What do we mean by the phrase ‘Trade War’?
There is much rhetoric in the newspapers that the world is on the brink of a trade war, if not already in the grip of one. Much of this has been hyperbole but financial markets have had to consider the potential effects of a full-blown trade war on global growth. This has been difficult given almost daily developments on the issue since early March. But are we truly experiencing a trade war or is this something else?
In this focus article we look at what we mean by the phrase ‘trade war’; how that differs from the negotiations we are currently witnessing; and how a true trade war could impact the global economy.
A trade war is an economic conflict where countries raise barriers to trade with each other. This generally takes the form of tariffs (import taxes), quotas on imports, or subsidies to domestic industries. It is usually motivated by a desire to protect domestic jobs and leads to competitor nations imposing tariffs or quotas of their own.
They start when one country perceives another country's trading practices to be unfair, or when trade unions pressure politicians to make imported goods less attractive to consumers.
Based on that definition it certainly looks like we are in the midst of a trade war.
To meet the requirements for a trade ‘war’ the barriers needs to be significant in terms of their size and the proportion of imports covered.
The US has now applied tariffs to almost half of all Chinese imports, but this is only 1.3% of US economic activity. China in turn has applied tariffs to almost 90% of US imports or 0.78% of China’s economic activity.1 Even if you combined all the proposed US and Chinese tariffs it would account for only 1% of global trade.1
Although large numbers, these are not ‘significant’ when we look at the bigger picture.
So while the rhetoric and sabre rattling have escalated over the summer, what we have really seen is a phoney trade war. This is a trade dispute in which the US is seeking a negotiated settlement to level the playing field, achieve better access for US exports to China, and better treatment of US intellectual property.
Donald Trump made cutting the country's trade deficit - the difference between how much the US imports and exports – a major focus. At the end of 2017, this stood at $566bn, while the trade deficit with China alone stood at $375bn.2
1. Alpinemacro, Lloyds Bank plc, September 2018
2. Can Trump Win an Escalating Trade War Against China? Bloomberg 18 September 2018; Trade wars, Trump tariffs and protectionism explained, BBC, 26 July 2018
Mr Trump has also accused China of unfair trade practices – including maintaining an artificially low exchange rate, theft of intellectual copyright and state-sponsored industrial espionage.
The US has threatened to impose tariffs on a further $267bn of Chinese imports but these are contingent on not reaching a negotiated solution.
The success or otherwise of these negotiations could result in these additional tariffs – and even all tariffs – being cancelled, delayed indefinitely, or watered down.
However, we are only at the start of what could prove to be a very protracted process and we may have some way to go before we know which outcome is most likely.
Trade in goods can be divided into four main lasses. Primary goods are those that occur naturally and require minimal processing. This includes foodstuffs, minerals and energy. Intermediate goods are semi-finished products such as components. Consumer goods are fully-formed products ready for sale and capital goods are the machines used in manufacturing processes.
Intermediate goods comprise the largest component of world trade, and thus far have been spared the imposition of tariffs; the main focus has been on primary goods and this is another reason to believe that this is not a trade war.
President Trump has repeatedly stated that he feels the US got a bad deal from globalisation. His main campaign slogan – Let’s Make America Great Again – is based on boosting US manufacturing jobs.
During the campaign, he repeatedly stated that he would renegotiate trade settlements, and three days after becoming president, he withdrew the US from the Trans-Pacific Partnership believing it would undermine the US economy and its sovereignty.
He also called the North American Free Trade Agreement "the worst trade deal the US has ever signed".
The US recently agreed revised trade terms with Mexico, Canada and South Korea, and this bodes well for discussions with other trading partners.
To impose these tariffs and quotas, President Trump is using the little-known and seldom-used Section 232 of the Trade Expansion Act of 1962 which allows the imposition of tariffs if "an article is being imported into the United States in such quantities or under such circumstances as to threaten or impair the national security."
Canadian Prime Minister Justin Trudeau responded: "That Canada could be considered a national security risk to the United States is inconceivable.”
Both the US and China have appealed to the World Trade Organisation (“WTO”, see box) for intervention and redress. China has questioned the legality of the broader tariffs, which it claims put the WTO in “unprecedented danger”.
The US’s trading partners have also responded to the tariffs in kind, with Mexico, China and the EU all implementing tariffs that match in value those applied by the US.3
As the dispute has escalated, China has threatened to continue imposing counter tariffs but this could prove difficult as China does not import enough from the US to achieve this aim. What Chinese authorities could do is slow down border checks and import permits to hamper US trade.
3. Trade wars, Trump tariffs and protectionism explained, BBC, 26 July 2018
At home, the tariffs have bipartisan political support with Democrats representing the major industrial heartlands joining Republicans behind the President.
However, talk of a trade war alarms many US business leaders, who largely support existing trade deals, and investors who fear lower profits and slower economic growth.
While Trump has argued trade wars are good and easy to win, most economists would say they are universally bad and easy to lose, and that a full-blown trade war could be as damaging as the Global Financial Crisis of 2007/08.4
Critics argue that protectionism often hurts the people it is intended to protect by slowing economic growth, and introducing price increases, particularly in manufacturing.
In a Reuters survey almost 80% of 60 economists believed that the tariffs on steel and aluminium imports would harm the US economy, with the rest believing they would have little or no effect; none believed they would benefit the US economy. 5
The steel tariffs are a case in point. Many more people are employed in industries that buy steel to make products than in steel-making itself; by a factor of 80 to 1. So eighty times as many jobs are potentially put at risk than might be saved. When the Bush administration imposed steel tariffs in 2002, 200,000 jobs were lost.6
Companies that do not export much are likely to benefit from reduced competition. Companies that do export will clearly face higher tariffs and reduced demand. On the day in September that the US imposed tariffs on $200bn of Chinese imports and China retaliated with tariffs on $110bn of US imports, shares in Boeing fell by 1.14%.
China also announced that it was cutting import duties for other trading partners.
If these companies are providing components for other manufacturers this increase is passed along the chain. If the company at the end of the chain is an exporter, not only are their goods more expensive, they could face tariffs themselves.
And we shouldn’t forget that many of these ‘Chinese’ imports are manufactured by overseas operations of American companies. Not only could these face import tariffs from the US, but Chinese authorities could make life difficult for these subsidiaries.
By increasing costs, trade tensions could boost inflation more than desired over the short term. As a result, the US Federal Reserve (the US central bank) might feel the need to raise interest rates faster than it had planned.
Chinese manufacturers are heavily exposed to export markets and could face bankruptcy and/or factory closures. This in turn would lead to job losses and falling domestic incomes.
If Chinese economic activity shrinks by $10bn, approximately 143,000 jobs could be lost. If it shrinks by $50bn, 700,000 jobs could be lost.6
The European Union (EU) has a much smaller trade deficit with the US at $92bn, while approximately 2.6m US jobs rely on trade with the EU7; there is currently an uneasy truce in place.
4. The Re-emergence of Protectionism, KPMG Economics & Tax Centre, April 2018
5. Economists united: Trump tariffs won't help the economy, Reuters, 14 March 2018
6. The Real Risks of Trump's Steel and Aluminum Tariffs, The New York Times, 1 March 2018.
7. Alpinemacro 2018, Lloyds Bank plc, September 2018
The issue with the EU is less about tariffs, which are only slightly higher than the equivalent US tariffs, but about other controls on US imports. These include border controls, food safety concerns, environmental controls that limit automobile imports, and country of origin checks.
As the US becomes increasingly protectionist, it could open up opportunities for the EU to strike deals across Asia, and replace the US as the major trading partner.
The EU recently struck a wide-ranging deal with Japan and has agreements with Indonesia, the Philippines, Australia and New Zealand in progress.
The UK’s import-heavy economy is more resilient to the impact of US tariffs than countries such as China and Germany, who export more goods than they import.
However, the steel tariffs could have a profound impact on the UK steel sector which is in the midst of a fragile recovery.
Supporters of Brexit hope that a free trade deal between the US and UK could make up for any economic pain caused by leaving the EU. However, an increasingly protectionist world could make inheriting the EU’s old trade deals and winning new ones difficult.
While the dispute between the world’s two largest economies appears to be contained for now, there are fears that Donald Trump’s stance on trade could cause serious damage to the global economy.
A full-blown trade war between China and the United States could be devastating with reduced trade and disrupted supplies. This would have a big impact on Asia and other emerging markets which rely on supplying raw materials and components to Chinese manufacturers.
And it could worsen if Donald Trump turns his attention to other trading partners. This could lead to an increase in global inflation and stalling economic growth as businesses become nervous about committing to new investments, or cancel those already planned.
While there has been plenty of rhetoric that we are in the grip of a trade war, the data indicate that the tariffs imposed by the US and China are neither deep enough nor broad enough to warrant such doom mongering.
President Trump built his campaign on promising to reverse the effects of globalisation on US manufacturing, and on what he sees as China’s unfair trade practices.
To achieve these aims he is seeking to increase the price of Chinese and other imports to level the playing field with domestic US manufacturers.
He has already had some success in renegotiating trade terms with some of the US’s trade partners but there has been little dialogue with China’s trade delegations, and talks with Canada are at a stalemate.
However, as tensions and tariffs escalate there is a risk that this skirmish could pass over to a full-blown battle. If that were to happen, it could have a major bearing on the global economy.
There is no reason to believe that things will reach that point. Trade negotiations are a long drawn-out process at the best of times: the recent trade deal between the EU and Canada took seven years to agree and a further two years to be implemented.
However, China does not have the same sort of official negotiating channels in place that other major economies benefit from, and initiating consistent dialogue can be difficult.
Forecasts of future performance are not a reliable guide to actual results in the future, neither is past performance a reliable guide to future performance. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed. Any views expressed are our in-house views at October 2018. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. This information may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.
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