Some Initial Consequences of Trade Tensions

The trade tensions are beginning to have measurable impact.  We focus on initial price changes and indications of changing trade patterns.

The Trump Administration argues that other countries have been taking unfair advantage of the US on trade for years, and what many are calling a trade war is really only the US finally saying enough.  The US has taken many several countries, including China, to the WTO for trade violations and wins the vast majority of cases it has brought.

It has become fashionable to talk about reciprocity and intuitively has much appeal.  However, when one delves into the data, one sees how this important principle is achievable on a high-level but may not be operative on a specific good level.  The weighted-mean tariff that is applied is roughly the same for the highly industrialized countries and considerably higher for emerging markets.

This chart from Pew Research is derived from World Bank data: 

According to this data, Canada has the lowest tariff barriers, while the US, Europe and Japan are within a few tenths of a percent of each other.  Is that an operational definition of reciprocity?  China’s weighted mean tariff is higher than the G7, though compared with other emerging market economies, including Mexico, Brazil, and India, it is not such an outlier.   However, China’s mean-weighted tariff is a prima facia case for it to continue to be considered a non-market economy, which makes it easier for its trading partners to take anti-dumping action.

One of the most significant achievements of GATT and its successor, the WTO, is to reduce tariff barriers to trade.  The main obstacle and distorting factors come from non-tariff barriers.  The challenge to the WTO grows out of its successes, and that is to suggest the low hanging fruit has already been picked.  This is tariffs on merchandise.  Extending the free-trade to agriculture, services, and investment is more controversial.  Addressing non-tariff barriers is even more difficult.

Some in the US Administration and other observers argue China not only violates the spirit and letter of the WTO agreement but that the multilateral institution is ill-equipt to address the challenges posed by it.   This is a powerful claim. In effect, is claims that what China is doing in some areas are not covered by the rules but it should be, and indeed there are discussions on changing the WTO.

It is important to tread carefully here.  As Dani Rodrik argued in a recent editorial in the Financial Times and Ha-Joon Chang argued in his important book “Kicking Away the Ladder:  Development Strategies in Historical Perspective” the US and Western Europe enjoyed economic development under precisely the set of macroeconomic conditions that they are seeking to abolish, such as protectionism, limited capital mobility, and fixed exchange rates.  Just like class mobility within countries has become more rigid in the US and Europe, if many of the trade warriors get their druthers, mobility among countries may be reduced.

The imposition of tariffs and the retaliatory actions will have two main consequences.  It will impact prices and shift trade patterns.  It will not reduce the US trade deficit and it the tariffs collected will not reduce the US budget deficit, which as early as next year will surpass $1 trillion, according to the government’s latest projections.

Measured inflation in the US was already rising before the escalation in trade tensions, which is part of the late cycle story we continue to monitor.   The July CPI is due out at the end of the week at it may have risen to 3.0%, the highest since late 2011.  Already at 2.9%, it is the highest since early 2012.   In recent weeks, several consumer goods companies, including P&G and Coca-Cola have announced price increases, to cover costs of pulp, aluminum and/or transportation (drivers as well as fuel).  Deu to high lumber prices, due to the tariff on Canada, the National Association of Home Builders report the price of construction of a new house has increased by around $7k.  The domestic price of aluminum and steel have risen by about 11% and 33% respectively.

The price of soy has collapsed 22% from late May through mid-July.  Soy has stabilized and recovered about a third in recent weeks.  The price of live hogs tumbled 25% from mid-June through the end of last week.  Several other agriculture products that are vulnerable to Chinese tariffs.  For example, China buys nearly a third of US pecans.  China bought $530 mln in US grown pistachios and is threatening to impose a 45% tariff.  It purchased almost $520 mln of US almonds and will slap a 50% tariff if the US goes forward with its threats.  California’s agricultural output leads the nation with its ~$46 bln industry.  Iowa is a distant second at $27 bln.  California has the most food processing plants ~5330 vs. New York’s ~2510 facilities.

Trade patterns will change as companies respond to the new tariffs and the rhetoric and defensive actions suggest no resolution is likely for a protracted period of time.  Several Taiwanese electronic goods producers are reportedly contemplating moving some production elsewhere in Asia.  Rising labor costs in China in recent years had already encouraged some off-shoring.  Thailand and the Philippines are reportedly among the top choices.  Some US producers, including Harley-Davidson, are reportedly moving some production offshore to avoid US tariffs (steel and aluminum) and retaliatory tariffs.

The tariffs the US imposed are not really aimed at raising revenue.  They are designed to inflict pain on its trading partners to get them to change their behavior in the desired way.  Reports suggest that the US has collected about $2 bln in tariff revenue due to the actions in recent months.  The government has offered some farmers hurt by the tariffs a $12 bln assistance facility.

The Trump Administration plays down the domestic economic impact of the tariffs.  Trump’s top economic adviser Kudlow said the impact was “de minimus”, though he did appear to acknowledge the impact on sentiment.  Most countries reported a decline in the manufacturing Purchasing Managers Survey for July.  Uncertainty surrounding trade is regarded as among the top risk by investors.