One of the looming concerns for investors this year has been the threat of a trade war. But headlines suggesting that the world may be heading for a 1930s-style depression look overstated, says Andrew Kenningham.
During his election campaign, and in his “American carnage” inauguration speech, Donald Trump pledged to protect US jobs by imposing huge tariffs on imports from China and Mexico.
President Trump has started to translate this rhetoric into policy, prompting alarmist headlines warning of an economic meltdown. But how big are the risks?
The US government began this year with some fairly innocuous tariffs on imports of washing machines and solar panels. But Trump then announced that he was imposing tariffs of 25 and 10 per cent respectively on all imports of steel and aluminium.
The US and China then exchanged a series of threats that could result in tariffs on trade in goods worth US$150 billion in both directions.
Back to the 1930s…
These measures, and the accompanying tweets by Trump promising that trade wars were “easy to win”, have raised fears that the world is heading for an all-out trade war.
This situation has been compared with the 1930s, when the notorious Smoot-Hawley Tariff triggered a headlong rush into protectionism around the world. This resulted in a 30-per-cent collapse in global trade and a slump in the equity markets.
Clearly, an uncontrolled escalation of protectionist measures along those lines could have dire consequences.
Trade accounts for nearly 30 per cent of the world economy, so anything that makes it much more costly would be like slamming the brakes on global growth.
But for now, I think such fears look overdone.
Four reasons not to worry
For a start, Trump’s threats are probably a negotiating tactic. In fact, he has already pulled his punches by granting temporary exemptions to the tariffs on US steel and aluminium tariffs for most trade partners.
And the threatened tariffs on imports from China have not yet been put in place. Now China and the US have started high-level trade talks, which suggests they may want to find a negotiated solution.
Second, even if the tariffs that have been announced so far were implemented in full, the direct economic fallout would be modest.
The maximum impact, based on the likely volume of trade, is only around 1 per cent of gross domestic product (GDP) for both China and the US. And even if the two sides were to put tariffs on all their bilateral trade, this would affect US exports worth around 1.2 per cent of GDP and Chinese exports worth around 3.6 per cent of GDP.
What’s more, tariffs would make a dent in this trade, but they would not bring it grinding to a halt.
Viable alternatives to China for the three products the US imports most of – mobile phones, laptops, and computer-network equipment – are limited. And importers of other products would probably switch suppliers. So global trade may not take much of a hit.
Tensions likely to remain high
Third, I doubt that the measures announced so far will turn out to be the start of a lasting shift in US trade policy away from globalisation.
Tensions between the US and China are likely to remain high. But this is down to the strategic rivalry between the two, and concerns about theft of intellectual property.
However, it would be difficult for both countries to put too many obstacles in the way of business ties. And to try to do that would provoke a backlash from US corporations and Congress.
Finally, the world’s other major trading nations will not easily be provoked into a trade war. Japan, in particular, is wary of being dragged into a mutually destructive cycle of tariffs.
European governments have drawn up a list of US products they’d target in a trade conflict (including Kentucky bourbon and Levi’s jeans). But experience suggests that they’re more likely to wait and see, hoping that this US protectionist period, and indeed Trump’s presidency, will pass.
Back to the 1980s
In fact, the Reagan years (1981-1989), offer a closer parallel for today than the 1930s.
By the 1980s, Japan had moved up the value chain from low-skilled to high-tech manufacturing. It was often blamed for US job losses and accused of unfair competition. President Reagan imposed restrictions on imports of numerous goods, including Japanese cars and semi-conductors.
However, the world economy and equity markets performed well during most of the 1980s. The tariffs and other measures were not on a large enough scale to derail global growth. What’s more, worries about Japan faded over time, and the protectionist measures were eventually allowed to lapse.
Of course, things will not pan out in exactly the same way this time – and China probably poses a bigger threat to the US than Japan ever did. But this does at least offer some comfort for those fearing that we are heading back to the Great Depression.
Gross domestic product (GDP): GDP is a measure of a country’s market value. It covers all goods and services produced within a time frame and can be used to compare nations’ economies.
Protectionism: Protectionism is where a government’s policies aim to restrict foreign imports, to protect that country from international competition.
Smoot-Hawley Tariff: The Smoot-Hawley Tariff Act of 1930 was a piece of US legislation that increased import duties by as much as 50 per cent. It was enacted to protect US farmers and businesses from foreign competition. Other countries retaliated and increased their tariffs. Some blame the Act for worsening the Great Depression.
First published Autumn 2018
Story by Andrew Kenningham, Capital Economics
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