Thursday, May 4, 2017

The Economic Costs of an Unthinkable War With China

While America's anti-Russia drums continue to beat the loudest, tensions with China appear to be growing, particularly over the situation in North Korea and the South China Sea while the Taiwan issue continues to simmer in the background.  In the past, I have posted an article on various war scenarios with China, who would be most likely to dominate and how long hostilities could fester.  In this posting, I want to take another look at a study by RAND that examines the costs of war with China, particularly the military losses, economic costs and political effects.  For this posting, I will be focussing on the economic costs of a war with China, a concern given that a very significant portion of global trade is linked to both the United States and China.

The study begins by assuming that the war would be regional (as opposed to global) and conventional rather than nuclear.  The war would be fought on sea, by aircraft and missiles as well as in space and cyberspace.  The authors postulate that hostilities would turn a great deal of the Western Pacific into a war zone and the study assumes that China would not attack the U.S. homeland except through cyber attacks.  Here is a graphic showing the various war scenarios as I noted in my original posting on the subject:

For the purposes of this posting, we will be focussing on the severe war scenario.

Now, let's move to the impact of war on the Chinese and American economies.  Here is a graphic showing the United States GDP growth between 2007 and 2015:

Here is a graphic showing China's GDP growth over the same timeframe:

According to the World Bank, total global GDP in 2015 was $74.189 trillion; this means that the United States and China made up a combined 39.2 percent of the world's economic activity.  Obviously, any hostilities between the world's two largest economies are going to have a significant impact on the global economy.

The United States and China are also significant traders with each other.  In 2016, the United States trade in goods with China was as follows:

Here is a graphic which shows China's exports to the United States and its share of U.S. imports:

In 2015, 21.8 percent of all U.S. imports were sourced from China.

In general, China has a greater reliance on international trade, especially in energy supplies, than the United States.  It is also the holder of trillions of dollars of U.S. debt with the latest Treasury figures showing that China held $1.059 trillion worth of Treasury securities in February 2017, down from $1.252 trillion in February 2016.  With 95 percent of China's trade being seaborne, obviously China would suffer greatly from war-time sea lane interruptions, particularly if the United States blockaded non-military sea transportation from China.  While China may lose its access to seaborne trade, it could always step up its use of overland trade by using trade routes through Russia.  One additional weakness for China could be its regional economic links with Japan, South Korea and Southeast Asia.  Much of the trade within the East Asian block is composed of intermediate goods and components; goods manufactured in one nation are shipped to another nation and then assembled into  a final product which is then exported (i.e. electronic goods with parts from several Asian nations that are assembled in a Chinese factory and then exported abroad).

With that background, let's look at the estimated aggregate effect on the GDP of both nations if both the United States and China stopped trading with each other (i.e. bilateral trading) from the time that hostilities began (T0) to the future with the width of the curves showing uncertainty:

The authors suggest that there would be an immediate 80 percent drop in trade between the two nations, rising to 90 percent after one year of severe conflict.  Looking at only the bilateral trade issue between the U.S. and China, within a decade, the U.S. GDP would have fallen by between 5 and 10 percent and China's GDP would have fallen by between 10 and 15 percent. 

Now, let's look at the estimated aggregate effect on the GDP of both United States and China in overall trade (i.e. global trade losses) from the time that hostilities began forward into the future:

You can clearly see that the impact of lost trade is significantly higher on China than it is on the United States, largely because the Chinese economy is highly reliant on exports, particularly to the United States.  Within a decade, the U.S. GDP would have dropped by between 5 and 10 percent (roughly the same as under the bilateral scenario) and China's GDP would have dropped by between 25 and 35 percent. 

Here is a table that shows the estimated economic costs to both the United States and China after one year of severe war:

The decline of between 25 and 35 percent in China's GDP is comparable to the situation in both Germany and Japan during the later stages of the Second World War when Germany saw its economy contract by 64 percent and Japan saw its economy contract by 52 percent.  The data from this analysis  does show one thing; the damage to the economies of both China and the United States would be asymmetric with China suffering far greater economic losses than the United States.  That said, all bets are off if China was able to launch an attack on American soil using its growing inventory of intercontinental ballistic missiles.  

Let's close this posting with a brief discussion on the impact of cyberwar.  Both the United States and China are highly vulnerable to large-scale attacks on computer networks.  In the case of the United States, studies suggest that economic damage from large-scale cyberattacks would range from $70 billion to $900 billion.  

As we can see from this research, the economic impact of a war with China would be substantial, particularly for the Chinese economy since it is so reliant on trade, particularly with the United States.  While that may be the case, by diversifying its trade portfolio, particularly with nations that don't rely on seaborne goods (i.e. Russia), the economic impact of a Sino-American war on China's economy may not be as extensive as this study suggests.  In any case, while the economic costs may not be as significant for the American economy, the costs of war are often much higher than Washington anticipates.  We need look no further than the examples of Iraq and Afghanistan to learn how high the cost can be, particularly in this time of the $20 trillion federal debt. 

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