Question

Assume that growing levels of Chinese debt, a trade war with the U.S., and uncertainties surrounding the COVID-19 virus are lowering MPK in China. What will be the effect on Chinese domestic investment, I? For each of the following two cases, derive the expected effects on Chinese and US interest rates, saving, investment, and net exports:.

a) Include graph explaining as China is a small open economy

b) Include graph explaining the world consists of 2 large economies: China and US

Answer 1

the latest tariff hikes are just a small manifestation of wider trade and investment frictions. While the direct hit from higher U.S. levies is unlikely to jeopardize China's outlook for the next year or so, the effects on household and business confidence are a wildcard that may amplify the short-term hit, with more profound risks lurking elsewhere. In particular, together with other manifestations of friction—including investment and export restrictions—the risks of disruptions to China's supply chains in the medium term are rising, particularly in technology sectors.

China's value-added share of exports to the U.S, which nets out parts that China imports from other countries, is about 90%. China's retaliatory tariff increases are unlikely to change this picture, given that they affect only $60 billion of imports from the U.S.

The short-term effect on China's economy may be amplified if higher tariffs weaken confidence and reduce spending by firms and households. Softer household spending growth in recent quarters has turned the focus on the consumer, but we think the impact on firms' investment plans are more important. Expected future returns on capital are likely to be highly sensitive to not only the level of tariffs but also the lingering uncertainty surrounding trade policies.

Manufacturing investment should be a key focus. Manufacturing investment growth, particularly in sectors exposed to tariffs—including electrical machinery and computer equipment—had a weak start this year (see chart 2). Investment in the electrical machinery sector for the year to April is now falling compared to the same period last year—the first time this has ever happened since at least 2004. Lower investment would mean a larger short-term demand hit to the economy, with manufacturing accounting for about 30% of total fixed-asset investment and more than 20% of China's GDP.

The implications of weaker manufacturing investment are serious, but expect a hard landing for capital spending, unless financial conditions also tightened substantially.

The trade war threatens to reverse these decades old trends and put downward pressure on Chinese economic growth.

TRADE EFFECTS 2018-2019

Changes in Imports

the impact of the tariff measures taken by the US and China so far on trade between the two countries.In order to analyze the role of the tariff increases in the decrease of imports and to determine the importance of anticipation effects, we look at the development of total imports between the US and China over time for different categories of products in greater detail.

Trade Diversion

The reduction in trade between the United States and China has led to trade diversion: more trade with third countries. The analysis in this subsection aims at identifying which countries have benefitted the most from the trade tensions in terms of increased exports to the United States and China and which sectors were primarily concerned by trade diversion effects.

The impacts of COVID-19 could cause further problems for the already suffering Chinese economy. Fazed by the tremendous pressure from the outbreak, it is very likely that China will soon direct its future development strategies and priorities toward improving its domestic economy instead of pursuing outbound investment. Consequently, this also means that the country’s plan of “going out” into the international economic and geopolitical scene would have to be put on hold for the time being.

Even prior to the outbreak, China’s outbound investment had already slowed down as a result of international trade frictions, particularly the U.S.-China trade war. Despite having reached the first phase of a trade deal with the United States, China’s attempts to retain its foreign investors have not eased up the slightest bit, and the U.S. government’s increasingly stringent scrutiny and restrictions on Chinese investments have hurt China’s overseas investments. As a result, China’s outbound investment had already begun to show a gradual decrease back in 2019.

On a regional level, China’s outbound investment have shown very obvious changes too. According to Ernst & Young’s data, Asia has risen to become China’s largest overseas M&A destination, accounting for nearly 30 percent of total investment. Meanwhile, Chinese companies’ M&A in other continents have declined to varying degrees, particularly in Europe and North America, where M&A fell by nearly 60 percent and 30 percent, respectively, reaching the lowest levels since 2014 and 2012