The Trade War

Trade war and its effects on the global economy.

Insights

What has happened?

Donald Trump has initiated a “trade war” with China where both economies have sequentially imposed increasing tariffs on one another. Between one another, average tariffs by the US have increased from 3.8% to 12% and China’s have increased from 7.2% to 18% from July to September in 2018.

 

Donald Trump has cited the large trade deficit that the US experiences with China. This deficit refers to the difference between the amount that China exports to the US (US$530B) and the value of US exports to China (US$110B). This left the US with a deficit of approximately $420B in 2018 according to the US Census, a statistic that led to Trump’s extreme policy decisions. A trade deficit refers to the extent to which import debits exceed export credits. 

China and US Trade Balance


The trade war has been described as a reflection of the resurgence of nationalism and protectionist policies, where nations feel they are no longer maximising their benefits from trade. US has taken a nationalistic stance with the slogan “America First” branding Trump’s policies as a tool to revitalise American industries and shield them from Chinese imports. 

Resurgence of protectionism

“By 2020, tariffs already imposed or announced would shrink global GDP by 0.8%. That is equivalent to the whole economy of Switzerland,” – managing director of IMF Kristina Georgieva.

 

Lastly, there have been growing concerns that the Trade War has reversed the progressions achieved by the World Trade Organisation in facilitating China as a signatory to free trade in 2001 and has tainted their purpose of dismantling barriers to trade in the global economy.

Syllabus Links

Infant Industry Argument

 One rationale for an economy adopting protectionist policies (subsidies, tariffs etc) is to shield domestic producers from overseas competition. In the case of the Trade War, Donald Trump has justified his protectionist policies under the presumption that by applying them, American industries and jobs will be given the opportunity to grow without competition from cheaper Chinese production methods. In doing so, in the short run the American economy will experience lower unemployment as workers do not shift from their jobs as a result of structural change derived from free trade. However, in the longer term, from a global efficiency lens, protectionist policies encourage a misallocation of global resources, in effect meaning that output is not maximised. Hence, in the longer term this will result in lower gross world product and in turn higher levels of cyclical unemployment as the global economy is not maximising output from given resources. 

Thus, protectionism allows economies such as the US to raise employment in inefficient protected industries, but accordingly lose employment in efficient exporting industries as labour is a derived demand - Australia has largely avoided these impacts due to active unilateral trade liberalisation.

In saying this, the rationale of the infant industry argument is to temporarily provide protection for new businesses to achieve economies of scale and become competitive globally.  A true test of infant industry protection is whether it has had an impact once removed, a signal that the artificial barriers have improved efficiency. 

Trade Flows

Protectionist policies act as barriers to the globalisation process. This idea is manifested in the impact of tariffs on trade flows, a prominent component on the globalisation process. Trade flows contribute to global supply chains, where companies seek to source inputs of their production process at the lowest costs across the global economy. China and the US are trade superpowers on a global level and contribute a significant amount to the functioning of these global supply chains. Due to the imposition of tariffs, these supply chains have been disrupted and in turn forced firms to either seek a new source for a particular activity or bear the higher costs of goods (post tariff prices). A proportion of goods traded by China and the US include inputs in other production processes, meaning higher costs in factor markets (production process) may also transfer over into higher prices of goods in product markets (consumer markets), leading to inflation and uncertainty on a global scale.

Decrease AS

This disruption will cause an increase in prices and result in lower aggregate supply levels as indicated above. This distortion will cause gross world product levels to reduce moving into the near future.

World Trade Organisation

The world trade organisation has two main roles; to facilitate the formulation of free trade agreements and resolve trade disputes. Given the sustained nature of the current dispute, the World trade Organisation has attempted to facilitate a resolution between the countries and a return to a free trade platform amongst these global trading superpowers. It can be argued that the World Trade Organisation has lost its prowess as an effective intermediary body in achieving its purposes outlined above. 

Consumer and Business Confidence

AD = C + I + G + (X-M)

The Trade War has also had flow on effects on consumer and business confidence leading to the distortion of decision making. The consumer sentiment index of the US fell to a 4-year low in 2019 where consumers were responding to the uncertainties presented through the media regarding the trade war. In times of political uncertainty, economic decision making by both consumers and business follow suite in the reduction of consumption and investment levels undertaken. As a result of lower sentiment levels, global stock markets have experienced one day free falls in response to Donald Trump tweets that add angst to the uncertainty. Lower sentiment deteriorates consumption and investment levels and in turn reduces demand levels and economic growth. With the ever increasing power of social media, it could be argued that tweets have embodied a new form of jawboning and in turn, distorted the desired effects of central bank and fiscal policies designed to skew demand. 

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References