Trade War: What it Means and How Likely is it?

Trade War: What it Means and How Likely is it?

 

With Donald Trump’s presidential campaign characterized by a number of high-profile attacks on China, there is a fear that the U.S. will apply punitive taxes on Chinese goods which could eventually escalate into a trade war. Bearing in mind the size of these two economies the effects of this could be damaging not just for the countries involved, but for the whole global economy.

This fear rests predominantly on Trump’s claims that the U.S. could put tariffs as high as 45% on Chinese imports, which would most likely be met by similar tariffs on the Chinese side. This would cause Chinese exports worth $483 billion (in 2015) and U.S. exports of $116 billion respectively, to collapse.

US Corporate Taxes

However, this would only be the start of it. There is the obvious issue, that the increase in the cost of imports would suppress spending. Increased tariffs would amount to what would essentially be a tax on U.S. companies and households. Beyond that there are fears of what a trade war could do to interdependent supply chains.

For example, 35% of China’s exports in 2015 was what is known as ‘processing trade’, whereby China imports the components and then assembles them for export. This means that $169 billion of Chinese exports to the U.S. actually represents imports from other countries such as South Korea, Japan and Taiwan, creating a more substantial need for forex trading in the broader economy.  This could have major knock-on effects for the global economy. What is more, having spent years developing the existing international trade regimes, the dismantling of these would create much confusion and uncertainty.

This is because much of Trump’s protectionist plans contravene World Trade Organization (WTO) regulations. U.S. firms could be particularly vulnerable to an increase in tariffs. Bearing in mind that around one-half off U.S. imports from China are capital goods and intermediate goods, used by American companies for production; domestic U.S. firms may find themselves having to pay more and thus losing competitiveness. This would be damaging for U.S. firms which have played a key role in driving innovation.

China Currency Manipulation

A trade war would be damaging to the global economy, but there are doubts as to whether it is likely to happen. Firstly, one of Trump’s claims that China is a currency manipulator is rather outdated, at least in the way Trump has depicted it. Counter to Trump’s claims, recently China has not been devaluing its currency in order to make its exports more competitive, in fact it appears to have been propping up the yuan.

Secondly, Trump may face strong opposition from pro-market Republicans in Congress who are likely to oppose protectionist policies deemed too much. Despite this, the President does have a fair amount of leeway in this regard. The 1974 Trade Act empowers the president to impose tariffs and other sanctions on countries engaged in unfair practices or relating to large balance of payment deficits. What course Trump takes is yet unclear, but what is clear is that a trade war would not be a good thing for the global economy.

Richard Cox

Richard Cox has a PHD in Macroeconomics and has taught the subject at the university level. He writes for several internet news outlets, including: CNBC, TheStreet.com, NASDAQ, and the Motley Fool.

Follow Richard on Twitter: @RCox_

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