Tariffs: A trade tool that’s losing its mojo

The recent victory of President-elect Trump has once again brought the tariff debate to front and center. Trump continues to talk about tariffs as the “go-to” tool for balancing our trading relationships, halting the “cheating” by our trading partners, bringing U.S. manufacturing home, and raising revenue to support other tax cuts.

Of the wide array of tariff proposals floated by Trump, his initiative to impose at least an additional 60 percentage points of duties on imports from China is one of the most severe. Even before recent Biden selective tariff hikes, the U.S. average tariff rate with China was close to 20 percent, having increased significantly during his first term.

An additional 60 percentage point increase would bring many of these rates to the “prohibitive zone,” essentially stopping trade. Some speculate this may be a way for Trump to gain leverage to negotiate a new bilateral trade deal with China. But, in many ways this time around it seems to be more about disentangling our two economies rather than getting to a deal.

What’s lost in the debate, is the effectiveness of such tariff increases, particularly at a time when Chinese investments in third countries are growing by leaps and bounds. For example, Chinese investment in ASEAN countries has surged from less than $4 billion in 2010 to $17 billion in 2023.

As Chinese companies set up more factories abroad in the automotive, clean energy and electronics sectors, the goods produced by these firms in third countries would not be subject to Trump’s 60 percentage point tariff increase. Rather, these goods under current international trade rules would receive the tariff treatment of the country hosting the investment and exporting the good to the U.S., provided specific product origin requirements are met.

An important consideration driving Chinese companies to move their operations out of China is the avoidance of U.S. tariffs. But, other forces are at play, including closer proximity to consumers in third countries and pressures from weak domestic demand, as well as strengthening economic ties with partners around the world. The latter is particularly critical as we see more of a bifurcation of the global economy along China/U.S. lines.

U.S. policymakers have taken certain steps to address concerns about this trend, particularly aimed at those Chinese investments intended to produce goods for export to the United States. After a respite of two years, the U.S. is now applying duties on solar imports from four Southeast Asian countries where Chinese companies have invested largely for tariff circumvention reasons.

The U.S. and Mexico have recently strengthened the United States-Mexico-Canada agreement rule of origin requirement for Mexican steel exports to the U.S. to further curtail Chinese exports from our southern neighbor. With respect to vehicles, the U.S. is finalizing a “connected car” rule based on national security concerns which would go a long way in banning the import of Chinese electric vehicles into the U.S., regardless of where they are produced.

Each of these efforts is notable, but all are rather ad-hoc and reactive in nature. The U.S. should develop a more strategic response, making it clear that Washington’s focus is not on all Chinese imports from third countries, but rather on those goods that are either unfairly traded, circumvent U.S. laws and regulations or create national security concerns.

As part of this response, for example, Washington should consider strengthening the anticircumvention provisions in our antidumping and countervailing duty statutes, taking into account recent steps taken by the European Union to do the same.

Second, priority should be given to strengthening the rules of origin in our existing trade agreements to incentivize more partner content and minimize Chinese content. Moreover, the U.S. should share with partners its concrete concerns with specific Chinese investments at an early stage, while helping them set up appropriate and effective investment screening processes.

Most likely, U.S. policymakers will be tempted to consider an outright ban on strategic imports from any Chinese company, regardless of the content of the product or the location of their operations. On the surface, this might look like an appealing path forward that would supplement other economic security policies. However, this option would create four key challenges.

The first challenge would be developing an airtight definition of what constitutes “a Chinese company,” that captures the intended targets and avoids unintended consequences for companies — including American companies — operating overseas, and crucially can be administered by U.S. customs authorities.

Majority ownership could be a starting point, but matters surrounding control, including by the Chinese government, would also need to be considered. Intensive monitoring activities would be important to detect circumvention efforts in real time.

Second, banning imports based on the nationality of the supplier — namely Chinese — versus the product’s origin would not be welcomed by many third-country governments vying to attract Chinese investment to help spur economic growth, develop much-needed infrastructure, promote domestic innovation and create jobs.

For example, Mexico has already publicly announced its opposition to the U.S. proposed connected car rule as an unfair attempt to curb what they consider to be potential Mexican exports. Affected countries could respond with their own retaliation and even more worrisome, be driven closer to China if forced to make a choice. Preserving existing access to the U.S. market alone may simply not be enticement enough.

Third, China may choose to mirror any U.S. restriction, potentially denying certain U.S. companies access to its large and innovative market.

Finally, such a proposal would upend a core multilateral trading system principle — that origin should be considered based on the content of the product, not on the nationality of the supplier. While the U.S. may give little weight to these concerns, our partners will use this another data point to show that the U.S. is determined to bring down the World Trade Organization rule-based trading system or as a license to breach the rules themselves.

Tariffs, if used judiciously, may help achieve certain policy goals, but in many respects, they are becoming yesterday’s tool. As trade and investment patterns continue to evolve, it’s important for Washington to stay ahead of the curve and develop innovative approaches to address new twists, turns and trends.

Wendy Cutler is vice president of the Asia Society Policy Institute.