China tariff: ongoing “Whac-A-Mole” game

US President Donald Trump officially announced an additional 10 per cent tariff on Chinese products on February 1, 2025, raising the overall tariff level from 13 per cent to 23 per cent.

“As tariffs can be unpredictable and inconsistent, China needs to adapt to the evolving trade environment by ‘popping up’ in other locations until the next hit.”

This outcome is favourable compared to Trump's initial claim of a 60 per cent tariff and his hawkish cabinet picks.

Despite the tariffs risk, China has already seen a significant decline in foreign investment (down 27.1 per cent year on year in 2024) and is experiencing persistent deflation (Producer Price Index: -2.2 per cent in 2024).

Combined with the already weak Renminbi, it raises questions about whether US tariffs will have a significant impact on China.

The level of tariff seems to be measured so far. However, a second phase of US tariffs against China cannot be ruled out; it depends on China’s reactions.

Trade route, or a diversion?

There has been much discussion already of how China responds to tariffs.

Many have used the phrase “trade diversion” and “trade rerouting” interchangeably, but these two concepts are different.

Trade diversion is in general motivated by efficiency-driven purpose.

A good example could be the reorientation of European Union (EU) export flows towards other economies in Eastern Europe and Central Asia since the Russia-Ukraine conflict.

This shift has been motivated by the prolonged conflict and the resulting trade sanction, which has made it necessary for the EU to find alternative markets and route to maintain trade efficiency.

Trade rerouting is tricky to define.

A well-received classification identified value-added as a key criterion to separate rerouting and non-rerouting activities. If finished goods from China are imported into Vietnam, where the country of origin is re-labelled, and then these goods are exported from Vietnam to the US, this process is referred to as rerouting as no value is added in Vietnam.

These no value-added products are a concern for the US, as they are subject to tax evasion.

Another similar term is transhipment, which refers to goods transferred under Custom control from one vessel to another. Transhipment is a common practice in trade, which could simply be due to no direct ship route, cost-cutting strategy, or shipping restrictions. COSCO Shipping invested Chancay port is a great example. As a transhipment port, it can facilitate the trade between China and South American countries.

This is different from re-export activities, where the goods for re-export must be cleared by the customs and stored locally to be re-exported in the future.

These trade practices are overseen by Rule of Origin, which is the fundamental guideline when implementing safeguard measures such as anti-dumping or determining whether imported products shall receive preferential treatment.

In reality, a seemingly straightforward rule can be messy to apply, especially with the absence of specific provision in on Tariffs and Trade (GATT) governing the process.

Trade ‘Whac-a-Mole’

The Whac-a-Mole game is a fitting analogy that captures the dynamic nature of US tariff and China’s responses.

As tariffs can be unpredictable and inconsistent, China needs to adapt to the evolving trade environment by “popping up” in other locations until the next hit.

Vietnam and Mexico have emerged to be the biggest beneficiaries since the 2018 China-US trade war. Within a timeframe of five years, Vietnam’s trade surplus with the US tripled and Mexico’s trade surplus with the US doubled.

This is an unprecedented growth speed.

This fast success attracts suspicion. Especially with the increased exports to the US from Vietnam and Mexico moving in tandem with their increased imports from China, the narrative that China has been using Vietnam and Mexico as intermediaries to reroute goods back to the US and circumvent tariffs were widely accepted.

However, if we dial the clock back before 2018, it seems like the correlation between Mexico imports from China and its exports to US had already existed. Our model estimation (see “Mexico imports from China and exports to US chart” below) indicates the tariff dummy is statistically insignificant, confirming this pre-existing correlation. The same correlation in the case of Vietnam (see “Vietnam imports from China and exports to US” chart below) seems less apparent, and the model further confirms there is no significant relationship between China exports to Vietnam and its exports to US, regardless of the trade war.

Mexico imports from China and exports to US

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Vietnam imports from China and exports to US

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On the strategic consideration, with heavy penalties in place, not rerouting is a sensible strategy for the rational players in the market.

Foreign-owned companies have no incentive to deviate and act differently from domestic companies.

Speed but not scale

Apart from the direct rerouting discourse, China’s investment to third countries with rerouting intention also caught attention.

Official data from China’s Ministry of Commerce indicates the Foreign Direct Investments (FDI) from China to Mexico and Vietnam increased 185 per cent and 125 per cent in 2023, respectively, compared to the levels in 2018.

This beats the average growth rate of 24 per cent.

Despite rapid investment growth, China remains far from being dominant in either market.

In 2023, China ranked as the fifth-largest investor in Vietnam, trailing behind other Asian countries such as Singapore, Japan and South Korea. In Mexico, the United States is the leading investor, accounting for 38 per cent of total investment, while China's share is only 2.5 per cent.

It is not the overall stock but the rapid pace of Chinese investment that has raised concerns.

China’s Ministry of Commerce's list of overseas investment enterprises shows 326 enterprises registered to invest in Mexico in 2023, up from 133 in 2020.

This demonstrates significant expansion interest even after the initial China-US trade dispute. Companies in the automotive and machinery manufacturing industries accounted for nearly half of this increase, along with a rise in material, logistics, and trade companies. The indicates the FDI wave is not only limited to individual companies for export purpose but the entire automotive ecosystem.

Beyond tariff threats

The reason for this trend is beyond tariffs threats. Low industrial profit under overcapacity concerns and relatively high production costs drives supply-chain shift overseas.

In addition, the China +1 strategy by large companies like Tesla and other multinational corporations further motivated Chinese companies to expand its footprints to better meet the demand of their major buyers.

Therefore, this movement which is also intrinsically driven is expected to continue.

On the other hand, unplugging the so-called FDI hole is against economic principles.

For the countries receiving China’s investments, the offer with tempting economic benefits including job creation technology transfer, and human capital development is hard to reject.

We estimate if China doubled its investment in Mexico, an additional 100,000 jobs will be created.

Moving forward in 2025, China’s export industry will face ongoing challenges. So we can expect this global game of Whac-A-Mole to continue.

Raymond Yeung and Vicky Xiao Zhou are Chief Economist, Greater China at ANZ and an Economist at ANZ