The High Costs of the New US Tariffs on Chinese EVs
Every time one set of protectionist measures against China disappoints, the United States escalates its economic war in the hope that additional restrictions will prove more effective. Yet by slapping massive tariffs on Chinese electric vehicles, America has laid bare its own hypocrisy and economic vulnerabilities.
The Dangerous Retreat into Protectionism
The latest round of US tariffs is part of an increasingly disturbing and dangerous trend. Step by step, major powers are unraveling an international economic order that delivered enormous, unprecedented gains over many decades through trade integration and globalization.
STOCKHOLM – Trade barriers, tariffs, and other protectionist tools are starting to feature more prominently around the world, often appearing under the heading of economic security. The recent decision by President Joe Biden’s administration to quadruple US tariffs on Chinese electric vehicles to 100% – as well as doubling the tariff on solar cells (to 50%) and more than tripling the tariff on lithium-ion EV batteries (to 25%) – represents a momentous new step in this direction.
Until now, US restrictions on trade with China had been justified on national-security grounds: to prevent the Chinese military from acquiring sensitive technologies. While one could debate whether this policy made sense, it at least seemed to fit into a longer-term strategy. But these latest protectionist measures have nothing to do with China’s military capabilities. Instead, they aim solely to prevent cheaper, often better, green technologies from reaching US consumers.
The connection to the US election is obvious. Biden has been trying to head off Donald Trump by playing to the same protectionist sentiments that Trump, the presumptive Republican nominee, has been stoking for years. It was Trump, after all, who put the world on a new protectionist path when he imposed sweeping tariffs on steel, aluminum, and many imports from China. Keen not to be outdone by Biden, he has already said that he would double the tariff on Chinese EVs from Mexico and apply additional ones to an even wider range of products.
Even taken in isolation, such measures are expensive and counterproductive. Tariffs impose higher costs on consumers and reduce competitive pressures, and thus innovation. In this case, they will also impede the transition to a net-zero-emissions economy. There are no economically redeeming features to the policy. Worse, the latest round of protectionist measures is part of an increasingly disturbing and dangerous trend. Step by step, major powers are unraveling an international economic order that delivered enormous gains over many decades through trade integration and globalization.
These were hard-won gains. The first great wave of globalization ended with World War I, and was followed by trade wars and deep depressions throughout the interwar period. Although trade integration resumed after World War II – facilitating the reconstruction of Western Europe and Japan – its scope remained limited. It was not until the late 1980s and early 1990s that the next great wave of globalization began, with global trade finally returning to its pre-1914 levels.
The rapid expansion of trade and investment flows over the next three decades would prove spectacularly successful across practically every macroeconomic metric. Roughly one-third of everything that has ever been produced was produced during this period, leading to the rise of a new global middle class. Poverty was dramatically reduced, and the gap between rich and poor countries started to close for the first time since the start of the Industrial Revolution.
But over the past decade or so, debates about trade have changed. The new emphasis is on economic security, “de-risking,” and supporting domestic industries through massive industrial-policy subsidies. We seem to be going backwards, raising the risk of a return to the trade wars of earlier, darker times.
The International Monetary Fund and the World Trade Organization have both published extensive studies showing that deeper economic fragmentation would reduce global GDP by 5-7%, with a disproportionately large share of the burden falling on less developed countries. These are huge figures with huge consequences. The Sustainable Development Agenda that United Nations member states champion every year will become more of a grandiose dream than a practical objective. In the absence of a growing, still-integrating global economy, most of the 17 goals will become more difficult, if not impossible, to achieve.
One can easily imagine a better, more sensible scenario in which the United States returns to defending the rules-based global economic order; China rebuilds its credibility by adhering to the rules of the game; and the European Union lives up to its ambition to be a global champion of free trade. In doing so, each would advance its own interests, as well as benefiting the rest of the world.
Yet the trend is moving in the other direction. While Biden and Trump vie to establish their protectionist bona fides, Europe, too, has started to regard Chinese EVs as a threat, rather than as an opportunity to accelerate its green transition. Add to this China’s own talk about creating a self-sufficient “dual circulation” economy, and India’s ongoing subsidies and resistance to trade, and you have the makings of a more radically fragmented global economy.
With these major powers rejecting the principles and policies that previously brought unprecedented economic gains, one must hope that policymakers everywhere will have the courage to step back and consider the bigger picture. History shows what we are risking by throwing globalization into reverse. We must not go down that path again.
Don’t Fret About Green Subsidies
Governments should stop decrying each others’ green industrial policies as norm violations or dangerous transgressions of international rules. The moral, environmental, and economic arguments all favor those who subsidize their green industries, not those who want to tax others’ production.
CAMBRIDGE – A trade war over clean technologies is brewing. The United States and the European Union, worried that Chinese subsidies threaten their green industries, have warned that they will respond with import restrictions. China, in turn, has lodged a complaint at the World Trade Organization about discriminatory provisions against its products under US President Joe Biden’s landmark climate legislation, the Inflation Reduction Act (IRA).
On a recent trip to China, US Secretary of the Treasury Janet Yellen warned China directly that the US would not stand by in the face of China’s “large-scale government support” for industries such as solar, electric vehicles, and batteries. Reminding her audience that the US steel industry had previously been decimated by Chinese subsidies, she made clear the Biden administration’s determination not to allow green industries to suffer the same fate.
China has scaled up its green industries with mind-boggling speed. It now produces nearly 80% of the world’s solar PV modules, 60% of wind turbines, and 60% of electric vehicles and batteries. In 2023 alone, its solar-power capacity grew by more than the total installed capacity in the US. These investments were driven by a variety of government policies at the national, provincial, and municipal levels, allowing Chinese firms to travel rapidly down the learning curve to dominate their respective markets.
But there is a big difference between solar PV cells, electric vehicles, and batteries, on one hand, and older industries such as steel and gas-powered cars. Green technologies are crucial in the fight against climate change, making them a global public good. The only way we can decarbonize the planet without undermining economic growth and poverty reduction is to shift to renewables and green technologies as rapidly as possible.
The case for subsidizing green industries, as China has done, is impeccable. Beyond the usual argument that new technologies provide know-how and other positive externalities, one also must account for the immeasurable costs of climate change and the huge prospective benefits of accelerating the green transition. Moreover, because the knowledge spillovers cross national borders, China’s subsidies benefit not only consumers everywhere, but also other firms along the global supply chain.
Another powerful argument follows from second-best reasoning. If the world were organized by a social planner, there would be a global carbon tax; but, of course, there is no such thing. Although a variety of regional, national, and subnational carbon-pricing schemes do exist, only a tiny share of global emissions is subject to a price that comes close to covering the true social cost of carbon.
Under these circumstances, green industrial policies are doubly beneficial – both to stimulate the necessary technological learning and to substitute for carbon pricing. Western commentators who trot out scare words like “excess capacity,” “subsidy wars,” and “China trade shock 2.0” have gotten things exactly backwards. A glut in renewables and green products is precisely what the climate doctor ordered.
China’s green industrial policies have been responsible for some of the most important wins to date against climate change. As Chinese producers expanded capacity and reaped the benefits of scale, the costs of renewable energy plummeted. In the space of a decade, prices fell by 80% for solar, 73% for offshore wind, 57% for onshore wind, and 80% for electric batteries. These gains underpin the creeping optimism in climate circles that we might just be able to keep global warming within reasonable bounds. Government incentives, private investment, and learning curves proved to be a very powerful combination indeed.
With the IRA, America already has its own version of China’s green industrial policies. The law provides hundreds of billions of dollars in subsidies to facilitate the transition to renewables and green industries. While some of the tax incentives do favor domestic producers over imports (or are available only with stringent sourcing requirements), these blemishes must be seen in the context of the political compromises needed to ensure the legislation’s passage. They may be a small price to pay for what many analysts view as a climate-policy “game changer.”
Countries have other interests besides the climate, of course. They can harbor legitimate concerns about the consequences of other countries’ green-industrial policies for jobs and innovative capacity at home. If they judge that these costs outweigh the climate and consumer benefits, they should be free to impose countervailing tariffs on imports, as trade rules already allow. It would be better for the world overall if they didn’t react that way, but nobody can or should stop them.
In fact, before globalization and the tightening of trade rules went into overdrive in the 1990s, it was not uncommon for countries to negotiate informal arrangements with exporters as a way to moderate import surges and keep exporters reasonably happy. Recall the Multifiber Arrangement for garments in the 1970s, and the voluntary export restrictions for autos and steel in the 1980s. While economists decried these schemes as protectionist, such arrangements did little damage to the world economy. They essentially acted as safety valves: by allowing pressure to escape, they helped keep the trade peace.
What governments should not do is decry green industrial policies as norm violations or dangerous transgressions of international rules. The moral, environmental, and economic arguments favor those who subsidize their green industries, not those who want to tax others’ production.
Why the US Can’t Win the Trade War With China – and Shouldn’t Try
At the heart of Sino-American trade tensions is the claim that China’s surging exports are a result of Chinese subsidies. But the driving force behind this glut of cheap goods is a significantly undervalued renminbi, a result of high capital outflows caused by both domestic policies and US restrictions on investment in China.
BEIJING – Allegations about China’s manufacturing overcapacity have sparked heated discussions among policymakers. During her visit to China in April, US Treasury Secretary Janet L. Yellen argued that “when the global market is flooded by artificially cheap Chinese products, the viability of American and other foreign firms is put into question,” adding that it was the same story a decade ago.
Yellen is partly correct: the Sino-American trade war has strengthened, not weakened, China’s export competitiveness. In 2023, China accounted for about 14% of total global exports, up 1.3 percentage points from 2017 (before the conflict began). More striking still, China’s trade surplus was around $823 billion in 2023, nearly double what it was in 2017.
Over a decade ago, China’s trade surplus was largely the result of an undervalued renminbi (RMB). Today’s circumstances are somewhat similar. My research shows that in 2023, the RMB was 16% undervalued against the dollar, contributing to China’s high exports and trade surplus.
I reached this conclusion because the inflation rate in the United States over the past two years has been ten percentage points higher than in China. According to purchasing-power-parity calculations, the RMB should have appreciated by 10% against the dollar; instead, it depreciated by 11%. From this perspective, the RMB was 21% undervalued against the dollar.
Of course, short-term exchange rates are influenced more by the interest-rate differential than by the inflation rate. I therefore used econometric methods, incorporating factors such as the interest-rate spread and economic growth, to estimate what the RMB exchange rate should be.
My comparative studies found that the extent of RMB undervaluation has been much greater than that of major ASEAN currencies over the past two years. Compared to the last round of US Federal Reserve rate hikes during 2015 to 2018, the extent of the RMB’s undervaluation in recent years has also significantly increased.
Strangely, there is no evidence that the Chinese government is targeting the exchange rate. Even the US agrees that China has not acted as a currency manipulator in recent years. In this respect, the situation today is very different from a decade ago, as China has made significant progress in reforming its exchange-rate system in the intervening period. As a result, the volatility of the RMB exchange rate has become more pronounced.
This raises the question of why the RMB is still undervalued. Looking at the balance of payments in 2020 and 2021, the cumulative net inflow of capital from direct and securities investments exceeded $400 billion, whereas in 2022 and 2023, the cumulative net outflow from the capital and financial account exceeded $500 billion. China’s enormous current-account surplus has not led to RMB appreciation – as one might expect – because of these high capital outflows. This makes exchange-rate changes ineffective in adjusting the trade balance.
Such capital outflows cannot be attributed solely to the changes in the interest-rate spread between China and the US. In fact, the capital outflow is mainly a result of non-economic factors, including some of China’s own policies such as its clampdown on certain industries. Recognizing this, the Chinese government began to incorporate non-economic policies into its self-assessment framework late last year.
More importantly, the recent escalation of Sino-American tensions has led the US to adopt a series of policies that discourage investment in China. This includes limiting venture-capital flows into China and exaggerating the risks of traveling there. The US Congress is also considering legislation that would further restrict American investment in China. Together, these factors have exacerbated capital outflows, thereby amplifying the degree of RMB undervaluation and further undermining the effect that exchange-rate adjustments would typically have on the trade balance.
As long as Sino-American relations continue to be rocky, the RMB exchange rate will most likely remain significantly undervalued, and Yellen’s complaints will become ever more difficult to resolve. Of course, the political factors distorting the exchange rate will also slow the development of China’s services sector, and thus hinder its structural-adjustment efforts.
Given all this, the solution seems clear. In the interest of both sides, China must develop a consistent mechanism for assessing the impact of its non-economic measures, and the US must ease its restrictive policies.
The Sino-American Trade War Benefits China’s Competitors
China is widely expected to retaliate against the latest US tariffs on its exports. While this could trigger a full-scale trade war and possibly a broader geopolitical conflict, India and other countries stand to expand their foothold in Western markets as Chinese manufacturers weaken.
WASHINGTON, DC – US President Joe Biden and his predecessor Donald Trump, the presumptive Republican nominee in November’s presidential election, are competing to portray themselves as tough on trade and China. Biden has already imposed a 100% tariff on Chinese-made electric vehicles, and Trump has vowed to impose a 200% tariff on Chinese cars manufactured in Mexico, along with a range of other protectionist measures affecting steel, solar panels, semiconductors, and batteries. The European Union is likely to follow suit, albeit more cautiously.
Under President Xi Jinping, China is widely expected to respond with tit-for-tat tariffs rather than turn the other cheek, thus increasing the likelihood of a trade war that could significantly impede the green-energy transition and potentially lead to a broader geopolitical conflict.
What is often missing from the debate about the escalating rivalry between the United States and China is the perspective of other countries, especially larger developing economies. After all, these tariffs are not just protectionist but also discriminatory. If there is any truth to the joke that China is the only country in history with a comparative advantage in every industry, then targeting the world’s most efficient exporter and supplier with protectionist measures could create lucrative opportunities for its competitors.
In analyzing these developments, it is instructive to consider the free-trade agreements of the postwar period. These FTAs were a mirror image of today’s discriminatory measures: while they reduced tariffs on imports from partner countries, effectively diverting trade away from third-country suppliers, today’s tariffs are being imposed on imports from perceived adversaries like China, redirecting economic activity toward third-country suppliers considered allies.
The Biden administration’s China trade policy, which US National Security Adviser Jake Sullivan likened to “a small yard and a high fence” in 2023, could further weaken Chinese manufacturing. In fact, the higher the tariffs, the greater the competitive advantage third-country suppliers will gain over Chinese firms, particularly in large markets like the US and Europe.
To be sure, these gains will depend on the extent of US protectionism. If Sullivan’s “small yard” grows larger, with US tariffs imposed not only on imported goods from China but also on goods from third countries that either use components produced in China or by Chinese firms located in these countries – the benefits to these third-country suppliers will be reduced. In the language of FTAs, rules of origin can be so restrictive on Chinese inputs that third countries gain less than they would otherwise.
In the first wave of discriminatory protectionism unleashed by Trump, the scope of protectionism was limited to direct imports from China. As a result, as documented by Aaditya Mattoo and others at the World Bank, third countries like Vietnam benefited significantly. This time, given bipartisan support in Washington for anti-China legislation, the scenario of a growing yard cannot be ruled out.
Broadly speaking, the countries affected by Western protectionism can be divided into two groups: those integrated into the Chinese supply chain, such as Vietnam, Thailand, Indonesia, Malaysia, and South Korea, and those less dependent on it, like Mexico, India, Turkey, Brazil, Poland, and Hungary. The second group stands to gain more from US trade policies.
India offers a prime example. It has successfully attracted several Western firms exiting China since launching its “China Plus One” strategy in 2014. Notably, Apple has significantly expanded its iPhone manufacturing operations in India, and Tesla reportedly may follow suit. This shift presents India with an opportunity to revitalize its consistently underperforming manufacturing sector. To this end, the government is offering subsidies to attract foreign investment and offset disadvantages such as relatively poor infrastructure.
By increasing the returns on investing in India, current US trade policy could complement its own industrial policy. If India can establish a supply chain that is largely independent of China – a trend that is slowly underway in the electronics sector – it could gain a competitive advantage over China and countries linked to it.
Solar panels are a case in point. I recently visited an American-owned factory just outside of Chennai that produces solar panels for export to the US. This operation owes its success to Trump’s tariffs on imported solar panels from China, which the Biden administration has maintained. Without these measures, Chinese manufacturers’ efficiency and scale – helped by massive government subsidies – would have rendered India an unattractive investment destination. But India was able to seize the opportunity and increase its solar-panel exports.
More broadly, the greater the overlap between America’s strategic interests and third countries’ capabilities and comparative advantages, the more likely that discriminatory protectionism will be long-lasting and provide certainty to investors seeking to diversify away from a ruthlessly efficient China. In pharmaceuticals, for example, India has the capability to step in if the US decides to impose tariffs on Chinese drug manufacturers, which dominate the global production and export of active pharmaceutical ingredients.
But China’s competitors should curb their enthusiasm. Discriminatory protectionism is currently confined to relatively sophisticated industries and is unlikely to extend to labor-intensive sectors like apparel and footwear, where poorer countries have a stronger comparative advantage.
More importantly, US and EU discriminatory protectionism is beneficial only in moderation. Should today’s trade war escalate into a full-scale geopolitical conflict, any potential advantages would be negated by a broader economic downturn and increased uncertainty, which could have a chilling effect on global trade and investment. In this scenario, everyone would lose.
NEW HAVEN – President Joe Biden’s administration has just announced 100% tariffs on electric vehicles (EVs) manufactured in China, prompting Donald Trump to promise a 200% tariff on Chinese cars made in Mexico if he is elected in November. Neither policy would have notable effects on the US car market, because imports of Chinese EVs are miniscule, owing to past tariffs and the anti-Chinese sentiment that has gripped the country in recent years. Nonetheless, the announcement is significant for three reasons.
First, the latest tariffs – which include steep increases for several other products, ranging from semiconductors to needles and syringes – are the final nail in the coffin of US-China trade cooperation. Denials of a complete decoupling can be put to rest. Gone is any pretense that America is merely erecting a “high fence” around a “small yard,” or trying to manage national-security risks without endangering bilateral economic cooperation. The United States and China are now in a full-blown economic war – one that will have far-reaching geopolitical consequences.
Second, the tariffs signal defeat. Trailing in the polls as this year’s election approaches, Biden and his team feel obliged to join the anti-China, anti-trade fervor that has emerged as one of the very few unifying issues in a polarized country. Moreover, the tariffs, combined with US complaints that China is producing too much and putting pressure on the global economic system, speak to a deep-seated anxiety about America’s international competitiveness.
These worries come despite earlier tariffs, export restrictions, and the aggressive industrial policy being pursued through the CHIPS and Science Act and the Inflation Reduction Act (IRA). By escalating the trade war, the administration is effectively admitting that these previous policies have not (yet) delivered, and that China is galloping ahead despite facing headwinds. Even if the tariffs are largely symbolic, they are a symbol of weakness.
Third, and perhaps most importantly, EV tariffs seriously undermine the broader climate-change agenda. Experts agree that time is of the essence in reducing greenhouse-gas (GHG) emissions. With every passing year of inaction, the costs of climate change increase, bringing us closer to dangerous planetary tipping points. Absent carbon pricing, which has proven politically infeasible in the US, the decarbonization of transportation has long been a worthwhile second-best alternative.
China is by far the most price-competitive EV producer, owing to aggressive consumer subsidies that started in 2010, big investments in charging infrastructure, and domestic content requirements that favor batteries from Chinese producers. With these policies, China has been able to benefit from network externalities and learning-by-doing.
Several provisions of the IRA and the European Green Deal – including domestic content requirements – aim to emulate China’s success. But the US and Europe start with a big cost disadvantage relative to China; and while one can debate whether China’s past use of domestic content requirements was “fair,” the fact remains that its EV industry is more competitive (especially in the lower-priced segment of the market).
Since we cannot rewrite history, we should try to take advantage of the circumstances that history has created. From a climate perspective, availing ourselves of cheaply produced Chinese EVs would have been a step in the right direction. But now, tariffs will delay EV adoption and could imperil the entire EV market. In the best-case scenario, US and European producers will catch up, but only after many years. In the worst-case scenario, US consumers will simply give up on EVs, repelled by the higher costs associated with manufacturing them in Western countries.
Apart from the direct consequences for GHG emissions, tariffs on EVs also expose the hypocrisy of some climate-change advocates, further undermining the cause. The Biden administration is saying that climate policies are fine if they promote the interests of domestic workers in advanced economies, but not if they happen to benefit China. Many in the West may consider this calculation acceptable. But it will be much harder to pressure less affluent countries, such as India, to adopt green policies that may be costly in the short run. If the US and Europe are not willing to put the environment ahead of their short-term economic interests, why should anyone else?
It should be obvious by now that recent efforts to promote domestic economic interests through trade protection have failed to produce the desired results. Yet every time one set of measures disappoints, the US escalates the conflict in the hope that additional restrictions will prove more effective. In the process, it undermines the very causes it stands for (in this case, addressing climate change).
The best way to stay ahead of rivals is not to trip them; it is to run faster by concentrating on what one does best. For the US, that means promoting research and development, stimulating the creation and exchange of new ideas, encouraging innovation, and taking advantage of international talent. America should focus on creating the next Tesla, not on costly, futile efforts to outcompete low-cost rivals.