Trump’s trade wars: modest escalation or economic meltdown?
October 2018 | COVER STORY | GLOBAL TRADE
Financier Worldwide Magazine
October 2018 Issue
When does a trade spat become a trade war? Observers of the reciprocal trade tariffs imposed by the US and China have been pondering this underlying question in recent months while the bigger picture narrative continues to unfold.
In some quarters there is no doubt at all that the world’s two largest economies are currently embroiled in a trade war: president Trump’s imposition of tariffs worth $34bn on Chinese goods – measures which China, while expressing “shock” at the US administration’s actions, responded to with tariffs of approximately $60bn on US goods – being deemed sufficient justification for such an assessment.
Others are less inclined to make a case for a trade war, pointing to the fact that the tariffs currently in place account for only a small percentage of the overall US and Chinese economies. Nevertheless, that tit-for-tat tariffs will negatively impact respective business environments is beyond question, with many companies already being hit, including the automobile and food and drinks industries.
In addition, president Trump’s trade offensive involves more than just the imposition of tariffs on Chinese imports. There are a number of jurisdictions in the president’s sights, with the European Union, Canada and Mexico all having tariffs placed on their steel and aluminium imports – a 25 percent tariff on steel and a 10 percent tariff on aluminium. All have responded with a round of countertariffs.
Although the global impact of aggressive US trade policies is likely to be significant, according to many analysts, it is the US itself that has the most to lose. Testifying to this is a CNBC survey of chief financial officers (CFOs) of major US companies, 65 percent of which expressed concern that US trade policy could tip the country into a significant economic slowdown, perhaps even a recession.
While much of the rhetoric coming out of the US, China and other countries may be cheap, the economic consequences of long-drawn-out trade disputes could well prove otherwise.
US stance: protectionism or paranoia?
What then is driving president Trump’s thinking and therefore US trade policy? More pointedly, to what extent is the US stance on China the logical and inevitable product of Mr Trump’s protectionist ideals – i.e., “America First” – or the result of the commander in chief’s paranoid tendencies – i.e., “fake news”.
“President Trump’s trade policy appears to be driven by a sense that the US is being taken advantage of in its current trade arrangements,” says Colin Grabow, a policy analyst at the Cato Institute’s Herbert A. Stiefel Center for Trade Policy Studies. “As evidence, he points to the fact that the US imports more goods and services than it exports, a number that he uses as a kind of scoreboard. Products subject to higher tariffs abroad than in the US also appear to be a source of his ire.”
As it happens, president Trump’s assertion that the US trade deficit is evidence that other countries are cheating the US is dismissed by the vast majority of economists. “The persistent US trade deficit reflects a lack of savings in the US,” says David Dollar, a senior fellow in the John L. Thornton China Center at the Brookings Institution. “The Trump tax cut has increased the fiscal deficit, which is a kind of dissaving, and hence has increased the trade deficit.”
Uncomfortably for Mr Trump, the US trade deficit is expected to be larger in 2018 than it has been in recent years. “His administration’s response to the rising trade deficit is to impose trade taxes on a wide range of partners,” observes Mr Dollar. “This risks undermining the global system that has been the foundation of peace and prosperity for decades. Trade disputes pose economic risks for the US, because many specific interest groups will be hurt, including farmers, manufacturing firms that are part of global value chains, and consumers.”
As far as attitudes in China are concerned, some hold the view that the president’s aggressive trade stance is driven by geopolitics – his intention being to contain China’s growth and prevent it surpassing the US as the world’s largest economy. “Others believe he is merely fulfilling campaign promises and wins more populist support and to be re-elected by bashing China,” suggests Dr Wallace S. Cheng, managing director for China of the International Centre for Trade and Sustainable Development (ICTSD). “It is a big gamble as trade protectionism will inevitably backfire. More dangerously, it fuels economic nationalism and political nativism, which will weaken the US, economically, politically and culturally.”
For Stephen Olson, a research fellow at the Hinrich Foundation, there are three factors driving president Trump’s trade policy. Firstly, that a tough stance on trade will play well for him politically, despite the fact his trade policies are actually hurting his base. Secondly, a belief that trade agreements across the globe are stacked against the US. And thirdly, a fundamental misunderstanding of trade which causes him to view trade balances as a scorecard on who is ‘winning or losing’.
“In terms of the risks of a trade war, the direct impacts on an overall basis are, at this point, likely to be small,” says Mr Olson. “However, the impacts for affected industries could be quite significant, and the ripple effects of market uncertainty and disruption to supply chains could also be significant. And, of course, there is always the danger of escalation.”
Given that the two countries’ strained relationship often claims the lion’s share of the headlines, a casual observer could be forgiven for thinking that China is the sole target of US trade tariffs. While that notion is patently false, it does beg the question as to why the Chinese are receiving particular attention from the US, over and above suggestions as to a battle for global economic supremacy.
“The primary reason for the focus on China is that the country’s industrial policies, in particular its ‘Made in China 2025’ programme, are viewed as a threat to traditional US technological pre-eminence,” says Mr Olsen. “China is employing a variety of non-market activities, including government incentives, subsidies, coerced technology transfers and government-backed acquisitions to establish Chinese global leadership in 10 strategic sectors, which include robotics, aerospace and clean-energy cars.”
Others see the singling out of China as having more to do with the fact that it singlehandedly accounts for more than half the gap between what the US exports to the rest of the world and what it imports.
“Given Trump’s obsession with such numbers and insistence that they are in balance, China would be a logical target of his trade policies,” suggests Mr Grabow. “Ideology plays a role to the extent it prevents China from adopting more market-friendly policies. But I doubt that Trump’s current approach is part of an explicit policy of ideological confrontation. Trump, after all, appears content to engage in trade spats with traditional friends and rivals alike.”
More open to an ideologically driven US trade agenda is Mr Cheng. “The world is not black and white – different societies have different way of organising economy and governance,” he says. “Unfortunately, president Trump and his supporters choose to believe that the US’ political and economic model is right and China’s structure is wrong. The US has accused Chinese governments of providing massive subsidies to its industries. However, the US is not a saint. Its federal, state and local authorities provide billions of dollars of subsidies to farmers and industries, half of which go to big companies such as Boeing, Intel, Alcoa, General Motors and Ford. In addition, US government bailout money for banks since 2008 is in the trillions of dollars, for example Bank of America received $3.5 trillion, Citigroup $2.6 trillion, Morgan Stanley $2.1 trillion and JPMorgan Chase $1.3 trillion. ”
The imposition of tariffs on China and other countries has certainly been challenging for the US in terms of justification. Indeed, many question the extent to which US concerns over China’s trade and other policies, including subsidies, currency manipulation and the acquisition of other countries’ technology, make US tariffs justifiable. “There are a number of legitimate grievances that need to be addressed,” agrees Mr Olsen. “However, the question is whether the US tariffs are the best way to accomplish that.”
As an example of questionable rationale, the Trump administration justified the imposition of steel tariffs on several countries on the basis of Section 232 of the Trade Expansion Act of 1962, which allows the president to impose tariffs if “an article is being imported into the US in such quantities or under such circumstances as to threaten or impair the national security”. This argument, however, is viewed by virtually all commentators as having little or no substance.
For his part, Mr Dollar sees little justification for current US trade policy. Nor does he consider tariffs to be a particularly intelligent strategy. “Firstly, much of the pain falls outside of China,” he explains. “China is at the end of many global value chains, so when its exports are taxed by the US, this hurts firms in South Korea, Taiwan and Japan, not to mention US firms. Secondly, about half of what the US imports from China are machinery and parts used by US firms, so taxing those makes US firms less competitive and may impact jobs. Thirdly, none of this would matter if China could be expected to cave in quickly to US demands. But the Trump administration has seriously underestimated China’s resolve to fight back and its ability to absorb economic pain.”
According to Mr Cheng, the US spent more than six months and millions of dollars on a 301 section investigation – based on the Section 301 of US Trade Act of 1974, which was ruled illegal by the World Trade Organization (WTO) in the 1990s – into China’s hundreds of laws, regulations and practices, but found only one error in China’s regulations that could possibly violate WTO rules. The only error brought by the US to the WTO is that some provisions in Chinese laws provide less favourable protection to foreign technology holders than that to domestic ones in joint ventures. “The Trump administration was unable to present competent evidence nor could it make a legal case for China violating the rules in all other three alleged areas,” he says.
“While China is almost certainly guilty of violating the spirit if not the letter of the law under WTO rules, this in no way justifies tariffs on US consumers and businesses that leave them exposed to retaliatory measures while doing little to move Beijing in a more free trade direction,” says Mr Grabow. “This approach appears likely to produce plenty of pain in exchange for little discernible gain. US tariffs on other countries mostly target their steel and aluminium tariffs, and are absurdly justified on national security grounds despite the fact that many of these countries are US military allies.”
At this stage, the outcome of the US-China trade spat is difficult to determine. “The Trump administration has proven to be one of the most unpredictable in US history, so one prognosticates at their own risk,” advises Mr Olsen. “The outcome I would like to see is a workable modus vivendi between the two countries. Current trade rules are incapable of accommodating and managing a country as large as China which plays the game of trade by a different set of rules, specifically, state-directed capitalism.”
In the view of Mr Dollar, if trade tariffs continue into 2019 the impact on the US economy could be great. “To avoid the negative effect of a potential trade war, some US businesses are already moving operations abroad. In the case of China, it makes sense for business to strengthen ties with Europe, developing Asia and the rest of the world. If the US is withdrawing from the world, then global firms will have to look for opportunities elsewhere.”
Escalation or moderation
Although the trade relationship between the US and China has provided enormous benefits to both countries, it has always been a complex dynamic and relations clearly remain uneasy. Certainly, if president Trump’s readiness to “go to $500bn” in China import tariffs and the continuation of reciprocal tariffs by China ($60bn worth of tariffs on US imports have been threatened) are anything to go by, the trade impasse will not be broken anytime soon, and the overall US-China relationship is unlikely to improve.
“The US-China trade dispute will probably not escalate too much as both sides have a lot to lose from escalation,” suggests Mr Dollar. “The stimulus from the US tax cut will start to wane in 2019 and there is a good chance that the Trump administration will have more appetite for a deal. China is willing to buy more of specific products, such as agriculture and energy, and is gradually opening up more markets. As the US economy weakens, it will become more open to accepting deals that the Chinese put on the table.”
Upping the ante to an extent is the US filing of WTO cases against countries retaliating on account of Section 232 tariffs. China, for its part, has requested WTO dispute consultations with the US, arguing that duties of 25 percent and 10 percent on imports of steel and aluminium products respectively are inconsistent with provisions of the WTO’s General Agreement on Tariffs and Trade (GATT) 1994 and of the Agreement on Safeguards.
“An escalation has largely been anticipated, but investors should take solace in the fact that WTO litigation suggests that parties are inclined to stick to the rules even as they ratchet up the rhetoric,” says Marc L. Busch, Karl F. Landegger professor of international business diplomacy at Georgetown University. “Legally, the US should avoid a WTO ruling on the Section 232 tariffs at almost any cost. Giving other countries licence to be protectionist under the guise of national security would be a disaster. The hope has to be that all of this will give political cover for a negotiated solution.”
Ultimately, to achieve a resolution, compromise will be required by all countries. Concessions are needed to re-establish mutually beneficial trade relationships and ensure that trade spats do not become trade wars.
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