Unintended consequences loom large over trade tariffs
On June 15, the United States government announced tariffs on 818 lines of Chinese imports worth $34 billion starting on July 6; and increasing the duty on an additional 284 lines of import products valued at $16 billion after further public consultation. Just six hours after the US announcement, China announced its retaliation measures — 25 percent tariffs on a first list of $34 billion in agricultural products and automobiles, effective on July 6; and a 25 percent tariff on a second list of $16 billion in US oil and gas, chemical products and medical instruments, to be implemented presumably at the same date of implementation of the second batch of US sanctions.
Tit-for-tat tariff measures have raised the specter of a trade war and the consequences of such actions. Will the US achieve its stated objective of narrowing the trade gap, encourage the re-shoring of the products and hit the Chinese exporters under the sanction list? A review of the unintended consequence of US steel safeguard measures introduced in 2002 could provide a glimpse of the likely outcome. In March 2002, then US president George W. Bush placed a temporary tariff of 8 percent to 30 percent to give American steel makers protection from a surge of imports. The measure generated a significant diversion of trade, and unexpected consequences of the trade diversion negated the intention of protecting the US steel industry. The US International Trade Commission did an economy-wide analysis in September 2003 and concluded that the impact of tariffs on the US welfare ranged between a gain of $65.6 million to a loss of $110.0 million, with a central estimate a welfare loss of $41.6 million.
In the 12 months after the safeguard tariff, the value of imports rose substantially for the three categories of exemptions — 21 percent for firm-specified product exclusions for companies claiming steel is their critical input; 53 percent for members of preferential trade agreements such as Mexico and Canada under NAFTA; and 63 percent for developing country exclusions such as Argentina, Thailand and Turkey. US steel imports increased 3 percent in the period following the safeguard.
One year after the tariff imposition, US steel production rose a marginal 4 percent, almost the same as the increase in imports. The final World Trade Organization ruling in November 2003 authorizing more than $2 billion of sanctions against the US finally forced the Bush administration to back down and withdraw the tariff on Dec 4, 2003.
The diversion of trade toward unaffected countries, diversion to other products in which the foreign producers do not face higher costs associated with higher tariffs on intermediate goods imports, as well as the increases in the competitiveness of foreign producers — which expands as inefficient and small exporters exit the market — all add up to make tariff protection ineffective to protect domestic industries. The effects are in addition to the domestic productivity depression effect and the higher inflation pressure as a result of reduced competition from imported products.
According to the US Trade Representative’s Office, the American tariff sanction list on Chinese imports “does not include goods commonly purchased by American consumers such as cellular phones or televisions”. The US strategy appears to prefer taxing intermediate/capital goods over consumer goods. The US also aims to target products “related to the ‘Made in China 2025’ initiative”. The steel is also an intermediate product and what happens in 2002-03 could well be replicated today. In contrast the Chinese retaliation list focuses on food and cars; they are targeting US President Donald Trump’s support base in the mid-west and southern states where foreign automotive plants selling popular high-end SUVs to China are located. The impact on China will be reflected mostly in higher inflation when trade diversion over agricultural products happens. The damage to the Chinese economy may be in the longer term; some of the products on the list are rather small regarding export value but may have high potential in the future, such as railway equipment, cars, robotics and aircraft.
The trade war between the US and China has created a lot of uncertainties, and the expanding US tariff imposition and foreign retaliation have thrown the world economy into a state of shock. Based on the compilation of Morgan Stanley, the US tariffs are expected to affect about $109 billion of imports, equivalent to 0.7 percent of global merchandise trade and 0.15 percent of global GDP as of June 18. Including the retaliatory tariffs imposed or under consideration by trade partners, the amount affected increases to $181 billion or 1.1 percent of global trade. The amount involved is manageable at this moment but any further escalation will be problematic for the global economy to handle.