Shenwan Hongyuan Group: "Overvalued" Impact of Tariffs?

Shenwan Hongyuan Group released a research report stating that the market overestimates the impact of declining exports on domestic employment and consumption. To measure the indirect effects of tariffs on the economy, analysis can be carried out on industries with a high degree of "Made in America" content, primarily concentrated in areas such as consumer electronics, light industry textiles, and machinery equipment. These industries account for a large proportion of manufacturing investment (31.4%), but a lower proportion of employment (9.8%) and labor compensation (6.1%), as overall employment in China leans more towards the service industry. Additionally, the transmission elasticity of the impact of declining exports on employment is less than 1, and import substitution may also increase domestic employment and GDP (orders undertaken by domestic enterprises), stabilizing residents' income and consumption. The main viewpoints of Shenwan Hongyuan Group are as follows: Misconception 1: The market may overestimate the elasticity and sustainability of the impact of tariffs on exports. There is a "non-linear decreasing" characteristic in the elasticity of tariff impact, with marginal impact decreasing. The market often estimates the impact of tariffs on exports to be 1, meaning that the rate of increase in tariffs is equivalent to the rate of decline in exports. However, elasticity is not fixed, and changes non-linearly with changes in tariff rates. Extremely high tariffs may actually reduce the impact elasticity, easing export pressure. For example, in 2024, the tax rate for new energy vehicles increased by 100%, but the impact elasticity was 0.3. Currently, with the U.S. imposing tariffs of 145%, the impact elasticity has decreased from 1.8 to 0.3. Tariffs have a "reflexive" nature, and U.S. importers may still seek exemptions from the list. Exemptions are not negotiated by China, but rather applied for by U.S. importers. During the period of tariff 1.0, the proportion of goods exempted from tariffs reached a peak of 60%, mainly for intermediate goods and capital goods in the supply chain that were difficult to decouple from China, reflecting that trade frictions have a greater impact on the U.S. economy and importers than expected by policymakers, also showing the irreplaceability of China in the global production supply chain. Currently, the U.S. has published an exemption list, and the speed of exemptions is significantly faster than during the tariff 1.0 period (with a delay of half a year). The sustainability of the following extremely high tariffs is also questionable. On April 4th, the U.S. released a new round of tariff exemption lists involving imports from China totaling $22.03 billion. Mainly comprising intermediate and capital goods, including pharmaceuticals and chemicals, wood and paper products, semiconductor devices, minerals and metals, as well as rubber and plastics, and steel and aluminum and automotive products subject to tariffs based on Section 232. Misconception 2: The market may underestimate the hedging power of trading partners and reliance on China. Canada and Mexico remain major global trade transit channels without equivalent tariffs being imposed. With the U.S. implementing discriminatory trade barriers in global trade, Canada and Mexico have become important "trade transit" channels, focusing on consumer goods and capital goods. The current U.S. "equivalent tariffs" have not been imposed on Canada and Mexico, implicitly acknowledging the model of tempering domestic economic pressure through transit, which can hedge the downward pressure on U.S. exports to China caused by U.S. tariffs, with a potential offset of up to 23%. Emerging countries are friends, not adversaries, and the form of trade is not limited to export transfers. During tariff 1.0, China's exports to emerging countries increased significantly, driven not by coordinated supply of intermediate goods, but by goods driven by emerging countries' domestic demand; in 2019, China's exports to developed countries and coordinated supply decreased from over 10% to around 0%, but exports to emerging countries and goods driven by internal demand and "export transfer" increased to around 9.4%. Looking at individual products, China's rebound in exports to emerging countries is mainly in consumer goods, but not all of these goods exported from emerging countries to the U.S. increased simultaneously, reflecting that the internal demand of emerging countries has also boosted China's exports. It is not advisable to overestimate the determination of emerging countries to substantially increase "dual tariffs" on China, as the industrial chains are deeply embedded with China and imposing tariffs on China will hinder the industrialization process in emerging countries that are picking up speed. From a data perspective, China's exports of coordinated supply goods to emerging countries (intermediate and capital goods) led the industrial production growth of emerging countries by 2 months, indicating that the industrialization process of emerging countries relies on China's supply of production materials. In the past two years, ASEAN has accelerated its imports of intermediate and capital goods from China (reliance on China has increased from 18% to nearly 20%), indicating a closer demand for supply chains in China. In this context, imposing tariffs on China by emerging countries will only increase the cost of imported production materials, raising the cost of industrialization. Misconception 3: The market may confuse the relationship between exports and GDP, employment. When calculating the impact on GDP, the value added and output are confused, and the cushion of imports is ignored. Exports represent "output," while GDP represents "value added," so a decline in exports does not necessarily mean a decline in GDP. In 2019, exports deviated from net export GDP, with the decline in exports linked to the slowing growth of imports, which is related to China's export model. China's processing trade accounts for 30% of exports, and once exports decrease, processing trade imports may also decline (GDP is exports minus processing trade imports), thereby mitigating the pressure on GDP. The transformation from trade methods to domestic substitutes will naturally reduce import demand, and external sanctions, retaliatory tariffs, and price advantages will strengthen the process of import substitution. Over the past decade, the proportion of general trade surplus has increased from 24.5% to 73.1%, while the dependence on imported processing trade has decreased from 60.4% to 10.4%, especially since the trade friction in 2018. Using mobile phones as an example, the outsourcing factories of Apple's iPhones have shifted to emerging countries, but the overall trade surplus of mobile phones only slightly decreased in 2018-2019 before reaching a new high, mainly due to the rise of domestic brands, with the proportion of general trade exports increasing significantly to over 50%. The impact of declining exports on domestic employment and consumption may be overestimated. To measure the indirect effects of tariffs on the economy, analysis can be carried out on industries with a high degree of "Made in America" content, primarily concentrated in areas such as consumer electronics, light industry textiles, and machinery equipment. These industries account for a large proportion of manufacturing investment (31.4%), but a lower proportion of employment (9.8%) and labor compensation (6.1%), as overall employment in China leans more towards the service industry. Additionally, the transmission elasticity of the impact of declining exports on employment is less than 1, and import substitution may also increase domestic employment and GDP, with orders being undertaken by domestic enterprises, stabilizing residents' income and consumption. Risk Warning Unexpected changes in the trade situation, geopolitical risks.Danger, non-systematic risks lead to the amplification of pressure in local areas.Hola! Cmo ests hoy?