Until recently, some thought President Trump’s trade rhetoric was sabre-rattling for the political base at home. Others that it was a re-run of the US-Japan trade spat in the 1980s. No one should be in any doubt now that President Trump is serious about waging a trade war. He thinks trade deals are a way which others exploit America, that China, the EU and his northern and southern neighbours are the worst offenders, and that the World Trade Organisation can be threatened or preferably, neutered. Trump has already put at risk or threatened about $1 trillion, or roughly 7 per cent, of world trade. It is by no means the end, and the consequences are not good.
From small acorns…
Trump fired the first trade salvo at the start of the year with tariffs on about $10 billion of imports of washing machines and solar panels. Next came the implementation of 25 and 10 per cent tariffs on $50 billion of steel and aluminium imports, respectively. These affected mainly Canada, Brazil, Mexico, S.Korea, Japan and the EU. Following warnings about and investigations into China’s intellectual property policies under Section 301 of the Trade Act 1974, the US vowed it would impose new 25 per cent tariffs on $50 billion of imports from China targeted at the 10 sectors China has prioritised in its Made in China 2025 industrial policy. These sectors are information technology, numerical control tools and robotics, aerospace equipment, ocean engineering equipment and high-tech ships, railway equipment, energy saving and new energy vehicles, power equipment, new material, medicine and medical devices, and agricultural machinery.
The real significance of these measures was not so much China’s exports, as such, which are still quite small, but the use of national security as the reason for the targeting of China’s key industrial sectors via trade measures specifically but also in broader and more enduring ways. These tariffs were implemented on 6 July, the first $34 billion of the $50 billion list of several hundred products immediately, with the remainder by the end off the month.
Because China retaliated against the US measures, as it said it would, the White House issued last week a further list of 6000 imported products, valued at $200 billion on which it is proposed to levy a 10 per cent tariff after a review period, and commencing probably around October. Most of these products fall under categories covered by electrical and other machinery, and electronics goods and are also aimed at Made in China priority sectors, but consumer products, such as furniture and vehicles are also included.
Higher tariffs on $250 billion of imports from China now 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 $200 billion of imports from China to higher tariffs. This would mean nearly all $505 billion of imports into the US from China would be affected by Trump’s tariffs. With full retaliation, China’s $130 billion 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.
But, assuming for the moment, that Trump’s tariffs meet with full retaliation, whatever the form, they will have affected $800 billion of world trade, The US is also considering the imposition of tariffs on imports of automobiles and parts, also under national security legislation, and covering products worth over $250 billion. 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 wanted to retaliate and keep the pressure on the US, it will have to find non-tariff methods once it has dealt with $130 billion of imports, and or subject some US goods to much higher new tariffs. Some observers have expected China to devalue the Renminbi or seen some of its holdings of US Treasury bonds. These actions are ‘old chestnuts’ and 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 — in which China has no interest.
Rather, China should be expected to target or discriminate against 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. Further, it could simply confirm the operational management difficulties about which foreign firms complain, by insisting that state-owned enterprises and other Chinese firms continue to benefit from special regulatory and commercial treatment, and make life difficult for US firms.
China has form when it comes to targeting foreign firms. In March 2017, it restricted tourists wanting to go to South Korea as a protest against Seoul’s adoption of a controversial US-supplied missile shield. Previously, in November 2016, angry about the visit of the Dalai Lama to Mongolia, it imposed punitive fees on the country’s commodity exports. In 2012, the Chinese government encouraged anti-Japan protests and actions against Japanese companies as tensions rose over the disputed Diaoyu or Senkaku Islands, and it also curbed tourism to and banana imports from the Philippines over the disputed Scarborough Shoal in the South China Sea. In 2010, China acted against imports of Norwegian salmon over the Nobel Prize award to Chinese dissident, Liu Xiaobao, and implemented a rare-earth export embargo against Japan and other western nations, partly related to an earlier dispute over the Senkaku Islands.
So, if it wanted to, Beijing could target companies where the domestic effects might be negligible, and or where there are alternative foreign suppliers. It could, for example, cancel orders for aircraft built by Boeing, whose China sales generated about 12 per cent of the company’s global sales in 2015. Airbus provides a ready substitute. It could target semiconductor manufacturers such as Qualcomm and Broadcom, most of whose revenues come from China. It could penalise US companies with big China operations, such as Apple, General Motors, Wal-Mart and Starbucks, all of whom do big business there and are looking to expand. Yet, this sort of policy could become highly risky for China, threatening not only Chinese jobs and the livelihoods of citizens, but also the remnants of whatever trust existed between the US and China. That is a price China may simply be unwilling to pay, except in extremis.
China will therefore, have to give serious thought to how to respond to Trump. It may have not taken Trump’s trade policy seriously enough at the outset, and under-estimated the impact that an escalating trade war might have on the export sector and wider economy that is experiencing slowdown pressures, regardless. So far, China has not acted disproportionately. Its latest responses include state rhetoric about refusing to be bullied, instructions to state media to down-play trade war coverage and reports about the Made in China 2025 strategy, a willingness to work with the EU and Japan directly and int eh WTO to counter American trade policies, and a preparedness to offer US and other foreign companies more liberal terms regarding entry into and ownership structures of specific sectors, such as autos and finance. The German chemicals giant, BASF, moreover, was revealed last week to have been allowed to proceed with a major Guangdong project in which it would be the sole owner. And BMW learned that from none other than Premier Li Keqiang that it ‘could’ become the first foreign auto company in China to be allowed to become a majority owner in its joint venture (with Brilliance Auto Group).
So far, most commentators and 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 among 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, UBS, 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.
It is questionable whether global markets are discounting properly the cumulative effects of a trade war on the scale that we can discern today. It is certain that they haven’t even begun to contemplate the effects of an escalation in the trade war.
What happens next depends on how this war is going to be fought. The US alone can’t fight a war if the rest of the world doesn’t play ball by retaliating. But by not retaliating, it will appear weak and willing to be bullied. Trump will doubtless oblige, and so we should expect this trade war to get worse first.