The phase one trade agreement between the US and China signed on Wednesday is only a truce in the trade war, rather than a major reversal of the tariffs imposed since 2018. Nevertheless, it halts a dangerous political momentum.
US President Donald Trump tweeted on 2 March 2018 that “trade wars are good, and easy to win”. That assessment has proven wide of the mark.
While there may be some long-term gains for the US from China’s concessions, the main immediate benefit is simply that the self-inflicted damage to the American economy caused by the tariffs will begin to be reversed.
Jan Hatzius of Goldman Sachs describes this as a “subtraction of the negatives”. Paradoxically, the worse the effects on US growth rates in the past two years, the greater the scope for a bounceback this year.
Mr Trump’s initial confidence about the effects of trade protection was based on a belief that China’s bilateral trade surplus with the US would force President Xi Jinping to make major policy concessions to safeguard his own export sector. The outcome was rather different: China retaliated with similar measures and this damaged American manufacturers.
The US trade balance, a litmus test of the success of the Trump initiatives, has not changed much overall, and is barely improved against China. Some of the benefits from the tariffs to the competitiveness of US-manufactured products were offset by a decline in the renminbi exchange rate.
A new study by Federal Reserve Board economists has concluded that the net trade effects of tariffs on US output have been slightly negative. This is because the gains from a drop in Chinese imports have been more than cancelled by reduced US exports and higher input costs because of Beijing’s retaliation.
Other Fed studies have shown that almost all the effects of the US tariffs have been passed on to American consumers in higher prices, rather than being partly absorbed by Chinese producers. This has led to a reduction in US real incomes and consumer spending.
The damage to financial and business confidence triggered by the trade announcements hurt US growth still further. The tightening in financial conditions caused by the rising dollar and the collapse in equities late in 2018 would probably have been more severe if the Fed had not reduced policy interest rates by 75 basis points since then.
Worst of all, US fixed investment growth has slowed sharply, taking the manufacturing sector close to recession. Some of the policy uncertainty caused by the trade war will remain entrenched for a long while, so there may be little immediate catch-up of postponed investment projects. Estimates by Fed economists suggest that these uncertainty effects may alone have subtracted almost a full percentage point from global gross domestic product.
Overall, the trade war can therefore be described as a large negative shock to US aggregate demand, offset in part by an easing in monetary policy.
Annualised real GDP growth in the UShas slowed from 3.0 per cent in the first half of 2018 to about 2.0 per cent in the second half of 2019. Goldman Sachs suggests that around half of this slowdown has been caused by the tariff increases but the larger Fed estimates of the uncertainty effects might imply an even bigger overall impact.
The good news is that part of this overall drag may disappear before the end of 2020, boosting American GDP growthby at least half a percentage point.
What about the longer-term benefits of the trade deal?
The purchase of $200bn of additional US exports in the energy, agriculture, manufacturing and services sectors, spread over two years, will reduce the bilateral trade deficit with China. But many of these exports will probably be redirected from elsewhere and will not boost US domestic output in those sectors.
Longer term, China’s business restrictions, including alleged unfair trading practices, appear to be easing. Given the political boost from the phase one deal, Chinese economic reformers such as vice-premier Liu He may be in the ascendancy in Beijing for a while.
US trade representative Robert Lighthizer has suggested that the strength of the reformers will determine whether the phase one truce is ultimately successful, but the road is long and treacherous. The knotty problems surrounding protection of intellectual property, cyber theft and China’s industrial subsidies have been parked in the “too difficult” box. They may prove just as intractable in phase two.
Unfortunately, now that trade protection has been viewed by a US administration as a legitimate weapon to use in international economic diplomacy, the genie is out of the bottle.
The US and China have been left with average tariffs on the other’s exports of about 20 per cent, an unprecedented restriction on global free trade in recent decades. Mr Trump is now threatening similar tariffs on car imports from Europe. The trade wars are far from over.
The trade war has significantly damaged US growth in 2018-19
Since President Donald Trump became more aggressive in his threats about trade protection early in 2018, US tariffs on Chinese goods have risen markedly, prompting retaliation from China. There have been only a few comprehensive studies on the overall impact of tariffs on the US growth rate.
A notable exception is the work of Jan Hatzius’s US economics team at Goldman Sachs. They have estimated the possible impact of rising tariffs on net trade flows, real incomes, financial conditions and business confidence, and have combined these effects to produce the aggregate growth estimates shown in the graph below.
As the negative effects of rising tariffs fade in 2020, the US growth rate is expected to be boosted by at least half a percentage point.