Trade Wars: Episode I - Competitive Tensions
David Robertson, Head of Economic and Market Research at Bendigo and Adelaide Bank
March-April 2018
The recovery in stock markets and risk appetite following February’s significant falls made good progress until early March – with Donald Trump’s announcement of US tariffs for imported steel and aluminium.
While protectionist policies are entirely consistent with Trump’s election platform, the timing caught the market off guard, bringing the reality of trade wars sharply into focus.
Protectionism: pros and cons
The primary forms of protectionism are:
- Tariffs (an additional tax on imported goods)
- Import quotas, and
- Direct subsidies of domestic businesses
Tariffs have been used with some success in the past in emerging economies trying to develop new industries, and seem to resonate politically during challenging times when the focus is on local jobs at a time of rising unemployment (e.g. post deep recessions).
This populist platform has been politically effective in many countries since the GFC, however medium to longer term implications are universally agreed by economists to be negative. The first disadvantage of protectionism is making the cost of the goods that the protected industry produces more expensive domestically. This adds to inflation (so puts pressure on monetary policy), and disadvantages a range of other industries e.g. with steel tariffs, initially via the increased cost of steel, then more broadly via derived goods.
In addition, consumers are deprived of a wider choice of affordable goods which are not produced locally, or seasonal constraints. The great depression 30s is a frequently cited example of the economic dislocation that a rise in trade barriers produces.
Protectionism can create short term job growth, but at the expense of competitive tensions required to drive innovation and productivity. Most importantly, an active protectionist stance sends the signal to other countries that their exports are not welcome, which makes it more difficult to build export relationships, and risks retaliatory ‘trade wars’.
Immediate consequences and trade war risks
Tariff’s announced by the Trump administration in early March were 25% on steel and 10% on aluminium imports, although exemptions were clarified soon after for Canada and Mexico (via NAFTA negotiations) and for Australia.
The motivation for the tariffs appears to be a concerted effort to reduce the US trade deficit, running at approximately US$566 B (primarily driven by imported goods).
A White House spokeswoman later stated the intention is to reduce China’s trade surplus with the US by $100 B, so given the very small part of this $375 B surplus being steel and aluminium, the focus shifted to what additional tariffs will be required to bridge this gap.
Implications for Australia
Given Australia is excluded from the tariffs, the primary implications and risks locally are indirect i.e. the risk of an escalating trade war. This would have adverse impacts on China, the EU and worst case on the global growth outlook. The Productivity Commission modelled a 15 percent increase in tariffs across the board, and calculated the following dramatic impact.
Tariff increases of this magnitude are highly unlikely to occur, however the negative impact of protectionism is universally acknowledged by economic research, and the resignation of Trump’s top economic adviser Gary Cohn has removed much of the rational free trade influence in the White House.
Some of the latest comments from the Trump administration are narrowing the focus specifically on China and their alleged ‘theft’ of US technology Intellectual Property.
For Australia, our dependence on East Asian growth and commodity prices makes this a crucial development to monitor. Ironically, at the same time that these new tariffs are being introduced, Australia and ten other nations have signed up to the Trans-Pacific Partnership, a free trade agreement including Singapore, Japan, Canada and Chile.
Stock markets and commodity prices are likely to be a good barometer for how this all evolves over 2018. A break back above the January highs would encourage the view that this is all just another speed hump to cope with rather than a reversal. US stock markets fell around 12% in early February, however the fall in Australian stock indices was only around 6%.
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