Will 2017 usher in a trade war between the world’s two largest economies?

The United States and China are on an economic collision course. Years of accusations of trade agreement violations and perceived unfair practices have chilled a once hopeful alliance. President Donald Trump has targeted this unfair treatment as one of the primary threats to the U.S. economy. In achieving his campaign promise to “Make America Great Again,” he has outlined an aggressive strategy to strengthen the United States’ negotiating position with China.

China joined the modern global trade regime in 2001, when then President Bill Clinton supported its membership to the World Trade Organization as a non-market economy, an important distinction for the coming trade battles between them and the rest of the world. Later, President George W. Bush granted China Permanent Normal Trading Relations (PNTR), which further legitimized their role.

China has been undergoing a tremendous economic transformation. It’s transitioning away from its role as a low-cost, low value-added manufacturing country into a global economic behemoth. The centerpiece of this reform is the China 2025 initiative, which is a multifaceted approach to cultivate new industries and to make China the foremost engineering and manufacturing country in the world. China is also leading the Regional Comprehensive Economic Partnership (RCEP), which is replacing the Trans-Pacific Partnership (TPP) as the primary Asia free trade agreement.

The future of Sino-U.S. relations remains completely unpredictable. President Trump’s policy proposals and cabinet choices portend potentially significant economic and military challenges between the world’s two largest economies. This could create serious uncertainty and disruption in global supply chains and force companies and sectors – including the promo products industry – to reconsider how they source even basic materials.

China’s Economic Uncertainty
China’s current economic position remains unstable, but improving. After a challenging period in 2015 and 2016, key economic indicators have ticked higher. The China Caixin PMI, which is an important indicator measuring the health of the manufacturing sector, rose to 51.9 in December, which is its highest level since 2013. And while manufacturing output has declined, China did achieve 6.7% GDP growth in 2016.

China also continues to be the dominant global trading partner. According to recent trade data, China is the largest trading partner for 124 different countries. Meanwhile the United States is the largest with only 56 countries. Despite its dominance, Chinese exports declined 7.7% in 2016, its worst annual change since the global economic crisis in 2009. The primary cause for this decline is its eroding competitiveness with low-wage countries. And China does not expect its trade to recover in 2017.

These indicators are part of a tectonic shift in China’s economy. Built up on its reputation for low-cost labor, China has experienced rising costs, which is forcing labor-intensive industries to move to Vietnam, Cambodia, India, Malaysia and East Africa. In fact, according to the World Bank’s report “Stitches to Riches,” this shift in manufacturing capacity is expected to create more than 1.5 million jobs in the textile and apparel sectors alone.

China is responding with an ambitious initiative: China 2025. This plan is the first step in achieving its ultimate goal of being the world’s dominant economy in 2049, which is a symbolically important date 100 years after the founding of the People’s Republic of China. Through targeted state policies, the plan will cultivate sectors such as green energy, robotics, and medical devices.

Is RCEP the New TPP?
Trump signed an executive order on January 23, 2017, formally ending the United States’ participation in the TPP. “We’ve been talking about it for a long time. Great thing for the American worker,” he said as he held up one of his first orders as president. After almost 10 years of negotiations between 12 Pacific countries covering everything from tariffs, the environment and labor rights, the TPP became politically toxic as both Democrats and Republicans joined forces to oppose the monumental trade agreement. In addition to excluding China, it allowed the U.S. and its allies to write the rules for the next generation of high-quality, multilateral trade agreements.

With the United States formally exited from the TPP, the RCEP has ascended as the dominant regional agreement. Led by China, the agreement includes the 10 ASEAN countries, Australia, India, Japan, New Zealand and South Korea. Two other TPP countries, Peru and Chile, have also expressed considerable interest in joining negotiations following the decline of the alternative. And the TPP could even continue with China as a partner. Australian Prime Minister Malcolm Turnbull said “there is also the opportunity for the TPP to proceed without the United States. Certainly there is the potential for China to join the TPP.”

While the long-term effects of the fall of the TPP and the rise of the RCEP are unknown, it does weaken the United States’ position and economic goals. It endows China with considerable power to control trade in the world’s fastest growing region, which ultimately runs contrary to Trump’s ambitions to strengthen the USA’s negotiating position against China. And by excluding the United States, it prevents U.S.-based companies from accessing this region with a preferential trade status. Ultimately, many analysts believe this shift from the TPP to the RCEP will have a negative impact on the U.S. economy.

Complaints Against China
China has been the target of complaints by governments and companies since joining the WTO. China supports and promotes national champions and its state-owned enterprises (SOEs). Central planners have supported sectors such as steel, aluminum, manufacturing, raw materials, and banking with preferential loans, favorable policies, and subsidized inputs. As a result, the U.S. Department of Commerce has continued to hit China with antidumping and countervailing duties on goods like steel in response.

There have also been complaints that Chinese enforcement agencies and authorities discriminate against foreign companies operating in China. Faced with everything from forced technology transfers and local content requirements, foreign companies continue to deal with considerable obstacles if they seek to do business in China. While disparate treatment has been common, the forced re-merger of several large manufacturing companies to create global champions accentuates China’s favoritism of domestic firms in applying regulations like the antimonopoly laws.

Additionally, China continues to face criticism for its intervention in the currency market. In August 2015, China engaged in a significant intervention to devalue the RMB, which inspired strong rebukes from Congress. However, President Obama and the U.S. Treasury did not respond with any retaliatory measures. In fact, the U.S. Trade Representative refused to include currency manipulation in any of its negotiations, deferring to Congress and the U.S. Treasury to enact and enforce manipulation bans.

There are several broader political and geopolitical issues that the United States has confronted China about as well. China has had an expansive policy of claiming islands throughout the South China Seas, most notably laying claim to the Diaoyu/Senkaku Islands in an ongoing territorial dispute with Japan. China is also building islands throughout the South China Sea, fortifying them with landing strips and military bases, and further securing its role as the preeminent force in Asia.

Not to be forgotten is this reality: the United States is in a precarious negotiating position with China. According to the U.S. Treasury, China currently owns 8.7% of U.S. debt, which makes it the United States’ largest foreign creditor. In fact, the Chinese own 30% of all U.S. debt held by other countries. And while China has not indicated it will significantly change its position, it provides them with considerable negotiating leverage with the United States.