Question 120 marks
Question
Trade war breaks out between the United States (US) and China 100 services 50 US$ billion primary income 0 –50 secondary income –100 –150 –200 goods –250 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2010 2011 2012 2013 2014 2015 2016 2017 2018 Fig 1.1: Components of the US current account, Q1 2010 to Q1 2018 6.90 6.80 6.70 yuan per US dollar 6.60 6.50 6.40 6.30 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul 2017 2018 Fig. 1.2: Chinese yuan to US dollar rate of exchange, August 2017 to July 2018 Extract 1: The US government says, ‘We are confronting China’s unfair trade policies’ For many years, China has pursued industrial policies and unfair trade practices – including dumping, discriminatory non-tariff barriers and industrial subsidies – that favour Chinese firms and make it impossible for many US firms to compete. China imposes much higher tariffs on US exports than the US imposes on China. China’s average tariff rate is nearly three times higher than the average US rate. Certain products are even more imbalanced, for instance the US charges a 2.5% tariff on Chinese cars, while China currently maintains a 25% tariff on cars from the US. China has banned imports of some US agricultural products, excluding US farmers from a major market for their goods. China has dumped and unfairly subsidised a range of goods for the US market, undermining US domestic firms. In 2018 alone, the US government has found dumping or unfair subsidies on 13 different products. Source: The White House, US government, 29 May 2018 Extract 2: Winners and losers in the US–China trade war The US government imposed a first round of tariffs on Chinese goods on 6 July 2018, by introducing 25% taxes on US$34 billion of Chinese imports. These were a response to China’s “unfair trade policies” – the US claimed China was selling Chinese products in the US below their normal price, called ‘dumping’, as well as subsidising the production of goods exported to the US. It was then announced that tariffs on a further US$50 billion worth of imports from China would come into effect. The US threats have risen since, with the president saying he is ready to impose tariffs on all US$500 billion of Chinese imports. China has retaliated, saying it will levy new tariffs on more than 5 200 US products, if the US government proceeds with its latest tariff threat. The duties would range from 5% to 25% on US$60 billion worth of US products imported into China, including further agricultural products such as soya beans. The US government imposed tariffs because they said that the “unfair trade practices” have resulted in a US trade deficit with China, but this makes no sense. The trade deficit is an inevitable by-product of a robust US economy, a large US fiscal deficit and a strong US dollar. If correcting the US trade deficit is the government’s policy aim then it should raise US taxes to reduce the fiscal deficit and the US central bank should act to lower the value of the US dollar against China’s currency, the yuan. Both countries will lose in a major trade war, but the losses will differ in kind and amount. It could cut China’s exports to the US by about a third, some US$200 billion annually. Eventually, Chinese firms will find new markets and create new products to compensate. For a period of two or three years, however, the disruption to workers and firms will be enormous. As many as 4 million Chinese workers could become unemployed, and many Chinese firms will go out of business. If US exports to China are cut by a third in a major trade war, the US will lose about US$50 billion of exports annually. About 250 000 US workers will lose their jobs. If US firms can see no end to the trade war, they will reorganise and locate production in lower-cost countries like Vietnam and Peru. The Chinese government, however, will strongly encourage Chinese firms to produce many of their goods at home, even though the cost will be much higher. Source: Gary Hufbauer and Mercy A Kuo, The Diplomat, 11 July 2018 (a) (i) Using Fig. 1.1, how is the US balance of trade in goods in Q1 2018 different from that in Q1 2010? [2] (ii) Explain how China’s imposition of tariffs of 25% on cars from the US might have contributed to the change you have identified. [2] (b) (i) Using Fig. 1.2, how has the value of the yuan against the US dollar changed between April and July 2018? [1] (ii) Identify and explain one factor that will determine the impact of this exchange rate change on China’s balance of trade in goods. [3] (c) Explain how, ‘a robust US economy, a large US fiscal deficit and a strong US dollar’ could each contribute to a US trade deficit. [6] (d) With reference to economic theory, discuss whether the US economy is likely to benefit overall from the trade war with China. [6] Section B Answer one question.
Mark scheme
1(a)(i) Using Fig. 1.1, how is the US balance of trade in goods in 2 Figures are not required, but if they are provided Q1 2018 different from that in Q1 2010? there must be an indication that this means that the balance of trade shows an increased deficit. If There is an increased/greater/bigger (1) deficit (1) figures are correct, but no mention of ‘deficit’ then 0 marks. ‘Deficit has worsened’ is only worth 1 mark unless it is shown what this means in numerical terms. 1(a)(ii) Explain how China’s imposition of tariffs of 25% on cars 2 Many candidates will respond with the usual diagram from the US might have contributed to the change you have of the impact of a tariff. This is not necessary for identified. both marks, but there must be recognition that supply will fall and price will rise. The imposition of tariffs would raise the price of US imports into China leading to a contraction in the demand for US goods (1) this would contribute to a bigger deficit (1) 1(b)(i) Using Fig. 1.2, how has the value of the yuan against the US 1 Accept ‘devalued’ on this occasion because although dollar changed between April and July 2018? technically incorrect it is sufficiently distinct from expressions that suggest that the value has gone up. The value has depreciated/gone down (1) 1(b)(ii) Identify and explain one factor that will determine the 3 The most likely response from candidates is the impact of this exchange rate change on China’s balance of price elasticity of demand for imports and exports trade in goods. (M-L condition: but this must be explained perhaps with reference to the J-curve). Other factors should For one factor identified (1) and explained (up to 2 marks) be credited if valid. For example the change in the value of the exchange rate might be offset by The own figure rule can be applied here. If the candidate states changes in US incomes. in 1(b)(i) that the exchange rate has appreciated then full marks are available for this question if the explanation is valid. 1(c) Explain how, ‘a robust US economy, a large fiscal deficit 6 A ‘robust US economy’ suggests higher employment and a strong US dollar’ could each contribute to a US trade in the US and higher incomes leading to increased deficit. US demand for imports (and/or the diversion of exports to the home market). May get some For explaining how each of the factors could affect the balance reference to income elasticity of demand for imports. of trade negatively up to 2 marks (3 x 2 marks) A ‘large US fiscal deficit’ suggests that there has If a relevant point is made but left undeveloped then award 1 been an increase in G and/or a fall in T raising mark. For the second mark, some elaboration of the identified aggregate demand that will lead to increased point is required. spending on imports. Possible increased spending by US government on Chinese goods. A ‘strong US dollar’ will lead to a rise in the price of US exports and a fall in the price of imports. 1(d) With reference to economic theory, discuss whether the US 6 The relevant economic theory is the principle of economy is likely to benefit overall from the trade war with comparative advantage. The trade war undermines China. this and confirms the idea that ‘both countries will lose in a trade war’. Some industries might benefit, For clear recognition of the benefits derived from specialisation but consumers will lose and some might be left and free trade (the principle of comparative advantage could be unemployed as their industries are denied access to implicit) (1 mark) China’s market. Some might argue that if China is indeed engaged in unfair trade practices, the actions For explanation of a possible benefit(s) to the US economy that of the US government might force them to stop these might derive from the trade war (Up to 2 marks) and free trade could emerge and in this sense the US could enjoy overall benefit. For explanation of a possible cost(s) to the US economy that might derive from the trade war (Up to 2 marks) Reserve 1 mark for a reasoned conclusion