By Giovanni Graziani, Professor of Economics of European Integration at the University of Parma
Sintesi
Questo contributo pone l’accento sulle possibili conseguenze di una azione di Europa e Cina contro gli stati Uniti, sottolineando come i benefici di una trade war tra Stati Uniti e Cina siano di gran lunga minori dei costi. La trade war ha implicazioni negative per l’economia cinese, sia in termini di impatto sugli scambi commerciali che in termini di investimenti e occupazione per i settori target. Nel medio-lungo periodo le tariffe hanno effetti negativi anche sui paesi che le impongono, quindi sugli Stati Uniti stessi. Una trade war tra Stati Uniti e Cina ha implicazioni negative anche per le filiere e le economie globali: la Cina è il maggiore esportatore al mondo e gli Stati Uniti il maggiore consumatore, insieme contano per il 40% dell’economia mondiale. Infine le azioni della amministrazione Trump e le risposte della Cina, entrambe in parziale deroga alle regole della WTO, hanno un generale effetto negativo in termini di indebolimento dei trattati multilaterali internazionali. Si invita quindi uno sforzo da parte dell’Europa unita a giocare da terza parte in questa trade war e per riformare la WTO, anche al fine di garantire gli interessi dei paesi meno forti.
Taken all together and including the recent threats by the Trump administration to extend new tariffs to almost all the American imports from China, the massive waves of US tariffs on China would raise them to levels comparable to those prevailing in the Great Depression years of the 1930s. The tit-for-tat retaliation on the part of China has increased the danger of an all out trade war.
President Trump has declared that trade wars are easy to win. In fact, at a closer inspection, the benefits of the present trade conflict are limited, short lived and uncertain, while most countries lose out, in a situation that appears to be far from a zero-sum game.
The costs to the Chinese economy
In the short term, American tariffs on Chinese exports and the bans on technology, as in the case of Huawei, obviously damage the targeted sectors - electronics, automobile, pharmaceutics, aircraft, furniture, railway locomotives, iron and steel, rubber articles, ships, articles of base metal, chemicals, optical instruments and so on. In the medium-longer run, China might be able to re-direct part of those exports towards other markets, but that takes time.
Although the trade war might have contributed to the slowdown of Chinese export expansion and GDP growth rate, the macroeconomic impact on the Chinese economy should not be overemphasized, given that China’s exports to the United States account for only 4 percent of its GDP.
However, another possible source of damage for the Chinese economy derives from its own retaliation, since imports of affected American products become more expensive. That is the reason why China has been avoiding to retaliate on some American products like aircraft, oil products and automotive products, while at the same time trying to limit the damage by cutting tariffs on all other goods coming from competitors of US producers, thus being able to import at lower prices from the rest of the world. In principle, China could replace imports from the United States with imports from Brazil (soybeans, wood), Germany (aircraft, mechanical equipment, auto), Japan (electric and mechanical equip, auto, optical, plastics), France (aircraft), Canada (seeds, aircraft, wood), Germany (aircraft, mechanical equipment, auto), South Korea (electrical and mechanical equipment, auto, optical, plastics). Some of this substitution is already taking place.
Besides the direct impact on trade, if the trade war is long-lasting China could also face some second-round shocks. The reduction in investment and employment in the exporting sectors hit by the tariffs might become a permanent feature and make it more urgent the task of rebalancing the Chinese export-led development model.
Another, more important, source of shocks derives from the disruption caused to global value chains. More than 40% of the value added in electronics, and almost 30% of that in machinery, is created outside China. Japan, Korea and Taiwan, as well as some European countries (e.g. Germany and UK), and even the US itself, are large contributors to the value embedded in Chinese exports to the US. In other words, value added embodied in parts and components from other countries besides China represent a substantial amount of Chinese exports – particularly in sectors like electronics. Applying tariffs onto those intermediate products is like taxing other countries as well, including the US.
The implications of such disruption of the global value chains for China appear ambiguous. On the one hand the shock might be limited because, as China’s exports to the US tend to decline, its imports of components and inputs from other countries will also decline, spreading in such a way the negative shock across the supply chains. Even the loss of profits might be limited, since many major exporting firms from China are foreign-owned.
On the other side and in the longer term, a protracted trade war might weaken China’s position in the global value chains. With its products restricted by the world’s largest market, China’s competitiveness in global manufacturing, particularly in high-value-added and sophisticated technology products, could decline, making it more difficult its technology convergence over the medium-term.
The downsides for the American economy
Contrary to Trump’s wishful thinking, tariffs are also costly to the country imposing them.
Broadly speaking, the Trump administration is imposing higher tariffs on two kinds of products - intermediate inputs and consumer goods. Certainly, in the short term, American steel and aluminium producers, the other protected industries and the US government (through the tariff revenues) could gain from the US tariff war since they face less import competition.
But these gains would be more than compensated by losses of millions of consumers plus the losses of producers who suffer from the price increase of their inputs.
Standard theory of protection shows that tariffs impose costs on consumers through the higher prices charged by retailers, by the lower volume of goods at their disposal and, finally, by a reduced access to foreign varieties of those products. The present case is no exception. If the last wave of tariffs threatened by the Trump administration comes through, all the consumer products imported from China – including mobile phones, clothing, shoes, toys – will be hit, forcing retailers to raise prices. So, the American consumers will bear the brunt of higher prices both of the goods produced with more costly inputs and of more expensive Chinese final goods. The Footwear Distributors and Retailers of America have estimated that the last wave of US tariffs would amount to $7 billion a year in additional costs for customers. It should be remembered that, in 2018, 69% of all the shoes sold in the US were of Chinese origin. That is also the reason why Walmart, America's largest retailer, which imports 26% of its merchandise from China, said it will raise prices on some products as a result of the Trump administration's tariffs on Chinese goods.
For consumer products such an import tax may also turn out to be regressive, if it reduces the purchasing power of lower-income Americans who spend a greater share of their household budget on consumer goods, including imports.
Moreover, in the medium-longer term, the new tariffs could lead to rising inflation expectations. Rising inflation expectations would force the Fed to raise the interest rate, which could lead to a decrease in stock and property prices.
However, US consumers would not be the only victims. First of all, China’s retaliation is bound to inflict harm on American exporters, including some of those that the Trump administration intended to protect. Soybeans, fruits, pork and various other agricultural producers – together with wood, paper and metal, machinery and chemicals - are now facing higher barriers to sales in the Chinese market.
But, most importantly, American industrial producers are also bound to suffer damages deriving from the basic nature of global value chains. Around half of the tariffs are placed on intermediate inputs coming from China. A considerable part of this kind of trade happens between American producers and their affiliates in China. Taxes on inputs like steel, aluminum, or so-called “parts and accessories”, are embodied in US production, frequently through cross-border supply chains. There is thus a first damage to American exporters, since their production costs become higher. In the medium-longer term this would require to reorganize the global value chains away from China, a very costly process indeed. A generalized reshoring , that is taking production back in the US, would also be costly both in the short and in the longer run, since US innovation depends heavily upon global networks. In either case, firms might be tempted to raise prices in order to overcome such costs.
At the same time, these exporters will also be harmed in the Chinese market by higher tariffs erected by China as retaliation. For instance, US based auto-makers (including German and other EU producers) have been affected by a 40% Chinese retaliatory tariff; farm products like soybeans, fruits, pork and other agricultural products have encountered a similar fate. However, this is not the whole story. As seen previously, while retaliating against the US, China has been lowering its tariff rates on competing products (except autos and parts) from all other WTO members, including Japan, Canada and the EU, who started enjoying a better access to the Chinese market. In this way, American firms are damaged both on the side of costs and on the side of sales. Three examples: in 2018 American soybeans exports were largely replaced by imports from Brazil and Argentina; Canadian lobster exports to China almost doubled, while the American ones declined by 70%; US exports of Pacific salmon to China were substituted by Japanese exports.
The result has been a rather large decline of American exports to China, caused also by a slower growing Chinese domestic demand. In the longer term the US could replace China with Mexico (electrical equipment, furniture, toys, automobiles, plastics), Vietnam (garments, toys, shoes), Canada (auto, plastics), Malaysia (electrical equipment), Japan (electrical and mechanical equipment, furniture, auto). Provided that the Trump administration can restrain from imposing new tariffs onto some of those countries as well.
Finally, China could retaliate in ways that differ from tariffs, like reducing aircraft orders – roughly one third of the world orders for the Boeing 737 Max come from China - or the purchase of American agricultural products and energy or restricting the sale of strategic minerals like rare earths, that are vital inputs for mobile phones and electric cars.
The longer-term toll might even be heavier. Raising the cost of intermediate inputs for downstream US industries makes them less competitive both in the North American and in global markets. Their competitors in the rest of the world can access similar inputs at lower prices because they do not face tariffs. This cost will be increasingly difficult to reverse as other countries start to benefit from discriminatory access to the Chinese market.
Despite the government’s wishful thinking, it is doubtful that there will be a substantial repatriation of jobs into the US. First, the goods imported from China show a much lower value than the goods that can be sold in the US at the American wage level. Second, quite a few developing countries - other than China - can produce these goods, so that American producers are very likely going to move or to source there.
Finally, the macroeconomic impact of the trade war might be even more devastating. Although US exports to China account for only 8.4% of its total exports and 0.6% of its GDP, an escalation of trade tensions could cause concerns among investors in the United States and trigger an equity market drop, which would then affect the US economy through wealth effects on consumption and investment. Firms might start looking for alternatives to locate their activities, eroding in this way the US tax base.
All in all the US trade policy appears to be a policy of self-inflicted wounds.
Impact on the global economy
The impact of a trade war on the global economy cannot be underestimated. China is the world’s largest exporter and the United States the world’s largest consumer; together the two countries account for 40 percent of the world economy.
Economies exporting intermediate products and raw materials to China, such as South Korea and Taiwan, could be hardest hit. Disrupting the global value chains will imply many other losses along the chain, threatening to drag the global economy into recession.
According to a study based on a multi-region dynamic general equilibrium model a global and generalized 10% increase in import tariffs could reduce global GDP by 1% after two years. This effect could be amplified by a fall in productivity, a rise in the financing cost of capital and a decline in investment demand. Taking all these factors into account could result in lowering global real GDP by up to 3% after two years.
The undermining of the rules-based system
There are finally costs that are not easily quantifiable, but are not any lighter.
In all its actions the Trump administration has gone counter either WTO provisions –among others violating the MFN principle of the multilateral system - or established international behaviours of restraint, deliberately weakening the rules-based, multilateral trading system. In fact, it has even gone so far as to block the appointment of Appellate Body members for the Dispute Settlement Body, thus slowing the resolution of ongoing disputes and impeding the process of an important function of the rules-based system.
Until the recent past, most of the trade disputes were treated through the WTO and the vast majority of US tariffs were justified as countervailing and antidumping duties. On the contrary, Trump has invoked US trade laws that afford the Executive branch of the US government enormous discretion to impose new trade restrictions, in particular an extended use of safeguard protection, beyond the one allowed by the WTO, on products like solar panels and washing machines; a very broad definition of national security in applying tariffs on steel and aluminum, undermining a norm of restraint when applying the national security exception; finally the Trump administration went through a very different approach than his predecessors on some long standing critical issues like Chinese unfair trade practices related to forced technology transfer, intellectual property and innovation, the role of the Chinese state in economic activity and its ties with big private companies, the favourable terms allowed to state-owned firms, their policies on foreign investment discriminating against foreign-based companies, a policy of cyber-intrusion into the commercial operations of American companies.
Instead of applying tariffs, there could have been alternative ways to deal with these issues. For example, using the negotiations over a US-China bilateral investment treaty, which were launched by the Obama administration; or challenging the subsidies being given to Chinese domestic firms under the WTO subsidies code, which prohibits such subsidies; or else dealing with threats of stealing trade secrets through security actions rather than trade measures; last, but not least, always acting in cooperation with the EU, Japan and other countries, whose firms have often expressed concern about their discrimination on the Chinese market.
Moreover, in the recent past the United States had established a long-term strategy of writing new trading rules through mega-regional agreements like the Trans-Pacific Partnership (TPP) agreement, to address many of the limitations of current trade agreements. Countering this experience, President Trump withdrew the United States from the TPP agreement.
Two major effects of this US trade policy have been: first, that China has felt obliged to respond with threats of its own without obtaining permission from the WTO, and as a result the two largest members of the trading system are no longer respecting the rules; and, second, that the Trump administration has launched new tariffs also onto established allies like the EU, calling into question a long-standing cooperation.
Paradoxically, these new measures were born out of the side effects of the trade war with China. In fact, other countries have started to benefit from discriminatory access to the two markets affected by the trade conflict. A recent study on the consequences of the Sino-American trade war shows that firms in other countries will capture 82% of the Chinese exports subject to US tariffs, 12% will be retained by Chinese firms and only 6% captured by US firms. Conversely, firms in other countries will capture 85% of the US exports subject to China’s tariffs, leaving small portions for Chinese firms (5%) and for American companies (10%). As expected, the countries that are supposed to obtain the largest gains are the most competitive ones. EU exports would likely increase the most, capturing around $70 billion exports ($50 billion of Chinese exports to the US and $20 billion of US exports to China). Other countries standing to benefit for lesser amounts are Japan, Mexico and Canada, each capturing about $20 billion. Smaller amounts, although representing sometimes an important share of their exports, are captured by Australia, Brazil, India, Philippines, Pakistan and Viet Nam. As for the EU products involved, motor vehicles, aircraft, semiconductor, chemical, machinery, plus some consumer goods stand out as the most promising in this respect. Moreover, the EU could also attract a larger share of Chinese investment, as it did happen in 2018.
However, these effects might be uncertain given the fuzziness surrounding the extent and the duration of tariffs. Moreover the negative global effects will tend to dominate, especially because the trade conflict might turn into a domino-like spiral of retaliations and even currency wars. The Trump administration has already placed tariffs on steel and aluminum towards all the countries in the world and has threatened new tariffs on $11 billion in EU products, in response to Airbus subsidies, and on EU car exports.
While the response of the EU cannot be of pure compliance – quite to the contrary it has announced retaliations on US exports - there should be a united effort of the EU member states to play as a third protagonist beside the two superpowers in order to reform the WTO towards a new rules-based system, which, in the end, is the sole guarantee that the interests of weaker countries will be taken into consideration alongside those of powerful countries and big trade blocs.
