Political risks from US-China trade war lead to increased firm exits, study finds

LAWRENCE — In a trade war, the main weapons deployed are tariffs.

The U.S.-China trade war has quickly expanded beyond tariffs to a wider set of policies aimed at the “decoupling” of the two economies. Heightened political tensions further jeopardize companies doing business overseas.

“The trade war and tariffs in particular have caused a lot more collateral damage than targeted damage. Multinational corporations have found China to be a less attractive place because of the cycle of retaliations that are part of increased geopolitical tension,” said Jack Zhang, assistant professor of political science at the University of Kansas.

His paper titled “Political risk and firm exit: evidence from the US–China Trade War” shows that heightened political risks since this war started in 2018 increased firm exits from China by 34%. These findings reconcile the conflicting expectations about how firms respond to political risk, highlighting the collateral damage tariffs can cause in an age of global value chains.

It appears in the Review of International Political Economy.

“We find that even though exits have increased, the manufacturers most exposed to tariffs are not driving the trend. It’s an across-the-board effect. American companies are not much more likely to exit than non-U.S. companies or U.S.-allied companies,” said Zhang, who co-wrote the paper with Samantha Vortherms of the University of California, Irvine.

At the center of this trade war are tariffs, which are taxes on imported goods. These are levied on American businesses, for the most part, that are importing items from China.

“This gets even more complicated because it’s not just Chinese companies that make things in China,” he said. “It’s a bunch of global companies, including American ones. Many American companies make things here but source inputs from China. So you end up with this situation where everybody needs to figure out how to cope with higher costs.”

When former President Donald Trump was in the White House, he referred to himself as “Tariff Man” — and based on his current election rhetoric, that is likely to continue if he regains office. In fact, Trump has repeatedly said he will impose a 10% tariff on every imported good, as well as a tariff as high as 60% on all Chinese imports.

“The takeaway from our paper is to push back a little against the narrative repeated in the campaigns where Trump wants voters to believe tariffs on China were a good policy and a success,” Zhang said. “What we find is that in this era of global supply chains, tariffs don’t get you a scalpel-like response. Rather, they’re more of a sledgehammer that hurts a wide swath of companies.”

Higher political risks are driving up firm exits, which are often misinterpreted as solely referring to a company closing shop.

“Foreign companies in China have to register with the Ministry of Commerce and provide some amount of information on an annual basis. We define firm exit as you register one year, and then you don’t another year. So a company could go out of business. It could change its name. It could be acquired by somebody else. But a majority of these exits are companies going out of business, or a particular plant in a particular region going out of business.”

Despite inviting corporate exits, the overall theory behind supporting tariffs is that they will either drive business back to the U.S. or prevent domestic companies in the first place from moving factories to countries where costs are cheaper.

“Yet we have no stories like ‘Tesla used to make cars in China. Now they only make cars in the U.S.,’” Zhang said. “We also don’t have evidence that tariffs achieved what they initiated the trade war to do, which is ‘China has too many policies that distort the playing field and favor domestic industrial policy at the expense of foreign investors.’ Instead, the trade war has made China double down on industrial policy.”

More commonly, when companies exit from China, they rarely return to the U.S. Instead, they simply set up in Southeast Asia or Mexico, Zhang said. Both China and the U.S. appear to be losing the trade war, while these other countries are the winners.

A professor at KU since 2019, Zhang is also the founder and director of the KU Trade War Lab. His research explores the political economy of trade and conflict in East Asia. His past articles include “In the Middle: American Multinationals in China and Trade War Politics” and “Measuring Chinese economic sanctions 1949–2020: Introducing the China TIES dataset.”

“The U.S. business community is pretty clear that tariffs are not what they want,” Zhang said.

“Tariffs create a downward spiral that is making it more difficult for foreign companies to invest in China and for foreign Chinese companies to invest in the U.S. Ultimately, that leads to higher prices and less competition here in the U.S.”