in terms of banning import tariffs for some previously targeted sectors, this can only be another bad news for those sectors in Europe, except for the parts of the value chain that are produced in the US and exported to China. As such, we should expect a trade diversion away from Europe and in favour of the US.

Within this context, European exporters would find it hard to benefit from filling the gap left by either the American or Chinese exporters. As most of the benefits of a US-led trade war for Europe would have come from the Chinese market and not so much the US one due to the sectoral similarities of US and EU exports into China, the key European beneficiaries that were supposed to replace US exports: car manufacturers and aircraft producers (by substituting US exports into China in the event of higher tariffs) shift to be the losers in a quick deal between China and the US is reached.

Further, even if China were finally to accept a huge import bill from the US, it would not be free: the key objective for China to accept such bill would have to be consistent with its ultimate goal, namely, moving up the technology ladder. However, it remains clear that China’s moving up the technological ladder could still be put at risk by renewed pressure from the US. In the long run, thus, China will become increasingly aware of its economic relations with the US and more eager to become less reliant on US technology. Against this backdrop, we should not be surprised to see a new wave of government-supported mergers and acquisitions (M&A) by Chinese companies, especially on the high-tech end such as in the semiconductor sector. The easiest target continues to be Europe given the increasingly wary attitude of the US on M&A by China.

In addition, we should not forget about the second part of the US reason to start a trade war with China: better market access, which is currently restricted by the large role of the State and a heavy-handed industrial policy. If China were to follow the US towards additional reform versus a market economy and opening up to foreign competition, it would of course also be very good news for Europe as a net exporter of goods and foreign direct investment. Unfortunately, President Xi’s speech at the 40th anniversary of China’s reform and opening up on Dec. 18^th seems to indicate that China is not keen on following the US mandate. In fact, President Xi made it very clear that the policies of China would not be influenced by the West. The lack of any formal announcement of opening up could also imply that China has realised that there is limited scope for concessions in expanding its market access even under pressure from the US and the rest of the world. This should come with the realisation that the role of the State in the production of goods and services is still very large and that there seems to be little intention to reduce it. In other words, it will be unlikely for Europe to benefit from better market access.

In a nutshell, a hastily agreed trade deal between China and the US may be good to ease the negative sentiment in global financial markets. The non-market way of reaching the deal, however, will probably bring a large cost for Europe since it will probably divert European exports to China towards US ones. The underlying of China’s strategy to accept to the bill also expose Europe as the targets for M&A on high-tech end. Worse yet, without an expectation of a larger market for European exports in the absence of additional opening up by Chinese authorities, European exporters should not enjoy the ongoing China-US negotiations.