Beware the escalating trade war

Trump's surge in import tariffs: from 18 products in January to more than 10,000 today, and other countries' lesser retaliation Source: New York Times

Are we heading for a global trade war? Possibly.

Are we here prepared for it? Sort of.

US President Donald Trump’s love of trade wars is the greatest threat of all. They “are good and easy to win,” he said as he unleashed punitive tariffs on steel and aluminium imports in March. Since then he has escalated rhetoric and action, triggering retaliation from a growing list of countries.

He’d begun in January with tariffs on just 18 products, all involving solar panels and washing machines. But since March the total has swelled to 10,000 across many US sectors, causing growing economic dislocation. Every time another country retaliates modestly, he’s come back with swingeing new tariffs, as this New York Times interactive graphic illustrates.

There’s much worse to come. Trump is threatening another barrage of barriers which would complete the coverage of almost all US imports of Chinese goods. His simple goal is to create more jobs at home by forcing more domestic production. To do so, he’s determined to break down global supply chains and the rules of international trade.

His is a “we win, you lose” trade strategy. This is pure mercantilism, an economic philosophy that dominated in Europe until the 18th century. A partial revival of it in the early 20th century caused the Great Depression. US import tariffs, averaging 45 percent and peaking at 59 percent in 1932, were reciprocated elsewhere.

Post-World War II, the US and other leaders including New Zealand created our current global trading system. It has benefitted people in countries large and small for many decades. Yes, there are some losers in every country. But tearing down the global system would be massively damaging for all. The remedy is to improve the global system and to improve domestic adjustment policies.

In response to Trump in particular, and an increasing backlash against international trade aboard and here, our previous Government lightly revised its trade policies. Our current Government has gone further to articulate a six-point trade strategy, much of it focused on defending and expanding the global rules-based trade system and to rebuild public support for it here.

The new strategy makes good sense for us, and it will see New Zealand play a useful role internationally. We have been chosen, for example, as a member of the 10-country taskforce to engage the US on the World Trade Organisation and to defend its role as the rules body for international trade.

There’s much to defend, as Vangelis Vitalis, MFAT’s deputy secretary of trade and economics, is telling audiences around the country. For example, the meat industry gets savings of some $1 billion a year on its exports, thanks to reductions in tariffs, and increases in enforcement of international rules by the WTO since 1995. Export companies in general are 36 percent more productive, employ 7-12 percent more people, and pay up to seven percent higher wages than their domestic counterparts. Some 625,000 of our jobs rely on open international trade.

But “trade is in troubled waters,” Vitalis told the meat sector’s annual conference last week. “I predict it’s going to get more difficult.”

As worrying as rising trade barriers are, the gravest threat is to the rules-based system. Trump has a simple strategy which could render the WTO ineffective as early as next month. His stranglehold is on the appellate body, whose judges hear countries’ complaints against each other.

There are only four judges left out of seven because Trump is refusing to support appointment of replacements. Come September, there will be only three, the minimum number for a hearings panel. But should one have to recuse themselves because of some connection with plaintiff or defendant nation the judicial system would shudder to a halt.

At that point a country appealing against an adverse WTO ruling could simply ignore it and carry on with their discriminatory trade practice, Mr Vitalis said. Recently, New Zealand won a major meat industry case against Indonesia, proving the value of the system.

The Government’s six-point strategy is to:

  • defend the rules by, for example, its advocacy for the WTO;

  • embed our economy more deeply in regional trade agreements, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP);

  • support other rules-based organisations, such as hosting the APEC summit in 2021;

  • support “open plurilateralism” by expanding our network of free trade agreements (these rely more on signatory countries enforcing the rules themselves rather than appealing to the WTO - currently, 33 percent of our trade is covered by FTAs, which will rise to 64 percent when the CPTPP is fully implemented, and to 72 percent if we conclude one with the EU);

  • use “economic diplomacy” to show New Zealand companies and public the value of open trade, including new online tools showing companies details of tariffs and non-tariff barriers on their products; and

  • engage the public with “Trade for All”, a "conversation" with the public to help “reconstruct the social license”, launched by Prime Minister Ardern this week, as Newsroom reported.

Vitalis' full exposition on the strategy to a parliamentary select committee in May is here, paragraphs 77-85.

For all the merits of this strategy, however, there is much for our Government and business to do to turn these plans into effective responses to the fast-deteriorating international trade system.

Trump’s intention to remake the global economic order to the greater benefit of the US is transparent. The first and still the best guide is the “Trump Economic Plan” published in September 2016. Its authors, Peter Navarro and Wilbur Ross, are now Trump’s Director of Trade and Industrial Policy, and Commerce Secretary respectively.

As Paul Krugman, the Nobel Prize economist, has written: “That white paper was a display of sheer ignorance that had actual trade experts banging their heads on their desks. So these people are completely unprepared for the coming blowback.”

Yet, that’s the plan Trump is pursuing. Navarro told Bloomberg in March: “My function, really, as an economist is to try to provide the underlying analytics that confirm his intuition. And his intuition is always right in these matters.”

But Trump’s ignorance and/or his enthusiasm for lying, knows no bounds. For example, he’s said: “Horrific barriers and tariffs are on US products going in to Europe.” But they face an average tariff of three percent. Yes, there are disparities, such as on cars. But those could be resolved by negotiation, not by destroying the system.

Nor does he understand the nature of global supply chains, which account for two-thirds of cross-border trade. Raising barriers is like “putting up a wall across a factory floor,” Richard Baldwin wrote in his 2016 book The Great Convergence .

Thus, a simple tariff on steel imports has vast repercussions. The average steel price in the US was $900 per tonne at the end of July, thanks to tariffs and the new pricing power they are giving domestic steel makers. This was a sharp rise from US$650 a tonne in February versus a largely unchanged US$600 a tonne in the EU and US$550 in Asia.

This, for example, has raised the cost of a Harley-Davidson motorcycle by US$2,200, prompting the company to move more production from the US to Europe so it can remain competitive in that export market. Likewise, the three major US car makers have all downgraded their production and profit forecasts in recent weeks.

The steel tariffs have also significantly politicised and bureaucratised business. So far companies have filed some 16,000 applications to the US government seeking exemption from the tariffs. Some 500 have been approved and some 400 denied. It’s hard to detect a pattern, but no domestic production seems to help win exemption. But inferior production using older US technology seems to win out against superior imports using new technology, as do US steel makers’ promises they can or will soon make the same product.

US Steel and Nucor, the two largest domestic steel makers, have filed submissions against 10,000 of the applications. It seems they’re getting a good hearing from Ross’ Commerce Department, as the Financial Times has reported; and Arcelor-Mittal, the world’s largest steel maker, has just reported booming US profits. It said it was not worried by the adverse impact on its Canadian, Brazilian and European plants.

In contrast, BMW has expressed concern about the impact of Trump policies on its Spartanburg, South Carolina, plant which exemplifies the power of global supply chains. Only 20 years old, it has attracted some 200 other companies from two dozen countries to set up around it. Together they account for 10 percent of jobs locally. The plant is BMW’s largest in the world, and it has made BMW the largest exporter of US-made cars. More on the story here.

Continental and global supply chains are more efficient than national ones, as the US, Canadian and Mexican car makers show in the North American Free Trade Agreement, just as BMW and others do globally.

There are many other distortions, such as the US$12b of aid Trump is giving US farmers hit by Chinese retaliation on US agricultural products to Trump’s tariffs on Chinese goods.

Clearly, mainstream US business leaders, regardless of their political affiliation are having no impact so far on Trump’s strategy. If Trump succeeds in making the US a more self-sufficient economy, it would be less productive, thereby squeezing living standards, heightening US fears it is falling behind other countries, and aggravating domestic divisions, not to mention global ones.

What would a global trade war look like? Krugman’s analysis in June in the New York Times estimates tariffs of 30-60 percent, a 70 percent reduction in the volume of global trade, a fall in international trade’s share of global GDP back to 1950s levels, and a reduction in global GDP of 2-3 percent.

But those would be largely first-round impacts. The subsequent and extensive restructuring of economies, not just the US’s, would lead to further economic damage.

Will it happen? Probably not if China and the EU, as the two other huge economic blocs, resist heavy-handed retaliation that damages them as much as the US. So far, their responses to each of Trump's rapidly escalating tariff blitzes has been modest and much less than his plays. This serves their economies well. For example, US imports of Chinese goods account for only three percent of Chinese manufacturing revenues. And in much of that, the pain of lost business is shared by component suppliers from other countries, including the US, rather than the Chinese themselves.

Rather than retaliate directly, China has newly widened its welcome to foreign companies. Tesla, for example, is the first granted permission to set up a Chinese car manufacturing plant without a Chinese partner.

But as China imposed its latest package of tariffs carefully targeted to have the greatest impact on US companies, the China Daily , a state-owned newspaper, gave an ominous warning. It pointed out that sales in China account for one-fifth of Apple's global revenues, "leaving it exposed if Chinese people make it a target of anger and national sentiment."

These are deeply perilous times. A global trade war is possible. Now more than ever we must fight for open and fair trade.