Comments to the US International Trade Commission Regarding the Economic Impact of Revoking China’s PNTR Status

Contents

Introduction and Summary 1

Defining National Power Industries 2

Assessing the Cost of Revoking China's PNTR Treatment 3

Methodology 3

Analysis of Dependency on Chinese Imports 4

Potential Costs of Revoking China's PNTR Status 8

Ways to Mitigate the Negative Effects of Revoking China's PNTR Status 9

Conclusion. 10

Endnotes 10

Introduction and Summary

The Information Technology and Innovation Foundation (ITIF) is pleased to submit the following comments for consideration by the United States International Trade Commission (USITC) for the self-instituted investigation on the Effects on the U.S. Economy of Revoking China's Permanent Normal Trade Relations (PNTR) status. ITIF is an independent, nonprofit, nonpartisan research and educational institute focusing on the intersection of technological innovation and public policy.

ITIF views the People's Republic of China (PRC) as a power trader, focusing on inducing trade dependencies and using trade to gain a competitive advantage for its advanced industries, all to limit the development and advancement of its adversaries.[1] China's failure to meet its accession commitments to the World Trade Organization (WTO)-including its forced technology transfer, subsidies for local champions, and weak intellectual property rights (IPRs) protections and trade secret theft-is well documented by ITIF.[2] China should come into full and immediate compliance with its WTO commitments; otherwise, as a last resort, the U.S. government should revoke China's PNTR status. ITIF previously proposed this approach in 2021, stating that "if China decides to develop an alternative economic system that is not compatible with existing multilateral rules, then it shouldn't be in the WTO-or at least it shouldn't enjoy the same benefits as countries that respect agreed-upon rule."[3]

The revocation of China's PNTR status should be implemented considering the mitigation of second-order effects, particularly on national power industries, which underpin America's techno-economic power.

With this goal, ITIF's comments focus on identifying: i) how dependent U.S. firms, especially those in national power industries, are on Chinese imports, ii) the cost of revoking China's Most-Favored Nation (MFN) status and imposing tariffs in column 2 of the Harmonized Tariff Schedule of the United States (so-called "column 2 tariffs"), and iii) potential remedies and tradeoffs of imposing China column 2 tariffs.

Revoking China's PNTR status could cost up to $7 billion a year to national power industries. Those are resources that will be redistributed in the United States, but they won't be allocated to strengthening U.S. techno-economic competitiveness. Policymakers should find ways to mitigate this effect, for example, by only gradually increasing tariff rates for goods that the United States is highly dependent upon China for, and by temporarily exempting national power industries from paying any tariff increase differential derived from revoking China's PNTR status.

Defining National Power Industries

National power represents a country's ability to both prevent other states from taking actions against its core interests and impose its will on other nations. The conventional view is that the only industries that matter to national power are defense industries. But that is now vastly too limiting. In the globally integrated economy of the 21st century, a key enabler of national power is strength in industries that not only support weapons system development and production but also provide leverage over adversaries and limit their leverage over us. These industries span across a spectrum of sectors including those for pure defense production, dual-use technologies employed in both military and commercial applications, and enabling industries that support the broader industrial commons. These industries include semiconductors, aerospace, biopharmaceuticals, telecommunications equipment, advanced chemicals, precision machinery, robotics, artificial intelligence systems, and dozens of other advanced sectors.[4]

As such, ITIF has developed a classification of U.S. industries for their relevance to national power. This can be viewed as a continuum between defense industries on one side and nonstrategic industries on the other, with strategic dual-use industries and strategic enabling industries in the middle. (See figure 1.) Weakening or fatally injuring firms in these industries would grant China dangerous leverage over the United States and its allies, even as Chinese firms face heightened tariff rates due to a potential revocation of PNTR status.

Figure 1: Industrial power scale

Assessing the Cost of Revoking China's PNTR Treatment

Methodology

ITIF's calculations are based on the 2023 Census of Economic Activities (Economic Census) data, which provides disaggregated information on every product imported (at the HS 6-digit level) by more than 300 industries, classified by North American Industry Classification System (NAICS) 4-digit codes. The number of imported products by industry exceeds 60,000 observations.[5]

Using USITC's import data, ITIF determined the share of imports from the PRC and Hong Kong by dividing them by the total of all U.S. imports.[6] With that information, the share of Chinese imports for each good across all sectors was imputed from total imports for that observation, weighted by the share of Chinese imports. Thus, Chinese imports are defined as total imports from the PRC and Hong Kong and are assumed to be linear across all sectors.

It was determined that a product is dependent on Chinese imports if the share of total U.S. imports of that good from China is above 30 percent. Likewise, a high dependence was established if that threshold was 50 percent or more. In this context, out of the 4,730 product categories analyzed, 930 goods were considered dependent on China, of which 474 were classified as highly dependent.

Later, ITIF determined the increase in import cost due to potential column 2 tariff rates for every good and every sector. This calculation is based on the difference between MFN rates and potential column 2 rates. The baseline tariff data is based on the World Bank's World Integrated Trade Solution (WITS) data for the MFN rate for Chinese exports to the United States for 2022 (the most recent available data), and column 2 tariffs, using U.S. tariffs on Cuban imports as a proxy, since this country is already levied with column 2 tariffs.[7]

Analysis of Dependency on Chinese Imports

The Economic Census data offers a precise estimate of U.S. firms' activities, which, naturally, are only a part of all activities taking place in the United States. Therefore, what U.S. firms import from China-shown in the Census data-is not necessarily proportional to total import activities. According to Census data, U.S. firms imported $250 billion from China in 2023, accounting for 14 percent of total imports. Meanwhile, the U.S. economy's total import data shows over $3 trillion in imports, with $427 billion coming from China.[8]

Less than 20 percent of the goods imported from China are classified with a degree of dependency from China-defined as 30 percent or more of that product category as a share of total imports coming from the PRC or Hong Kong. However, imports of goods dependent on China account for 61 percent of the total value of imports from the Chinese economy. Likewise, high-dependency imports-defined as products in which the United States is 50 percent or more dependent on China-account for 11 percent of total goods but 16 percent of the total value of imports. (See figure 2.)

Figure 2: U.S. firms' imports from China, by the degree of dependency on Chinese imports, 2023[9]

Additionally, U.S. firms' imports from China are highly concentrated in total value. Figure 3 shows that 10 products-classified under the Harmonized System at the 6-digit level-account for 28 percent of the value of total U.S. firms' imports from China, among the 4,370 products in the sample. One product category alone-laptops, tablets, and similar devices weighing 10 kg or less (HS code 847130)-accounts for 10 percent of total imports from China.

Figure 3: Cumulative value of U.S. firms' imports from China by product (HS 6-digit), 2023[10]

National power industries are less reliant on Chinese goods than other economic sectors. National power industries' imports from China account for 8 percent of their total imports of $825 billion, while the share for non-national power industries is 20 percent of their total imports ($941 billion). Additionally, only 26 percent of U.S. firms' total imports from China supply national power industries. (See figure 4.)

Figure 4: U.S. firms' imports, by origin and type of industry, 2023[11]

National power industries are also relatively less reliant on goods that are highly dependent on the Chinese economy. Figure 5 shows that 19 percent of national power industries' imports from China are highly dependent (i.e., goods in which China accounts for half or more of total imports), while this share is 54 percent for non-national power industries. Similarly, 37 percent of national power industries' imports from China are of goods classified as dependent, while this ratio for non-national power industries is 69 percent.

Figure 5: U.S. firms' imports from China, by type of good and industry, 2023[12]

Potential Costs of Revoking China's PNTR Status

This subsection presents a simple linear calculation of the cost increases for Chinese imports if they were added to the column 2 tariffs, by industry dependency and industry type. However, imports of goods considered dependent or highly dependent on China face higher practical switching costs, as companies' efforts to change suppliers are more time-intensive.[13] In addition, there would be so-called "stickiness" in imports from China during the first few months after the imposition of column 2 tariffs on Chinese goods, as contract commitments would continue for a set period.[14] Naturally, a more comprehensive estimation should include substitution effects and line-by-line price and import elasticities. Another limitation of this analysis is that the latest available data is from 2023, which evidently omits the second Trump administration's tariff escalation and the subsequent adjustment costs that firms have already assumed.

The calculation uses WITS data to estimate the potential immediate cost increases for U.S. firms' imports from China that would result from revoking China's PNTR status and imposing column 2 tariffs. Because column 2 tariffs are often a mix of ad valorem and quantity-based tariffs, ITIF uses the current U.S. column 2 tariffs on Cuba-a country already outside PNTR status-as a proxy to estimate how column 2 tariffs would affect imports from the PRC and Hong Kong.

Figure 6 shows the effect of imposing column 2 tariffs on national power and non-national power industries. Because it does not include potential substitution effects, it represents the maximum potential additional costs. Adding all Chinese goods to column 2 tariffs would increase annual import costs by $7 billion for national power industries and $36 billion for non-national power industries. Narrowing the set of goods added to column 2 by excluding those that are dependent and highly dependent on China would imply additional costs of $4 billion and $3 billion for national power industries, respectively. For non-national power industries, excluding dependent goods would increase import costs by $10 billion, while excluding only highly dependent goods would increase import costs by $7 billion.

Figure 6: Maximum potential additional annual import cost for U.S. firms of revoking China's PNTR status[15]

Ways to Mitigate the Negative Effects of Revoking China's PNTR Status

While supporting revocation of China's PNTR status, ITIF urges the USITC to consider mechanisms to mitigate the potential negative effects of this measure on national power industries. In particular, U.S. trade authorities should explore two specific mechanisms.

▪ Policymakers should gradually increase tariffs for goods categorized as dependent and highly dependent. USITC should pre-define a set of product categories based on their dependence on Chinese imports, and establish a gradual increase in the imposition of column 2 tariffs. For example, for products in which Chinese imports account for 50 percent or more of total imports, column 2 tariffs should be implemented over a five-year horizon, with an annual linear increase from year zero to year four.

▪ Policymakers should explore legislating a temporary tax rebate for tariff increases due to China's revocation of its PNTR status. Given the techno-economic importance of national power industries' competitiveness and the fact that these industries are already less reliant on Chinese imports than non-national power industries, Congress should authorize a temporary tax rebate to exempt national power industries from the differential between MFN and column 2 tariffs. This proposed exemption should be narrowed in duration (e.g., to three years) and gradually phased out. For example, the first year could be a 100 percent exemption of the tariff increase, the second year a 50 percent exemption, and the third year a 25 percent exemption.

Conclusion

If China continues to refuse to come into full and immediate compliance with its WTO commitments, then the Information Technology and Innovation Foundation supports-as a last available option-the revocation of China's PNTR status due to China's long history of economic mercantilism, but advises policymakers to do so with consideration for national power industries. Increasing the competitiveness of these industries is of critical importance.

Thank you for your consideration.

Endnotes