The Skinny on the Big, Fat Trade Dispute…

The current trade debate began back in January when the Trump administration, fed up with what it viewed as unfair trade practices, began threatening to levy tariffs against China.  These threats became real in early July when U.S. slapped levies on $34 billion worth of Chinese goods. China responded by imposing tariffs on a similar dollar value of U.S. imports. Both sides are now threatening further levies on billions more of trade. While we cannot predict the ultimate impact of this evolving trade war, here are a few things we do know.

China has more to lose than the U.S. but…At first blush it would appear that China has more to lose in a trade war than we do. About 20% of the country’s exports (4% of their GDP) go to America while less than 10% of our exports (less than 1% of our GDP) go to China. But this analysis ignores the secondary “knock-on” effects (see below) and longer term impact of any prolonged trade war. China already has plans to become a leader in ten strategic sectors ranging from semiconductors to agricultural machinery. The latest dispute will only hasten these efforts. By throwing up trade barriers, we may also inadvertently strengthen the relationships of our key trading partners with China.

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There will be collateral damage…Given the complex nature of global supply chains, any prolonged trade war with China is likely to produce unintended consequences. Consider that German based Daimler and BMW now face 40% tariffs on the U.S.-made sport utility vehicles that they export to China. And California-based Varian Medical Systems, which makes equipment in China for export to the U.S., also now faces new tariffs. The stock markets of export-oriented Asian economies such as Malaysia and Thailand, which often route their goods through China, have already sold off and U.S. inflation is ticking up.

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Global growth will likely slow…A basic law of economics is that the higher the price of a good, the less is consumed. Tariffs which increase the price of goods have a long and documented history of depressing global growth. And while most consider tariffs a way of penalizing imports, the reality is quite different. Dartmouth professor Douglas Irwin examined the long-term relationship between imports and exports and found that they tend to move pretty much in lock step (see chart above). The logic here is pretty straightforward – by shutting down a trading partner’s imports you also deprive them of the money needed to buy exports.

Tariffs don’t directly address the real problem... The proposed new tariffs do little to address the larger and more troubling issue of our trade relationship with China: U.S. firms’ restricted access to Chinese markets and intellectual property theft. Companies looking to do business in China today typically must establish joint ventures with local firms and agree to “share” important technology. This practice remains in effect despite being in violation of accepted World Trade Organization rules. Policies aimed at forcing China to address these trade practices should be encouraged. But using the threat of tariffs may be akin to using a blunt hammer to conduct fine surgery. You may get the job done but lose the patient in the process.