U.S. Protectionism: Hype, Hope Or Hell To Pay?

Some see trade-war threats as posturing for negotiating advantage. Still, a lot of companies could get hurt along the way.

After the globalization binge, is the world’s economy entering a period of trade wars?

In March and April, the US announced exceptional measures to cut a bloating trade deficit, prompting retaliation from China and fear everywhere else that the struggle could trigger a global recession. After all, international trade has been—and in most cases still is—one of the main causes of economic expansion.

Altomonte, Bocconi University: If we throw out free trade, we are throwing out the growth engine.

Businesses cried foul against the decision to impose tariffs on a multitude of goods but didn’t move the US administration, which seemed ready to take the economic risks of its anti-globalization crusade.

“Trade wars are good and easy to win,” President Donald Trump tweeted, with economically displaced voters in mind. Over the past 20 years, not all workers and not all countries benefited equally from trade-fed economic growth, with some losing jobs and business. Trump has become their paladin.

“From the mid-’90s to 2011, we had a real explosion of international trade, which jumped from levels around 16% to 17% of GDP to the current levels of around 29% to 30%,” says economics professor Carlo Altomonte of Bocconi University in Milan. “But this globalization binge also created problems for how these gains are distributed.”

Now that we face the question of how to address those problems, “there’s a risk of throwing the baby out with the bathwater,” Altomonte continues. “If we throw out free trade, we are throwing out the growth engine and not the distribution mechanism.” President Trump recently expressed interest in joining in the new Trans Pacific Partnership—an abrupt reversal from his campaign rhetoric, and a repudiation of his voters.

Peak Globalization?

The surge of protectionism is no surprise. In the past few years, global trade had already stopped growing at the same pace as before. Second, many in the US are convinced they have been losers as trade has expanded, and thus have less at risk in a trade war. Along with those workers who lost their jobs because manufacturing moved to countries with lower labor costs, US exporters are dragged down by stagnating productivity.

“If your productivity is falling at the same time that your currency is going up 45% against many of your trading partners, clearly you’re going to have a lot of companies which are going to struggle,” says Jan Dehn, head of research at Ashmore Investment Management.

Donovan, UBS: We are probably approaching “peak trade”—or “peak globalization.”

Global trade benefited in the past from complicated supply chains, whereby several countries were involved in the production of the same final good. This is slowly becoming simpler, with some manufacturing returning to developed countries.

“Maybe not immediately, but over the course of the next few years global supply chains are likely to simplify,” says Paul Donovan, global chief economist at UBS Wealth Management. “They will become shorter as a result of the technology. It’s robotic, it’s digitization, the Internet of Things. Essentially, it is no longer automatically cheaper to produce in a low-cost economy. You can have a hundred robots and ten people doing the work of 5,000 people in Asia, and you might decide to have your factory close to your customers as much as possible. [This will mean] that we are probably approaching peak trade—or peak globalization if you prefer—because part of the trade expansion of the last 20 years was caused by supply chains becoming longer and more complicated.”

Smoke And Mirrors

The protectionist measures announced by the US, and China’s response, have so far been relatively limited and economists say that the tone and direction of the discussion worry them more than the actual economic reality. With US midterm elections in November looming, trade measures are powerful political messages to middle-class voters who have lost economic power in the past 20 years. Yet the 25% tariffs on steel and aluminum imposed in March affect a very small part of the American economy, with limited impact on final goods. UBS’s Donovan says that the aluminum tax’s effect on a six-pack of Budweiser is just under 3 cents. Because of extensive exceptions, these tariffs were actually imposed on less than 35% of actual imports.

“One of the things with Trump’s administration is that there’s a huge amount of noise and a lot of reality-TV activity. But at the end of the day, what actually happens is a lot less than what is actually said to be done,” says Bernard Hoekman, economics professor at the European University Institute in Florence. “You saw that happening with the steel and aluminum tariffs and the exemptions, and the same thing happening with the China intellectual-property action.”

The complicated economic links of international trade make forecasting the impact of the newly imposed tariffs nearly impossible. Hoekman mentions as an example the case of household-appliance producer Whirlpool, which saw its stock price surge in January after Trump threatened a steep levy on the import of washing machines from Europe and Asia, amid expectations of lower competition and higher profits for the US maker. But when tariffs on the raw materials of steel and aluminum taxes were imposed, worries over higher input costs knocked the stock even lower than it had been before the tariff talk started.

This game of smoke and mirrors could be, at least in part, a ploy in global trade negotiations, such as discussion over intellectual property with China or the renegotiation of the North American Free Trade Agreement (NAFTA) with Canada and Mexico, even though those nations were exempt from the tariffs at the start. Trump blamed NAFTA for much of the US trade deficit and said he was not going to renew the pact. Still, many observers believe NAFTA, which was implemented in 1994, will be renewed.

More broadly, this tough talk might not amount to much action. “The evidence so far supports the view that trade disputes will be resolved through negotiations, without trade wars and detrimental supply-chain disruptions. The US will likely move on,” according to a Loop Capital study.

A Better Hand Of Cards

A still-unlikely trade war would damage everyone, but less so the US than other large economies, according to Paul Mortimer-Lee, chief market economist at BNP Paribas, and this helps explain Trump’s unorthodox policies.

“Part of the theory says that the big countries, because they have market power, can gain from raising tariffs. That is because the elasticity of demand for their products is not that high,” says Mortimer-Lee. He mentions a 2017 study by Australia’s Crawford School of Public Policy, which calculates the GDP decline for large countries in case of general tariffs. Under a trade-war scenario, all countries are worse off, but the losses to China and Germany are around three times larger than those of the US.

“It’s a question of what do you mean by ‘winning’ a trade war? If you mean that it adds to GDP, then nobody wins in a trade war,” says Mortimer-Lee. “But if you mean that you lose less than your competitors, then these results say yes, the US can win because it has more market power.”

With the tax cuts that were approved at the end of 2017, the US public deficit is expected to expand in the medium term.

“Given [that Trump] decided that the public deficit will rise a lot in the coming five years, he cannot also afford a high trade deficit. Therefore, he will work to reduce the latter and he will ask other countries to do so. There is method in this madness,” says Bocconi’s Altomonte. “It’s a self-serving, short-sighted strategy but with an underlying logic.”

Dehn, Ashmore: If Trump becomes more protectionist and pulls America out of the world, China will be more open to stepping in.

From the second-largest economy, the European Union, the US demands more spending on its exports, according to Altomonte. “Trump is telling Europe to increase its public deficit, which is the only way to cut into the trade surplus,” he says. “Trump is telling Europe to put austerity to an end and spend more.” He noted that even a 1% increase in military spending in Germany would fit the bill.

The battle with China has already started, but expectations are that the third-largest economy will be limited in its response. “The Chinese will respond and are responding in a measured and proportionate way, matching the US measures blow-for-blow but not exceeding the US tariffs and not involving any third parties,” says Ashmore’s Dehn. “If Trump becomes more protectionist and pulls America out of the whole world, China will actually be more open to doing trade with other countries; to step in where the Americans are pulling back, just like the Chinese have done in [the Trans-Pacific Partnership]. China ultimately sees the protectionism in the United States as contributing to the decline of the role of the [dollar] as the global reserve currency and, ultimately, that works in favor of the Chinese as they assume the crown of global currency over the next few years.”