Effects Of The U.S. – China Trade War

This past week I read an article published by The Economist, that detailed the trade war between the United States of America and China over dominance in several key technology markets and innovative developments. The two “arenas” this will supposedly be fought in are those of the semiconductor industry and green technology. Both nations will attempt to promote domestic industry and discourage reliance on foreign firms and technology. As I see it, the United States’ arsenal of weapons intends to incentivize domestic production by reducing production costs and increasing costs for Chinese firms by stifling access to US markets and US-based firms’ exports.

Concept: Short-Run Costs & Production

A few of the key concepts that are integral to understanding short-run production costs are detailed below:

• Natural resources, labor, capital, technology, and entrepreneurship are the necessary factors of production that have to be paid for with factor payments
• Fixed inputs can not be changed in a short period, and fixed costs are associated with such inputs; thus, fixed costs are independent of output
• Variable inputs are those that can be changed in a short period, and variable costs are associated with such inputs; thus, variable costs are dependent on output
• Average total cost is the total cost of variable and fixed inputs per unit of output
• Average variable cost is the total variable cost per unit of output
• Average fixed cost is the total fixed cost per unit of output
• Marginal costs are the costs incurred to produce an additional unit of output
• Profit margin is the difference between the market price and the average cost of a unit
• Variable inputs have diminishing marginal productivity due to fixed capital constraints

Relationship between Concept & Current Event

U.S Subsidies of Semiconductor Fabs

The subsidies under the CHIPS Act have provided billions of dollars to firms, such as TSMC and Samsung, to construct fabrication facilities in Arizona and Texas. Since such facilities are capital-intensive inputs whose cost is incurred upfront and does not vary with production, fabs are fixed inputs with fixed costs. As such, the subsidies will reduce average fixed costs (AFC), and as an extension average total costs (ATC).

Furthermore, the eventual construction of these fabs may reduce variable costs for foundries as new capabilities may be incorporated into the production process, reducing manufacturing costs associated with component stacking, packaging, cooling mechanisms, testing, transportation, and/or overproduction. TSMC aimed to achieve such reductions in variable costs last year with plans to invest in an advanced packaging plant. Such reductions in variable costs will inevitably lead to decreases in ATC.

By reducing the cost to produce a unit of output, foundries can increase their profit margin; therefore, the shareholders may enjoy increased returns as a factor payment for investment in the company.

Disruptions in Supply Chains & Tariffs

The global tech war between the US and China has disrupted supply chains as both have exercised export or commodity controls. The result is that both American and Chinese firms that are dependent on the other’s technology or output will incur short-term costs. The process of finding new suppliers or establishing alternative channels can increase marginal costs, leading to increases in AVC and ATC. Despite this period of higher short-term costs, in the long run, the firms could implement new infrastructure to enable economies of scale to decrease such costs.

The same could be said for the effects of the tariffs that have been enacted on Chinese green technology, solar panels, and EV components. The raised cost of materials for American firms will increase short-term variable costs, providing an incentive to switch to domestic alternatives. This exemplifies the additional costs of the short-term factors that will have to be incurred before long-term efficiencies are realized.

Short-Run Production Adjustments

China’s dominance in the green tech sector has pressured the US to rapidly increase production capabilities in solar panels and batteries. However, if production is scaled too quickly with increases in variable inputs, fixed capital may constrain the productivity of the additional inputs, as described in the law of diminishing marginal productivity. The additional costs of such inputs paired with the limited marginal increase in output could increase the average cost of production. However, in the long-term, since no input is fixed, firms could purchase additional capital and technology required to effectively ramp up production.

Conclusion

The tech wars between the United States of America and China illustrate a few of the consequences on short-term production for individual firms. Apart from the subsidies for the fabrication facilities–the tariffs, export controls, and pressure on production will lead to increases in short-term costs. Such inefficiencies may be resolved in the long term as firms work towards economies of scale by changing infrastructure and fixed inputs. In the meantime though, the inefficiencies in the chip and green tech markets may lead to “sagging economic growth and slower decarbonization” as The Economist described it.