Trump Era Portending Radical Policy Changes
The economic agenda, as propagated by President Donald Trump during his 2016 election campaign, aims at boosting job growth for Americans, thereby strengthening the manufacturing sector and bringing in sustained economic growth. The main areas in focus were tax cuts, infrastructure spending, immigration, and trade. However, President Trump’s economic program, if implemented, will have radical implications for the US and global economies. In the case of trade, the rhetoric centers on two primary focal areas: practicing trade protectionism and combating unfair trade practices.
USA’s Anti-dumping Rules and Retrogressing US-China Relations
US-China trade ties have expanded multifold since China embarked on the path of trade liberalization in the late 1970s and established itself as the largest merchandise trading partner of the United States. In effect, total US-China goods trade increased from a meagre $2 billion in 1979 to an average of $636 billion in 2017, with a compound annual growth rate (CAGR) of 16.7%. In the first two months of 2018 alone, total trade between the two countries amounted to $104.5 billion, increasing from $94.0 during the same period in 2017. China has remained the largest import partner and the third-largest exporting market to the US, following Canada and Mexico. China’s share in total US imports, standing at 21.6% in 2017, is steadily growing. Total import in the US from China, as of 2017, matched import from the whole of Europe. Import from China accounts for about 50% of the total US import from the whole of Asia. As a result, US trade deficit with China has increased substantially over the years. It amounted to $375.2 billion in 2017, up from $10.4 billion in 1990. However, the United States has a trade deficit with most of the countries in the world, with its world trade deficit rising from about $100 billion in 1990 to about $760 billion in 2017.
Chart 1: United States Imports, Exports, and Trade Balance with China, United States, 1990–2017
The Trump era is witnessing a rather aggressive stance to reduce the US trade deficit for promoting “fair and reciprocal” free trade as well as the President’s much heralded “America first” policies. Unfair trade policies relating to the alleged dumping practices governed by China have always been criticized by the US. There has also been a gradual shift of production sites from the East Asian countries of the Pacific Rim to China in the last two decades due to the gradual ushering in of a favorable investment environment in the country. This has caused US manufactured imports from China to increase.
Possibility of a Trade War
Some of the recent developments are indicative of increasingly tense trade relations between the two powerhouses. In August 2017, the United States Trade Representative (USTR) launched a Section 301 of the Trade Act of 1974 investigation into China’s Intellectual Property Rights (IPR) policies to analyze the impact of such policies on the US economy.
Section 301, which was there even before the inception of the World Trade Organization (WTO), is a powerful tool in the hands of the US. It gives legal authority to the USTR to impose import duties in response to foreign trade barriers. Since the formation of the WTO, all trade-related disagreement cases have been taken to the WTO Dispute Settlement Body. However, with the initiation of Section 301, the US is unlikely to follow WTO rules; and President Trump appears to be prepared to leverage it for the country’s international trade ties.
On November 28, 2017, the US Department of Commerce initiated an antidumping duty investigation for imports of common alloy aluminum sheets from China. Notably, in 2016, imports of common alloy sheets from China amounted to $603.6 million. The situation exacerbated when on March 8, 2018, President Trump announced that it would levy additional import tariffs on steel (25%) and aluminum (10%) with exemptions given to allies such as Canada, Mexico, European Union, Australia, Argentina, Brazil, and South Korea. The tariff will raise the costs of imported steel, which is primarily sourced from China. Unquestionably, the Chinese economy depends heavily on steel exports. Additionally, based on the Section 301 report released by the USTR on March 22, 2018, President Trump announced an increase in tariffs by 25% on certain Chinese products. On April 1, 2018, China retaliated by increasing tariffs from 15% to 25% on 128 products (primarily, important food articles)—an estimated $3 billion of these products were imported by China from the US in 2017. On April 4, 2018, the USTR went with a further announcement of 25% tariffs on 1,300 types of technology, transport, and medical products to take effect from May 15 onwards.
Predictions and Scenario-based Implications
Both the US and China are in violation of WTO principles, which will harm their economies leaving other countries in economic and political jeopardy.
An ensuing trade battle could have three possible outcomes:
- Moderate Trade War Scenario (Chances of Occurrence in 2018: 50%):
Let us assume that the announced tariffs are implemented and no further escalation is announced. This moderate trade war scenario, where the US and China increase bilateral tariff from 15% up to 40% in 2018, will affect China adversely as the country is expected to lose 1.5% of investment in 2018. This will affect its trade balance, with exports diminishing by about 1%, and eventually pull its real GDP growth rate down to 6.0% in 2018, compared to the previously forecast 6.5%.
In the US, with hiked tariffs for steel and aluminum, the energy and automotive industries will be adversely affected in the short run, with growth likely to be lower than projected in the second half of the year. Moreover, the trade balance might not improve, as opposed to what President Trump had foreseen. In an economy where corporate taxes are slashed, a favorable investment environment will be promoted, encouraging borrowing. Hence, the budget deficit would equiproportionately worsen with higher capital inflows and a larger trade deficit. Hence, in a country aiming at burgeoning manufacturing, US companies will eventually find alternative sources of import without altering the trade balance significantly. US investment inflows and real GDP will see a moderate drop in the short run. However, the growth of manufacturing jobs, as propagated by the Trump administration, might take a few years to rebound due to the low availability of skilled labor (only 6.9% (as of 2016) total laborers were devoted to manufacturing in US, as opposed to more than 30% in China).
While the European Union (EU) is exempted now from steel and aluminum tariffs, there is a likelihood of tariff increase or an import quota if negotiations with the US are not completed before May 1, 2018. The EU is also likely to resume the Transatlantic Trade and Investment Partnership (TTIP) discussions with the US.
- No Trade War Scenario (Chances of Occurrence in 2018: 40%):
In this scenario, US and China could potentially initiate discussions on intellectual property rights and agree to cut the trade deficit by $100 billion as per President Trump’s initial target. If this scenario eventuates by the end of Q2 2018, the associated risks can be downscaled.
- Intense Trade War Scenario (Chances of Occurrence in 2018: 10%):
With an intense and restricting trade stance toward the end of 2018 and retaliatory tariff strategies by both US and China on possibly all manufactured products, there are chances that the United States finally will pull out of The North American Free Trade Agreement (NAFTA) and impose tariffs on Canada and Mexico as well with regard to steel and aluminum imports. In effect, Mexico could also impose identical tariffs on the US, causing rising inflation in the US alongside rising import prices. The Federal Reserve will in turn raise its benchmark interest rate to temper inflation growth. While on the external side, trade will be tapered due to the rising cost of capital limiting investment influx, domestic demand could also be dampened due to greater uncertainty as well as volatile inflation and rising interest rates. In such a dire situation, the EU might also apply countermeasures to combat its positioning by slapping duties on US products (including steel, peanuts, and clothes), prompting Trump to hike tariffs on European car imports. Given the impending arrival of the Brexit day in 2019, the United Kingdom will also stand highly affected in a high protectionist environment.
If this continues through 2019, the US might plunge into recession yet again by 2020. Hence, with accelerated trade frictions due to aggressively protectionist policies, the spillover effects will go overboard. A global fallout might result in 2020 with a temporary dampening at the WTO.
Thanks to Trump’s policies, a greater risk is associated with a scenario when there is an extensive usage of Section 301, which could eventually result in a WTO without the United States. However, given that both China and the European Union are keen on avoiding all possibilities of any escalation toward a global trade war, a global recession following extreme global protectionism seems to be a remote possibility.