The economic consequences of a resurgence in protectionism

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Tensions over trade policy have continued to escalate. The US administration has sought to concentrate its fire on China, and worked towards accommodation with Canada and Mexico to agree on a replacement for NAFTA, and effectively signed a truce with the EU.

A coalition against Chinese trade practices ?

In July, European Commission President Jean-Claude Juncker met for negotiations on trade policy in Washington, Although the EU protested the US’s implementation of steel and aluminum tariffs in the second quarter, the Europeans have really been most concerned that the US might impose tariffs on autos, under the guise of a Section 301 ‘national security’ review.

The discussion led to an agreement to establish a working group to discuss a number of trade topics, with the declaration that further tariffs would be held off while discussions were ongoing. Specifically, the working group would “work together toward zero tariffs, zero non-tariff barriers, and zero subsidies on non-auto industrial goods…. (and) work to reduce barriers and increase trade in services, chemicals, pharmaceuticals, medical products, as well as soybeans.” The two sides also “agreed …. to strengthen our strategic cooperation with respect to energy. The European Union wants to import more liquefied natural gas (LNG) from the United States to diversify its energy supply.”

Of course, this was really just an agreement to negotiate. But within the statement was also the strong hint of a coalition against Chinese trade practices. As per the statement, “we agreed today to join forces to protect American and European companies better from unfair global trade practices. We will therefore work closely together with like-minded partners to reform the WTO and to address unfair trading practices, including intellectual property theft, forced technology transfer, industrial subsidies, distortions created by state owned enterprises, and overcapacity.”

The US has been pressing the EC on this topic for some time, especially on the issue of China’s IP/technology transfer practices and alleged metals dumping, and used steel and aluminum tariffs as a stick to incentivize cooperation.

USMCA replaces the NAFTA

In late September, the Trump administration separately reached a deal with Mexico and Canada to replace the North American Free Trade Agreement. The new deal, named the United States, Mexico Canada Agreement (USMCA), involves additional restrictions on content and wages in auto production, as well as Canadian concessions on dairy.

While US trade tensions with the EU, Mexico and Canada might have eased, it’s the opposite with the Chinese relationship.

We have been of the view that the US administration was not bluffing in its threat to impose tariffs on imports from China, and that the US remains determined to see China adjust its practices on market access and intellectual property.

Correspondingly, at the completion of the consultation phase in early September, the Trump administration made good on its threat to initiate tariffs on a further $200bn of imports from China. The tariffs were set at 10%, but will reset to 25% in 2019, providing time for US purchasers to identify and source substitutes. China responded with retaliatory tariffs on $60bn of imports from the US, and filed a complaint with the WTO. China also cancelled proposed trade talks. Our view remains that the gap between Beijing’s industrial policy direction and Washington’s requested trade practices is too wide to be bridged, so that any resolution to the trade conflict is unrealistic in the short-term.

The escalation of trade tensions between the US and China matters to the US bond market because of the following impacts:

  • The disruptions caused to global supply chains could damage corporate earnings and business confidence.
  • The direct impact of tariffs on consumer prices, which should lift CPI by between 0.2% and 0.4%. The magnitude of the impact will depend on whether consumers or retailers and producers absorb tariffs, and on potential for second-round effects.
  • The impact on US employment and growth over time. Tariffs could cause significant disruption to global supply chains, as the prices and availability of basic, intermediate and finished goods are impacted. US manufacturing firms would need to substitute from Chinese suppliers to other suppliers (where possible). The disruption to prices and supply chains can have negative near-term impact on employment, as vulnerable firms lack working capital to finance adjustment costs.

In the medium term… 

Relocation of offshore production back to the US could be expected to boost US manufacturing employment in some sectors.

But, over the longer term

Removing the gains from international trade, as countries no longer focus on areas of comparative advantage, could reduce potential growth.

This combination of higher prices and reduced long-term growth is a ‘stagflationary’ phenomenon. Put another way, if globalization contributed to subdued inflation and rapid global growth over the last two decades, then resurgence in protectionism should reverse that trend. Ultimately, that would be supportive for breakeven inflation rates and keep long-dated real yields contained.


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