An International Trade Commission hearing got underway this week as part of the Trump administration’s probe into China’s intellectual property practices under Section 301 of the 1974 Trade Act. The action gives the president broad authority to impose tariffs on foreign goods – and could hold dire consequences for US cotton producers.
In mid-August, the Trump administration initiated a ‘Section 301’ investigation “to determine whether acts, policies, and practices of the Government of China related to technology transfer, intellectual property, and innovation are unreasonable or discriminatory and burden or restrict US commerce.”
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Sounds wonkish, but, believe it or not, this action could hold dire consequences for US cotton producers. Huh? Let me explain.
Trump has brushed off a provision of an old trade law still on the books allowing the US government to initiate unilateral investigations into perceived unfair business practices – in this case, absconding with intellectual property.
Although still technically part of US regulations, Section 301 has remained mostly dormant since the advent of the World Trade Organization (WTO). Previous administrations deferred to WTO rules to address trade disputes. By initiating a Section 301 investigation, the Trump administration suspects policies maintained by the Chinese government encourage the stealing of American company patents, copying proprietary designs, and violating copyright rules.
Strong stuff. The US action is onerous but it is fraught with problems – not least of which is the potential for China to retaliate if the investigation uncovers evidence of intellectual property theft and if the US as a consequence were to impose punitive tariffs or other penalties on Chinese products.
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By GlobalDataAlthough the investigation will take months to unfurl, the short-term implications are political. Trump ran for president on a protectionist trade platform and singled out China for “unfair” trade policies. Moreover, Trump is also pressuring China to lean on North Korea to temper its missile programmes and aggressiveness in the region. Section 301 only adds pressure to US-China relations as Trump looks to leverage China to meet his political objectives.
Possible retaliation?
Geopolitical concerns aside, the Section 301 action opens the possibility for China to retaliate if the investigation was to find proof of Chinese trade abuses.
If so, how? A possible tact for Chinese officials would be to impose retaliatory tariffs on US exports to China. Indeed, if the US was to find trade violations under Section 301, the Chinese would want to send a pointed message to the US government in response. Any form of tariff retaliation by China would aim to make a strong political point while also inflicting some degree of economic pain on affected US export sectors.
So, which products are vulnerable?
To help answer that question, let’s first take a look at what the US exports to China. The following table shows US exports of the top-20 products to China for the year-to-date June 2017. Of the top-20 products shipped from the US to China, the first two are airplanes and autos. After that, the US exports soybeans, various kinds of equipment and raw materials. Cotton is 18th on the list of top-20 products shipped to China.
For the top two exports, planes and cars, it is hard to see China retaliating on those as the Chinese economy is still partially reliant upon the importation of those products. Moving down the list, it’s also difficult to envision China retaliating on foodstuffs, like soybeans, as food products tend to be high-priority items for the Chinese government – although countering the US on soybeans would be both politically and economically dramatic, so it can’t be ruled out.
Regarding the remaining products on the top-20 list, the Chinese could choose to retaliate on medical and chemical equipment exports, but it’s hard to see them caring much about raw materials such as wood pulp and waste paper as the political effectiveness of retaliation on those products may be marginal. And, of course, China could opt to retaliate on products imported from the US not on the top-20 list.
The point is: should the US claim that Chinese companies somehow stole or copied American technology and patents, the Chinese government will feel obligated to respond in some manner, whether through tariffs or other means.
Hitting cotton
Regardless of the product, it is likely that China will want to make a statement, but not provoke an all-out trade war; they would leave that to the Trump administration.
When considering possible trade retaliation, Chinese officials will undoubtedly look for a product or products significant to the American economy and readily understood by the American electorate.
Wood pulp? It’s hard for an American voter to get too worked up over that. But for cotton, the average American voter knows what cotton is – and its importance to vast portions of the American South, a region that voted strongly for Trump during the presidential election. Chinese retaliation on cotton wouldn’t be lost on Trump administration politicos, as any such action would be designed to split the president from key constituencies in the South.
Some may say that retaliating on cotton will only harm China’s textile industry and close off a major supplier of quality cotton. For sure, such an action would create problems for the local industry, but there are alternatives – Australia and India, for example.
From a broader perspective, there are a few other factors to consider. First, China still has an ample supply of previously purchased cotton in its national warehouses. Second, demand for cotton has been weak over the past few years and has only recently shown signs of renewed interest from mills. And, third, there’s a growing supply of cotton available in the global market.
Concerning the last point, recent statistics published by the International Cotton Advisory Committee (ICAC) suggest that the available supply of cotton on world markets is growing, which in turn has helped to depress cotton prices. Of course, the impact of Hurricane Harvey on Texas cotton growers is only now being realised, but prices may go back up in light of a washed-out crop in southern parts of the state – yet there’s a growing amount of cotton available in world markets.
A workaround
Despite a growing world supply, this brings up a fundamental aspect of China’s current usage of cotton: China is not obligated to import more than 894,000 tons of cotton from the world each year. It’s part of the agreement that granted China membership in the WTO.
The government may increase the quotas as market conditions dictate, but there are years when the government doesn’t raise the import cap. And for many Chinese textile mills, hassling with vagaries of the Chinese cotton quota, it is much easier just to import cotton yarn from other countries. Moreover, many mills prefer to source yarn from outside of China as often prices and quality are better than found from domestic spinners. Let’s take a look at the data.
Imports of cotton yarn have eased off over the past couple of years in line with weaker production in China’s textile industry.
However, Vietnam jumps out as the largest supplier of yarn to China, as many Chinese mills have opened plants in Vietnam often with the aim of explicitly supplying yarn to domestic weaving and knitting operations. Although dramatic in and of itself, the growth of Vietnam takes on new significance when we consider that Vietnam is now the largest buyer of US cotton, according to US export statistics:
There’s little doubt that much of the US cotton finding its way to Vietnam ends up to China, only in the form of yarn. In effect, this is an efficient – and legal – way of not only bypassing China’s raw cotton import quota but also ensuring a consistent supply of new, high-quality cotton in the Chinese market, only in the form of yarn.
Political and economic impact
If China were to retaliate against US cotton exports, the action would carry a significant economic impact, walloping US farmers, but also harming overall US textile export performance. For example, if we plot the value of raw cotton exports against the value of all textile products shipped to China, it’s clear that China is importing more cotton this year than the previous few years when the overhang created by the large cotton warehouse reserves put a damper on new purchases.
Even so, when considering the overall US export profile of textile-related products to China, cotton jumps out as a major product – and so far this year has helped to push US textile-related exports higher after several years of weaker sales to China.
Could such an action precipitate a trade war? Perhaps, but remember that the US has already started down that path by initiating a Section 301 investigation in the first place. Economically, retaliatory tariffs on raw cotton would harm US growers for sure, although not as badly as could have been the case a few years ago when China was importing so much more cotton. Nevertheless, it would hurt.
Politically, that’s another matter. Many of the cotton-producing states voted for Trump during the election. A cotton tariff could put many of the voters in those states at odds with the president, driving an economic wedge between the president’s trade policies and many of his supporters. Whether such a wedge would hit deeply enough with voters in those states is tough to say, but it would send a strong message from China: Section 301 is unacceptable.
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