Running head: U.S.

– CHINA TRADE WAR 1

The effect of Trade Policy on the soybean industry: Evidence from the U.S. – China

Trade War

Name

Institute Affiliation
 U.S. – CHINA TRADE WAR 2

The Effect of Trade Policy on the Soybean Industry: Evidence from the U.S. – China

Trade War

Introduction......................................................................................................................................2
Literature..........................................................................................................................................3
Case Background.............................................................................................................................8
Analyses...........................................................................................................................................9
Conclusions....................................................................................................................................11
 U.S. – CHINA TRADE WAR 3

Introduction

States throughout the history have utilized various economic approaches such as tariffs

and sanctions to pursue their global strategic interests. The year 2018 has witnessed an increase

in trade tension as well as economic disputes among the leading economic counties in the world.

The United States president, Donald Trump, announced an imposition of tariffs on products

coming into the U.S in an effort to penalize foreign nations for various political gains, safeguard

domestic market from the competition abroad and lower the U.S trade deficits. States such China

and Turkey accused the U.S of waging the financial war. In June 2018, the U.S declared a trade

war against China with the objective of limiting Chinese trade malpractices. The Chinese

government responded by putting in place tariffs to meet the one declared by the United States

government. The literature highlights the uneven benefits of trade policy. For instance, Lavoie

(2014) considers trade tariffs to be pro-producer since the benefits connected to tariffs on

imported products is that the domestic producer experience less competition from foreigners and

they are able to gain market power by producing more. On the other hand, Dunn and Mutti

(2004) argue that trade tariffs are anti-consumer since they hurt the business of foreign

companies and result to increased consumer prices. The report seeks to explore the implication

of the trade war on soybean trade, production and consumption between the United States and

China.
 U.S. – CHINA TRADE WAR 4

Literature

The basic reality of global trade is that the trade surplus in one country is a deficit in

another country. The trade deficit develops when the imports of a country exceed its imports.

Specifically, this implies that consumers purchase more foreign products than domestic goods.

Cakan et al. (2015) consider this to be an unfavorable balance of trade. A surplus in trade

happens when the export of a country exceeds its imports. Global trade can be effected through

various national policies that seek to influence the flow of products leaving and entering the

country. The literature highlights the uneven benefits of trade policy. For instance, Lavoie (2014)

considers trade tariffs to be pro-producer since the benefits connected to tariffs on imported

products is that the domestic producer experience less competition from foreigners and they can

gain market power by producing more. On the other hand, Dunn and Mutti (2004) argue that

trade tariffs are anti-consumer since they hurt the business of foreign companies and result to

increased consumer prices. There is exists a debate on whether trade barriers are a cause for

concern. Maynard Keynes believes that trade tariffs increase the rate of unemployment in a

country while harming its economy and causing global financial instability (Milberg, 2002).

While some economist argues that trade deficits are not problematic, some still believe

otherwise. Summers (2016) share Keynes’ perception of trade tariffs which indicates that the

classic views still hold strong this day. The research seeks to determine whether tariffs have a

negative effect. Specifically, the research measures how the trade war between the United States

and China impact the countries’ soybeans industry.

The research is based on the comparative advantage model. The comparative advantage

framework is a classical model that demonstrates how countries specialize in generating certain

products. The concept is depicted as follows:

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Based on the above figure, two assumptions can be set. First, it can be assumed that a

country, as a closed economy, has provided labor supply and technology that can be allocated to

producer either good 1 and good 2 or both. Because of the different attributes of the products, the

labor and technology needs for the generating each product varies. As demonstrated above, when

all resources are utilised to produce good 1, the country can supply at most A units of good 1.

Besides, when all technology and labour are directed towards producing good 2, there will be B

units of good 2 available. Since the correlation between good 1 and good 2 is linear, it can be

concluded that any combination in the line AB is feasible and results in the same quantity of

resources like that in A and B. therefore, the line AB is termed a production possibility curve.

Note that when a country is generating on line AB, there is no extra resource; therefore, there is a

built-in assumption of a zero-unemployment rate. Any point inside region OAB is also feasible

except that they are not exhausting all resources and do not create unemployment.

Second, we assume that the market is one of perfect competition, which means the price

of the commodity produced is equal to the cost of producing it. Based on this assumption, we can

come up with the following relationship between price and resource cost: P = R/Q
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Where P refers to the unit price of that product, R is total resources used, and Q is the

quantity produced given R. Based on this equation, we can derive the price ratio of good 1 and

good 2:

Which, stated differently, also represents the marginal rate of substitution between good 1

and good 2. The marginal rate of substitution measures how much revenue from good 1 will be

sacrificed in order to produce one more unit of good 2, and vice versa.

According to the price ratio, we can calculate the slope of the curve above:

Keeping constant the price of good 1, if the price for good 2 is higher in the international

market, as shown in line BC, the revenue loss, or opportunity cost for producing one unit less of

good 2, is higher than that in the domestic market. This also means that if the country allocates
 U.S. – CHINA TRADE WAR 7

all its resources to produce good 2 and trade them in the international market, they can exchange

more units of good 1 than if it produced good 1 by itself. The country is said to have a

comparative advantage in producing good 2. Seemingly, the country will use all its resources in

good 2 production which ends at point B. On the contrary, if the international price for good 2 is

less than the price in the domestic market, then the country will specialize in producing good 1.

Comparative advantage now resides in good 1.

Tariffs have long been regarded as a barrier to international trade but also a means to

protect domestically produced goods. The effect of tariffs is basically to increase the price of

imported goods, forcing these goods to be sold at a higher price domestically. The graph that

follows demonstrates the basic mechanism of a tariff.

Suppose, in a given country with supply and demand, as shown above, the market price

may not always be the one that clears the market. Hence, it will need to import goods from the

international market to cover the gap between demand and supply. The quantity it imports

depends on the international price of the goods. When international price is 𝑃0, domestic supply

lies at 𝑆0 but demand is higher at 𝐷0. In order to meet domestic demand, the shortfall amount will
 U.S. – CHINA TRADE WAR 8

be satisfied by import; this amount is denoted as 𝐼𝑚𝑝𝑜𝑟𝑡0. It can be assumed an additional tariff

is imposed on the good and the price increases to 𝑃1. Domestic supply increases to 𝑆1 due to the

higher price and profitability, while domestic demand decreases to 𝐷1. The gap between supply

and demand becomes smaller, so the country will import less, denoted as 𝐼𝑚𝑝𝑜𝑟𝑡1, from the

international market. A rising price is bad news for domestic consumers; the consumer surplus

will be consumed unless an alternative supply is found or there is an attempt to avoid tariffs. This

is how tariffs adversely affect consumer purchases.

Case Background

The research seeks to understand how the U.S-China trade tariff affect the soybean trade

in both the United States and China. Since taking office, President Trump has waged trade tariffs

on China as an approach to harmonize trade and limit China’s unfair trade practices. The U.S

implemented measures to limit the freedom of trade China enjoyed. China retaliated to United

States’ approach by imposing bans which affected the U.S agricultural sector. The trade war has

specifically impacted the soybean market, evident in Chinese consumers and United States’

farmers. The development of the U.S-China trade war has witnessed a decline in the overall

import of soybean from the United States, resulting in high demand from other markets. Brazil is

the biggest beneficiary from this trade conflict with an increase the soybean exports to 66.1

million tons in 2018. This was a 30% increase from 2017, which demonstrates the need to fill the

gap left by the United States. However, this has not been enough to sustain China’s demand for

soybeans, with the Chinese turning towards Russia as alternative suppliers.

Since China is the largest buyer of US soybeans, customers in China will look closely at

the US soybean price in order to manage material costs and do their budgeting in advance. As the

US futures price reflects the spot price in the future, Chinese customers may consider the former
 U.S. – CHINA TRADE WAR 9

when negotiating contract prices with US sellers. Following the same logic of this relationship

between futures price and spot price, the Chinese futures price also reflects the consensus of spot

price in the future. As US farmers decide how much soybean to produce, they might want to look

at future Chinese demand by studying the expected future price. If the futures price rises a lot,

they may want to produce more and to profit; if the futures price exhibits backwardation, they

might cut the production volume to avoid loss. The change in supply will affect the spot price in

the US. Thus, there might be a relationship between the US futures price and the Chinese spot

price.

Analyses

China and U.S maintained a healthy trading partnership. The soybean markets in both

countries should have been operated as usually expected. However, in June 2018, the US

declared a trade war against China, and the situation deteriorated. In August 2017, the US

government initiated a Section 301 investigation under Trade Act of 1974 on imported goods, for

the purpose of detecting and punishing trade partners who were involved in unfair trading

activities. Although this investigation was said to apply to many countries that trade with the US,

China was the actual target. From January to March 2018, the United States announced

additional tariffs on steel, aluminum, and some industrial accessories imported from China.

However, these were just expressive of trade frictions and were not part of a trade war (because

they counted for only a small portion of total trading volume). However, the situation became

worse on March 22, 2018, when the US government announced additional tariffs on 50 billion

dollars of goods from China. A month later, a detailed list made public showed a further 25%

tariff would be imposed on more than 1,330 categories of goods, totaling 50 billion dollars.
 U.S. – CHINA TRADE WAR 10

To fight back, the Chinese government held a pressing conference on April 4, 2018, at

which it announced the imposition of an additional 25% tariffs on 106 kinds of products

imported from the US. The detailed list from June 15, 2018 included soybeans. This is the time

period in which soybean trade was involved in a trade war.

The above graph compares the tax and price before and after the trade war. The left side

of the graph visualizes the relationship between the imported soybean price and the tariff level.

The linear function crosses the vertical axis at 𝑃𝑝𝑜𝑟𝑡, which is the imported soybean price before

tax, also the FOB price in the US plus shipment cost from the US to China and other related

costs. Before the trade war, when soybeans arrived at any port in China, Chinese Customs would

charge a tax, raising the price up to 𝑃0. At this price level, China’s domestic market could absorb

𝑄0 soybeans and maintain an equilibrium. However, as China imposed an extra 25% tariff on

imported soybeans, it was difficult for buyers and sellers to negotiate alternative contract terms,

which could then adversely affect the trading volume between the two countries. Import volume

would decline, and supply decreases to 𝑄1. In the future, the supply level could decrease even

more if the Chinese government decided to retaliate for a longer period. In order to meet the

previous demand of 𝑄0, China needed to find alternative resources or to tolerate the high price.
 U.S. – CHINA TRADE WAR 11

This is why China imported more soybeans from Brazil and lowered its tax rate to zero for some

other Asian countries, hoping to maintain enough import volume and support domestic demand.

Due to the additional tax, the import volume from the US decreased, and the relationship

between the US soybean spot price and China’s soybean spot price might no longer exist, and

futures prices might diverge between the two markets. Ultimately, the price relationship between

China and the US might disappear.

Conclusions

Before the introduction of the trade war, China has increased its use of U.S soybeans. A

short term impact of the trade war was that China purchases less of U.S soybeans in 2019 to

exert pressure on the United States government. The reduction in the importation of the United

States soybean resulted to the increase in U.S soybean inventory as well as reduced the U.S

soybean production. Resultantly, the farmers in the U.S are likely to switch to other crops since

the market confidence has compromised because of the declined purchase. The trade war made

the U.S and the Chinese market segment in the context of soybean trading. It is evident in both

the spot market and the futures markets. It is reasonable to conclude that a retaliatory trade war

or retaliatory tariffs could negatively impact the efficiency of a market by introducing trade

restrictions that function as a link between the markets. As such, a negative effect can be

predicted. International traders would have to renegotiate their trade terms and conditions, while

commodity derivatives traders would have to rebuild their hedging or speculation portfolios, as

previously normative price patterns would no longer be operative. Both US producers and

Chinese consumers would likely be in danger of suffering deteriorated market conditions.

The way to mitigate the long term effect of the U.S-China trade on the United States

soybean market is to increase the demand for the United States soybeans for other importing
 U.S. – CHINA TRADE WAR 12

nations. However, the soybean market will continue to encounter difficult challenges in the

future if the trade policy cannot be reached between the two countries.
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References

Cakan, Esin ; Doytch, Nadia ; Upadhyaya, Kamal P. (2015). Does U.S. macroeconomic news

make emerging financial markets riskier? Borsa istanbul Review,15(1), 37-43

Dunn, R. & Mutti, J.H. (2004). International economics 6th edition. USA: Routledge

Lavoie, M. (2014) Post-Keynesian Economics. UK: Edward Elgar Publishing.

Summers, L.(2016). The Case of Free Trade is Weaker Than You Think. Retrieved from

https://www.wsj.com/articles/the-case-for-free-trade-is-weaker-than-you-think-

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