Effects of the US-China tariff escalation

In the last one year, the US has imposed tariffs worth $250 billion on Chinese imports and China has retaliated by covering US imports worth $110 billion under higher tariffs. It began with the imposition of safeguard tariffs by the US on imports of solar panels and washing machines in January 2018 following USITC findings on injury to US industry in October 2017 under Section 201 of the 1974 Trade Act. This was followed by US President Donald Trump’s announcement to impose 25 per cent tariff on steel and 10 per cent tariff on aluminum on all trading partners on national security grounds under the seldom-used Section 232 of the 1962 Trade Expansion Act. These tariffs came into effect in March 2018. Canada, Mexico, the European Union, South Korea, Brazil, Argentina, and Australia were initially exempted from the steel and aluminum tariffs, but the exemptions ended in June 2018. 

This led to a flurry of retaliatory tariffs on US exports imposed by China, the EU, Canada and Turkey. In fact, Harley-Davidson announced on June 25, 2018, that it was shifting additional motorcycle production outside the United States to avoid the retaliatory tariffs.

Before 2018, average US tariffs on Chinese imports were 3 per cent compared to average Chinese tariffs on US imports of 8 per cent. Post the tariff escalation on either side, the average tariffs have increased to 12 per cent and 20 per cent respectively. Thus, both countries are suffering the costs of applying higher tariffs. One immediate fallout of tariff imposition is the wedge between the prices that producers receive and the prices that consumers pay in the importing countries. Recent academic research on this subject suggests that importers in both the countries have borne most of the tariff incidence imposed in 2018 and there have been few terms of trade gains from these tariffs. Another study from the Peterson Institute of International Economics (PIIE) finds that Trump tariffs have raised steel prices by 9 per cent, creating 8,700 jobs in the US steel industry, but steel users pay an extra $650,000 for each job created.

Note that tariff costs get inflated in a world of global value chains (GVCs) as firms import intermediate inputs, add value, export semi-finished products for another (multiple) layer(s) of value addition leading to the final product, with each cross-border flow of goods entailing tariff costs. Significantly, the bulk of US tariffs on China have been imposed on intermediate goods, which have a greater adverse effect on firms, including in the US, that are large and steady importers of Chinese intermediate inputs. In contrast, China has been wary of not hurting its own supply chains as most of its own tariffs on US imports are imposed on consumer goods. Even so, this tariff escalation has rendered GVC-integration challenging not just for these two countries but also for their significant GVC-trading partners. In the case of China, for instance, eight of its top 10 GVC-trading partners are based in South-East Asia, which paves the way for regional spillover effects.

These trade wars have also caused political risks and uncertainty, which coupled with the stagnation in growth of GVCs, have also led to an adverse effect on foreign direct investment (FDI), as also acknowledged by UNCTAD’s 2017 World Investment Report. In fact, global FDI flow fell by 23 per cent in 2017 relative to 2016 with both cross-border M&As and announced greenfield investment projects witnessing significant double-digit declines in the respective year-on-year growth rates.

But there are other important indirect fallouts. The imposition of steel and aluminum tariffs on national security grounds has seriously undermined the multilateral trading system and set a dangerous precedent that other WTO members can follow. This can be particularly problematic for less developed and small and poor developing countries whose trade-related development concerns have so far been sought to be addressed via the WTO. In fact, some other PIIE research suggests that Trump’s steel tariffs have had a disproportionately adverse effect on small and poor countries that have seen a 12 per cent decline in steel export volumes to the US and 15.5 per cent less revenue, compared to the six months preceding the tariffs, even as strong economic growth actually increased US imports of steel by 2.2 per cent. Ironically, had these tariffs been imposed under Section 201 of the 1974 Trade Act, that is, on grounds of injury to US domestic industry instead of for national security reasons, small and poor countries would have been automatically exempted as their exports would not have been large enough to hurt US domestic industry.  

What is likely to happen next? Initial reports suggest that the tariffs imposed during 2018 are likely to stay even in the event of a successful deal between these two economies, which suggests a new higher-cost equilibrium for global trade. Some actions of the past year such as imposition of steel and aluminum tariffs on national security grounds and renegotiating past trade agreements like NAFTA are clearly Trump-specific (POTUS has scant respect for rules of the game) and are likely to erode the US’ credibility in international policy-making. However, other measures are consistent with broader US policy (even the Obama regime blocked appointment of WTO appellate body members; concerns about Chinese export subsidies to state-owned enterprises and the undervalued Chinese currency have preceded Trump). It would have been much better if Trump had used the US’ clout and built relationship with allies to address such concerns rather than alienating US’ important trading partners and allies via tariffs.
 

The author is senior fellow, ICRIER