The real problem is that no one knows where it will endby George Magnus / July 16, 2018 / Leave a comment
No one should be in any doubt now that President Donald Trump is serious about waging a trade war. He thinks that China, the European Union and his northern and southern American neighbours are using trade to exploit the United States, and that the World Trade Organisation can be threatened or preferably, neutered.
While the UK isn’t centre-stage in Trump’s jaundiced view about how the world’s trading system works, Brexiteers should have known not to trust the US President, and over the weekend he devastated their hopes. But the problem goes far wider. Trump has already put at risk or threatened about $1 trillion, or roughly 7 per cent, of world trade. This is still escalating, and the consequences could be deeply troubling.
Trump fired the first trade salvo at the start of the year with tariffs on about $10bn of imports of washing machines and solar panels. Next came the implementation of 25 and 10 per cent tariffs on $50bn of steel and aluminium imports, respectively. These affected mainly Canada, Brazil, Mexico, South Korea, Japan and the EU. Following warnings and investigations, on 6th July, the first $34bn of a $50bn list of several hundred products from China were subjected to a 25 per cent tariff, with the rest coming into effect soon. These goods were selected under trade legislation specifying “national security” and aimed at China’s technology capacity and its industrial policy, called Made in China 2025.
Because China retaliated against the US measures, as it said it would, the White House issued last week a further list of 6,000 imported products, valued at $200bn, on which it proposed to levy a 10 per cent tariff after a review period, and commencing probably around October. Most of these products fall into the electrical and machinery categories and the plan is also aimed at Made in China priority sectors, but consumer products, such as furniture and vehicles are also included.
Higher tariffs on $250bn of imports from China would cover half of all US imports from that country, and just under 9 per cent of all US imports. Assuming that China retaliates in ways yet to be determined, the US has threatened to subject a further $200bn of imports from China to higher tariffs. This would mean nearly all $505bn of imports into the US from China would be affected by Trump’s tariffs. With full retaliation, China’s $130bn of imports from the US would also be affected, but it is clear that China’s counter-measures would have to go beyond simple tit-for-tat tariff behaviour because of the much smaller volume of imports.
“There will be multiplier effects across countries as lower output and higher prices get passed around”
But assuming for the moment that Trump’s tariffs meet with full retaliation, whatever the form, they will have affected $800bn of world trade. The US is also considering the imposition of further tariffs on imports of automobiles and parts under national security legislation, covering more than $250bn worth of products. These would have a far-reaching impact on America’s principal allies in Europe and Asia, and bring the total value of trade subjected to new higher tariffs to at least $1 trillion. With full retaliation, the volume can be expected to go considerably further.
It is important to note that China’s tit-for-tat opportunities are limited because of the huge imbalance between American imports from China and vice-versa. If China wants to retaliate and keep the pressure on the US, it will have to find non-tariff methods once it has dealt with $130bn of imports, and/or subject some US goods to much higher new tariffs. Some observers expect China to devalue the Renminbi or sell some of its holdings of US Treasury bonds. These actions most unlikely. The latter would be self-defeating because Chinese reserve asset values would drop. The former would risk reigniting capital flight at a highly sensitive time for the Chinese economy, and destabilising Asian and global markets.
Rather, China should be expected to target US companies operating in China, making it more cumbersome or expensive for them to do business relative to say, EU or Japanese companies. The government could delay or block licenses and approvals for US companies in China, and subject US investment in and imports to China to administrative delays, inspections, and general awkwardness.
So far most commentators, along with financial markets, have been relatively unperturbed about this escalating trade war. The Chinese equity market is an exception, having dropped sharply to flirt with levels last seen in the 2015-16 crisis, but this has more to do with what’s going on in China rather than what’s being done to China. From what we know today about the scale of the trade war, the effects will be harmful to global growth, but not critically so. International institutions and global banks think the impact might be limited to about 0.25-0.5 per cent globally over 12 months, and push inflation up by perhaps 0.25 per cent. The effects on the US and China would be rather larger, but still not enough to provoke a recession.
The trouble is that no one knows where this will end. There will be second-round effects as supply chains become disrupted, investment flows and business confidence weaken, and multiplier effects across countries as lower output and higher prices get passed around. These trends are then likely to re-enforce additional protectionism, impair competition and foster bad blood between nations. This is an environment in which downside growth risks loom a lot larger. Further, the cycle of trade responses could intensify, with the US, for example, upping new tariff rates to well above 10-20 per cent.
Under these circumstances, we should expect the global consequences of a trade war to become much more serious. One major investment bank has suggested that in a more aggressive trade environment, the world economy could become as recessionary as it became after the Lehman crisis, with a hit to US and Chinese growth of between 2.25-2.5 per cent, and to the EU of about 1.5 per cent.
What happens next depends on how this war is going to be fought. The US alone can’t fight a war if other nations don’t play ball by retaliating. But by not retaliating, they will appear weak and willing to be bullied further. Trump will doubtless oblige. We should expect this trade war to get worse, and hope that the rest of the world lines up to support long-term interests in America but to oppose Trump.