Today, trade war is the highest risk to global growth. Previously, lower tariffs and relaxed trade barriers reinforced global supply chain and caused a major increase in global trade. According to statistics, the average rate of tariffs on imports by World Trade Organization members declined from a little more than 12.74% in 1996 to 8.8% in 2016. Hence, global trade went from $5 trillion in 1996 to $19 trillion in 2013.
However, the United States has started trade disputes with several different economies in order to achieve what it believes to be fair trade. The most intense one is its conflict with China, resulting in a series of additional tariffs. People are assuming that because America is the net buyer and China is the net seller in their trade relationship, China will lose the trade war and ultimately surrender. The truth is that tariffs will hurt both countries. This is because most tariffed products can’t easily be replaced, so they will continue to be purchased and this time at higher prices.
Hence, if no deal is reached by March 2, Trump has said he will proceed with raising tariffs to 25 percent from 10 percent on $200 billion worth of Chinese imports, at a time when China’s economy is slowing significantly. On the other hand, Beijing has retaliated in turn to U.S. tariffs. When a tariff is applied to a particular good, here’s what can happen:
Due to the trade war, it is certain that in some industries, companies will be reluctant or unable to pass the cost onto their customers. Therefore, this implies reduced profits for the company. At the same time, for public companies, earnings will be affected and therefore could also impact stock prices.
Let’s take for example Alcoa, the largest producer of aluminium in the US. At first glance, anyone would assume that Alcoa would benefit from tariffs on foreign producers of aluminium; but it’s not that simple. In fact, Alcoa’s input costs have risen because it utilizes a significant amount of primary aluminium from Canada, which it melts to produce its own aluminium. In an interview, the CEO of Alcoa has diplomatically argued that not only do tariffs hurt profitability, they distort the market and make it less efficient “by incentivizing the restart of aged, inefficient capacity” in the United States.
Due these tariffs, many companies may decide to pass the cost on their customers which is the case for Apple, for example. Thus, this means that consumers pay more for the same item, leaving them less money to spend on other goods or services.
As companies pass the cost of tariffs to their customers, at the same time, demand decreases because consumers would want to cut back their purchases. For instance: “demand destruction” is already being experienced in an industry that was one of the first to be involved by the imposition of tariffs at the start of 2018: washing machines. In fact, the same thing could happen to other items, including other big purchases such as cars, if tariffs are applied to them.
Besides, tariffs have other negative effects. For instance: they undermine business confidence by increasing policy uncertainty. Additionally, tariffs can create inefficiency and lower productivity.
US China Trade war – Is it the right approach?
It is certain that the United States has legitimate issues with China; valid concerns about access to markets and intellectual property violations. Many believe that the right approach is to pursue them with the World Trade Organization, not through tariffs. This is mainly because using tariffs only opens it up to retaliation from China. We should not forget that China has a large arsenal of weapons, beyond tariffs, that it can use against the United States. Some of these weapons are:
- One of the actions which China is currently taking: Counter the drop in foreign purchases of Chinese goods through increased domestic spending. The US executive branch cannot execute similar stimulus without a spending bill approved by Congress.
- The possibility to depreciate the yuan to lower the price of Chinese goods to American buyers in order to counter the impact of tariffs.
- China can deal with this situation by creating closer trading relationships with other countries to isolate and exclude the United States (for example, China cut auto tariffs for US allies).
- China can also go all the way to encourage North Korea to antagonize the United States, given that improved relations with North Korea has been an important goal of President Donald Trump’s.
- Another action which can be taken is to execute a regulatory crackdown on American companies (environmental or anti-monopoly investigations, for example).
- China can place an embargo on the sale of rare earth metals to American companies and the US government (It is to be noted that this is a required material for many smart phones and US missile defense systems).
For the time being, the good news is that the two countries have agreed pause their trade war. However, it’s not at all clear whether they will be able to work out a resolution. The bottom line is that, given President Xi’s status as president for life, China can drag this situation over time. On the other hand, President Trump has a re-election campaign to worry about in less than two years.