Trade Wars Undermine Global Stability

Since the middle of the twentieth century, world trade has grown faster than the gross domestic product of individual countries. Trade was conducive to economic growth and stabilized the political situation.

In 1947, the General Agreement on Tariffs and Trade (GATT) was signed. Successive rounds of negotiations on trade facilitation under GATT led to average tariffs falling from 40% in 1947 to around 3% in 2012. Non-tar- iff barriers, such as import quotas, have also been eased or abolished. In 1995, the GATT was replaced by the World Trade Organization (WTO), to which 160 countries belong. In theory, the WTO ensures that trade is fair, that no member state violates the adopted rules.

Practice deviates from theory. The WTO is not in a position to enforce compliance with the rules, especially if they are broken by a country with high potential. This is one of the reasons for the protectionist sentiment that began to dominate in the United States.

The flight of jobs

Free trade has been particularly beneficial for poorer countries. Large companies began to build industrial plants where the cost of labor is many times lower than in the USA or Western Europe. This is facilitated by free trade areas, within which exchange of goods and services is facilitated: the European Economic Community, transformed into the European Union, and the North American Free Trade Agreement (NAFTA) embracing the United States, Canada and Mexico. As a result, jobs, especially in traditional industries – machinery, automobiles, steel – began to move from rich countries to poorer ones.

For the United States, which was the main advocate of free trade after World War II, the flight of jobs to poorer countries had become a problem. Protecting U.S. industrial production from imports and maintaining jobs in the industry was one of the key election promises of President Donald Trump. The President promised to engineer reindustrialization, i.e. rebuilding industry in regions that flourished in the twentieth century and which are now referred to as the “rust belt”.

The decrease in employment in the industry of rich countries results not only from the relocation of production to countries with low employment costs, but above all from a huge increase in productivity. Industry in the United States and other rich countries currently produces several times more than half a century ago but employs about 30% of the workers once needed. Trump’s promise that old jobs would be restored was therefore pure demagogy. In 2018, however, under the pretext of protecting American workers, the President launched protectionist measures.

A customs war

The President of the United States took specific steps in January 2018. He imposed duties on washing machines and solar panels. Washing machines are an export product of Korean big players – Samsung Electronics and LG Electronics – while panels come mainly from China.

Free trade has been particularly beneficial for poorer countries. Large companies began to build industrial plants where the cost of labor is many times lower than in the USA or Western Europe.

The American corporation Whirlpool, which is also an important player in these fields, benefited from these measures. The American stock exchange reacted with a run on its shares. The growth only lasted, however, a few weeks. Whirlpool shares at the end of 2018 were over 30% cheaper than at the beginning of the year. The tariffs did not turn out to be a miracle cure for the prosperity of American companies.

Trump announced his intention to introduce a 25% tariff on steel and a 10% tariff on imports of aluminium on 1 March 2018. The legal basis is Section 232 of the Trade Expansion Act 1962, which in specific circumstances allows the President to impose duties based on a recommendation from the U.S. Secretary of Commerce if “an article is imported into the United States in such quantities or under such circumstances as to endanger or undermine national security”.

The decrease in employment in the industry of rich countries results not only from relocation of production to countries with low employment costs, but above all from a huge increase in productivity.

The use of this provision surprised even the Americans themselves. Although imports of steel and aluminium do cause problems for American companies, it has nothing to do with national security.

Canada and Mexico have been exempted from customs duties, provided that they sit down with the United States to negotiate a new free trade area agreement in North America. During the election campaign, however, Trump threatened Mexico with the imposition of 35% tariffs if it did not agree to a more favorable trade agreement.

According to the Economic Policy Institute, duties on aluminium have allowed an increase of production in the USA, creating 300 jobs. An additional 2,000 jobs have been created in companies that process aluminium. These are not impressive figures.

On 21 November 2018 the Dispute Settlement Body (DSB) of the WTO dealt with the complaints of seven countries that had been affected by U.S. duties on steel and aluminium. The WTO has not decided who is in the right in this dispute. The issue will be the subject of negotiations in the coming months.

Customs tariffs on steel had the biggest impact on Turkey, which is the eighth largest steel producer in the world and one of the largest exporters of steel products to the USA. The heavily indebted Turkish economy experienced a severe crisis in mid-August 2018 and was only saved by a loan from Kuwait.

U.S.-China trade war

The main target of Trump’s protectionist policy is China. The U.S. trade deficit with the world’s second-largest economy rose from $83 billion in 2000 to $376 billion in 2017. This year’s deficit will be even greater. Americans agreed to China’s accession to the WTO (in 2001) and now regret it.

President Trump presented a plan to impose duties on imports of Chinese goods on 17 September 2018, worth a total of 200 billion dollars. Earlier, Trump had already imposed duties on Chinese goods worth 50 billion dollars. The President also announced that if China took retaliatory action, he was ready to introduce further import tariffs worth USD 267 billion immediately. The rate of duty would initially be 10 %, and from 1 January 2019, it would increase to 25 %.

The condition for the withdrawal of duties is that China agrees to greater access for U.S. companies to the Chinese market and stops requiring the transfer of modern technologies to Chinese partners.

Accusations of unfair practices by China are not unfounded. According to the U.S. Trade Representative Office (USTR), the U.S. government agency responsible for trade policy, the Chinese government is forcing technology transfer by imposing restrictions on foreign investors.

According to the Economic Policy Institute, duties on aluminium have allowed an increase of production in the USA, creating 300 jobs. These are not impressive figures.

Chinese law prohibits foreign investors from doing business in certain industries unless they cooperate with a Chinese company. Licenses for operations in China are conditioned by technology transfer. Foreign companies have to even disclose details of technology at times, for example, application codes. Such practices are made possible by the discretionary and non-transparent system of foreign investment permits. Following its accession to the WTO in 2001, China committed itself to stop such practices. Chinese authorities maintained them, however, but instead of officially existing regulations, there are unwritten, informal “administrative guidelines” for Chinese companies and authorities to force the transfer of technology.

It’s just negotiations

There are a number of indications that the rhetoric of the American President, as well as the duties imposed on imports of Chinese goods and steel and aluminium products from many countries, are part of a negotiation strategy, typical for hard-dealing businessmen, although unusual in the world of diplomacy.

On 30 November 2018, on the first day of the G20 summit in Buenos Aires, the three countries of North America signed a new trade agreement entitled USMCA – an abbreviation for the United States, Mexico and Canada. The negotiations lasted more than a year, but the changes are minor, although generally in favor of the U.S.

The main target of Trump’s protectionist policy is China. Americans agreed to China’s accession to the WTO (in 2001) and now regret it.

According to the revised agreement, automotive companies selling goods in the U.S. market must produce at least 75 percent of their components in Canada, Mexico or the United States. It had been 62.5 per cent earlier. At least 30 percent of the components must be manufactured by employees earning at least $16 per hour. This share will increase to 40% in 2023. Cars that do not meet these requirements will be subject to customs duties.

Canada will be required to open up the dairy market to U.S. farmers, and Mexican trucks entering the United States have to meet U.S. safety standards before crossing the border. The new agreement provides better protection for patents and trademarks. U.S. pharmaceutical companies will be allowed to sell their products in Canada for 10 years before competition from local, cheap- er generic drugs will be introduced. Under NAFTA this period was 8 years. Trump achieved success, but on a much smaller scale than he announced.

President Trump met with the Chinese leader Xi Jinping at the G20 Summit. China and the United States agreed to halt the imposition of additional duties and engage in trade negotiations. In other words, the threat of a full-scale trade war starting on 1 January 2019 has been defused.

A trade war would slow down the economy

According to the Munich Ifo Institute, the additional tariffs introduced by the U.S. will reduce economic growth in China by 0.1 to 0.2 percentage points, and if increased up to 25 %, the loss will be between 0.3 and 0.5 percentage points. According to Gabriel Felbermayr, Director of the Ifo Centre for International Economics, the slowdown in China caused by U.S. sanctions will be mild, given that growth in this large economy is still higher than 6%. The moderate effect of sanctions is due to the fact that China has been reducing its dependence on foreign trade for several years now. In 2017, the ratio of exports of goods and services to GDP, according to World Bank data, was 19.8% in China, down from the record level of 36% in 2006. The U.S. is China’s most important trading partner, but exports to the U.S. account for only a few percent of China’s GDP.

The greatest risk for the global economy may be the appreciation of the dollar, which will hit emerging economies, as it will cause an outflow of capital. The U.S. Federal Reserve can respond to the inflation caused by the rise in the prices of Chinese goods or their substitutes in the U.S. market by raising interest rates faster, and they are still higher than in Europe.

Some over-indebted Chinese companies will also be under pressure. As of the global financial crisis, the debt of the world economy has increased by more than 40% and has grown fastest in emerging markets. It is estimated that about 87% of the debt of emerging markets is denominated in local currencies and the rest in dollars.

Instead of officially existing regulations, there are unwritten, informal “administrative guidelines” for Chinese companies and authorities to force the transfer of technology.

The rise in interest rates on world markets has already raised the cost of servicing U.S. dollar-denominated debt, and has also led to capital flight from emerging economies to U.S. dollar-denominated assets.

A large margin of uncertainty

U.S. tariffs on Chinese goods could improve Europe’s negotiating position, which could benefit from the concessions which the U.S. enforced on China. This would increase the competitiveness of German producers more than their American counterparts. American exporters to China and Chinese exporters to the USA will lose out in the U.S.-China trade war. This may increase the share of European companies on both the Chinese and American markets.

For emerging markets, the effects of an escalation in the trade war may vary. Over the short term, capital flight will worsen credit conditions in these countries and will further reduce the pricing of listed companies.

A slowdown in Chinese economic growth will also have a negative impact
on economies based on raw materials, some of which are exported to China. Taiwanese, Vietnamese, Malaysian or Mexican companies could, however, replace Chinese companies in the supply chain for American companies.

The greatest risk for the global economy may be the appreciation of the dollar, which will hit emerging economies, as it will cause an outflow of capital.

There is always a large margin of uncertainty in such projections. The threat of a customs war affects the moods of investors, producers and consumers around the world. This is difficult to estimate, but the impact on the economy will be negative. The only question is to what extent.