The US-China trade war is approaching its second year. In this paper, we explain how a relatively small tariff on Chinese exports to the US can greatly disrupt supply chains, employing the concept of the effective rate of spillover protection. The essential difference between nominal and effective rates of (spillover) protection relates to the share of value added by US and Chinese producers in their exports, and the ability to shift activities associated with their production across borders to minimise costs.

We estimate domestic value added of Chinese exports to the US. For total manufacturing, domestic value added is estimated at just 15 per cent. Therefore, transferring these activities out of China to avoid the 25 per cent tariff makes sense as long as competitor locations can carry them out at less than 170 per cent of the costs. This is a huge buffer, and explains why so much restructuring can take place following a relatively small tariff change.