When Donald Trump first ran for president, he made decreasing the trade deficit and fighting back against China key components of his platform.
So, it was no real surprise when, a year into his presidency, he followed through on campaign promises to impose tariffs on China, sparking what would become a multi-year trade war. After two years of tit-for-tat tariffs, negotiations between the two countries produced the Phase One trade deal in January last year. The agreement, though it included a promise on China’s part to purchase $200 billion worth of U.S. goods and services, left in place 25 percent tariffs on $250 billion in Chinese imports, including apparel and footwear.
The future of the trade relationship between the dual superpowers is unclear. As president-elect, Joe Biden said he wouldn’t remove the tariffs he inherited from Trump right away, but instead promised to conduct a full review of the Phase One deal. In March, his administration delivered to Congress its 2021 Trade Agenda, a document that identifies “addressing China’s coercive and unfair economic trade practices” as a key policy agenda and commits to “using all available tools to take on the range of China’s unfair trade practices.”
As economists and historians parse out the exact consequences of the U.S.-China trade war, one of the central points of debate will almost certainly be the extent to which Trump succeeded or failed in narrowing the country’s trade deficits. According to a report released by the U.S.-China Business Council earlier this year, data suggested the deficit decreased between the U.S. and China in 2019, but increased with the rest of the world at the same time, leaving the overall trade deficit broadly unchanged.
According to recent analysis from two Federal Reserve economists, however, even the degree to which the trade deficit with China decreased may be greatly exaggerated.
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The report, written by Hunter Clark, an assistant vice president at the Federal Reserve Bank of New York, and Anna Wong, a principal economist at the Federal Reserve Board, analyzes an unusual discrepancy between the trade deficits suggested by the two countries’ data.
Historically, the U.S.-reported bilateral goods trade deficit has been about $95 billion larger than that reported by Chinese counterparts, they said. In 2019—months after the trade war began in 2018—that gap suddenly narrowed and in 2020 it reversed. According to Clark and Wong’s analysis, this development primarily reflected a sudden divergence between U.S. imports from China as reported by the U.S. Census Bureau and China exports to the U.S. as reported by China Customs.
Where the U.S. Census Bureau’s data showed exports falling sharply in 2018 and 2019, its Chinese counterpart reported a more subdued decline. Then, when numbers rebounded in 2020, China Customs’ data reported a much stronger upswing—one that led its numbers to overtake those reported by the U.S. “for the first time ever,” according to the two Federal Reserve economists.
They offered two “likely” explanations for this mismatch: U.S. importers underreported shipments from Chinese in an effort to evade U.S. tariffs and Chinese exporters reported higher exports due to changes in tax incentives in China.
Ultimately, the report concludes misreporting by U.S. importers explained the majority of the sudden discrepancy. Comparing 2017 to 2020, they found an $88 billion decrease in the gap that traditionally exists between U.S.-reported imports from China and China’s reported exports to the U.S.
Of that number, Clark and Wong calculated $55 billion was due to U.S. importers evading U.S. tariffs.
They also determined $12 billion was due to either overreporting or a decrease in underreporting by Chinese exporters. Policy changes made by the Chinese government, the report explains, lowered gross value-added tax (VAT) rates and increased export VAT rebates between 2017 and 2020. As a result, the average net VAT rate—unlike many countries, China does not fully rebate VATs on exports, meaning the gross VAT tax rate minus the VAT export rebate comes out to what is effectively an export tax—fell from close to 7 percent at the end of 2017 to around 2.5 percent in 2020.
Beyond this overall average rate, the percentage of export products facing zero net VAT rates grew from 5 percent of all goods in 2017 to roughly 50 percent in 2020. Given this change, Chinese exporters suddenly had less of an incentive to underreport to avoid VATs, something Clark and Wong calculated had a $12 billion impact on the Chinese exports reported by China Customs.
Factoring in their calculations for misreporting, the two economists found the gap between U.S. imports reported by the U.S. Census Bureau and Chinese exports reported by China Customs returned much closer to its historical level.
When factoring these adjusted numbers back into the trade deficits reported by the U.S. and China, the narrative of the trade war changes. Whereas the U.S. Census Bureau’s data indicate the trade deficit between the two countries returned to a level in 2020 not seen since the middle of former President Barack Obama’s administration, Clark and Wong’s calculations indicate the deficit decreased from 2018 to 2020, but only to a level slightly better than 2017 and still above 2016.
Though the debate over whether Trump’s tariffs worked or not will almost certainly continue, American manufacturers are still dealing with the consequences of the tariffs that continue to this day.
Ohio-based bedding maker Downlite is one such company. Due to continuing tariffs on one of its key raw materials, the company said it has been placed at a disadvantage compared to Chinese competitors, which don’t face tariffs on their finished products. “This unintended consequence,” Downlite argued, gives China-made finished goods “a clear cost advantage” over American-made products.
“It’s basically just helping the Chinese right now while hurting U.S. manufacturing,” Josh Werthaiser, president of Downlite’s feather and down division, said in a statement.