Trade Wars - What's Been Going On?

The Tamim Global Equity investment team takes a closer look at Trump's Trade War and the potential ramifications as it ramps up.  

Increased globalization and the industrial development of China, Korea, Brazil, etc. has created winners and losers. Economic theory states that increased trade, with low or no tariffs benefits all parties, as those with a comparative advantage (costs, know-how, etc.), in particular goods and services, produce more of those goods and service, etc. At the broad macroeconomic level, this has largely been borne out as standards of living have broadly risen for those countries that have taken part in global trade.

However broad macroeconomic statistics don’t tell the whole story, as we know. Workers and regions in the West that have relied on old traditional industries – steel, shipbuilding, mining, car production – have clearly lost out in globalization as these jobs have moved East – either eastern Europe or Asia where labour and material costs have been lower. Increased migration has also pushed down relative wages for those in less skilled work categories in many parts of the West too. 

Donald Trump clearly identified this understandable loss and anger felt in America’s Rustbelt states and promised to bring back jobs to these hard-hit areas. This clearly helped him win the Presidency in key States like Ohio, Pennsylvania, Iowa and Illinois.

Now Trump clearly believes this has a lot to do with unfair trade terms between China, Europe and whoever else is exporting goods in certain categories – steel, aluminium, engineering products, etc. The key questions are: Is this a purely political gesture to his voter base to make them feel better, or will it have a material positive economic impact on these areas? Who will be the winners and losers? How far could it escalate? What will be the wider economic and the political impact of such a trade war? How much will it affect markets?

Is current trade “unfair” as Trump states? It is true that the USA, Europe, China etc. level different tariffs on the same type of goods between themselves. So for example on cars, the USA only imposes a tariff of 2.5% on imported cars, whereas the EU imposes a 10% on imported cars and the Chinese impose a 15% tariff (reduced from 25% from 1 July 2018). However, on train carriages, the US imposes a tariff of 14% whereas the EU only imposes a 1.7% tariff. So it all depends on what you wish to choose to highlight on where the unfairness lies. It’s true that countries like China and Korea do have state subsidies in a number of key areas, which other countries, in theory, don’t allow.

So what about the claim that the USA would “win” from a Trade War? Does it really matter whether it’s true or not? If he truly believes his claim, Trump may continue to pursue the policy to a substantial degree. Well, what will the effects of increasing tariffs be? For those categories where the tariffs increase for Chinese imports into the USA, there is likely to be some substitution for locally produced products if the tariffs make the Chinese imports more expensive than the similar US products, but it is very unlikely to spur the resurrection of old closed plants or new plant capacity unless investors believed the tariffs were to be permanent. So yes, at the margin some jobs could be saved/created in some of the areas hit by globalization.

Of course, China has pledged to hit back with tariffs covering a similar value of trade. Most of the products China have listed from the USA are agricultural products – high-quality fruits from California, Pork products from the Midwest, etc. Now, this may lead to some lost sales for these farmers and ultimately some job losses in the US. The net effect of job losses here versus potential gains in the Rust Belt is difficult to predict, but Trump may regard this as a victory because it helps his voter base more. So you can conceivably have a net economic loss, but a political gain for Trump. So things are never as simple as economic theory suggests.

Macro economically, across the world, tariffs overall raise global prices, consumers buy less, and there is a reduction in economic activity. Of course, government treasuries gain all those tariff charges but they may lose tax revenue from lower economic activity – again it’s difficult to know the net effect.

When investors hear “Trade Wars” they invariably think of the 1930s which was the last time there was a period of significant tariff increases, which was a dark period for the world economy. But we have to remember that there were lots of other policy errors during that time period – fixed exchange rates, allowing banks to collapse, generalized deflation, etc. So trade tariffs were just part of a toxic mix back then.

At the moment, we have to put all this into perspective and recognize that what has currently been announced is actually quite small despite the headlines of $ billions here and there. The USA has the lowest proportion of overseas trade in the world as a % of its GDP. Imports only account for 15% of its GDP, while Exports account for 12% of GDP. Trade is also relatively low for China, Exports 20% of GDP, Imports 17% of GDP. Whereas for Germany its Exports account for 46% of GDP, Imports account for 38%. For the Netherlands, Exports account for 82% of GDP while Imports 71%.

The recent tariffs imposed by the USA on EU steel and aluminium products only fall on $12.5bn of goods traded (2.8% of EU exports to USA); while EU imposition on US agricultural and steel products only amount to $7.5bn of goods traded (2.5% of EU imports from USA).

The size of trade affected by tariffs between China and the USA is altogether more substantial. The US has already announced a total value of $250bn of imports from China with extra levies of 10% (total of 25%) covering over half the value that the US currently imports from China ($462.5bn) These cover a very wide range of goods, covering 28 pages from the US trade’s representative office from aircraft parts, lithium batteries, ICT, robotics, printers & copiers, machinery, autos, cranes and oil & gas parts. Notably, it excludes TVs, and mobile phones, but most manufactured goods are on the list. Of the companies our portfolio hold, the most likely impacted from the Chinese tariffs on the USA would be Caterpillar, with the Japanese rival, Komatsu benefiting at its expense.

“When investors hear “Trade Wars” they invariably think of the 1930s”

World stock markets are understandably worried about escalation risks. Tariffs raise prices across the world and reduce consumption. Further escalation with Europe would likely see a significant sell-off in markets. If the tariffs are broadly confined between USA and China, markets could probably live with that. If these tariffs stick and there is negotiated settlement between the USA and China it will be interesting to see how Chinese companies cope with the increased price and whether they can absorb some of it through reduced pricing, or even moving some of its production offshore. To put it into context, if China lost 30% of its exports to the USA that would reduce Chinese GDP by 1.2%; if they lost every single sale to the USA it would be 4.0% of GDP.

The Tamim Global Equity