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The US and China beware: trade war tariffs are a double-edged sword

12/12/2019    11

Tariffs are the key weapon of US President Donald Trump’s trade war with China, and thus they are also the key to eventually unlocking the intractable problems of the marathon US-China trade negotiation. Any good deal should include the removal of punitive tariffs.

But the latest inhospitable rhetoric over when and how much of these duties should be removed suggests the issue has become the main point of disagreement preventing Washington and Beijing from finalising their “phase one” deal on time, despite their claims it would be completed a few weeks after they reached an oral agreement during the October 10-11 trade talks in the US.

In the past week, Trump and his commerce secretary Wilbur Ross have threatened to move forward with their planned additional tariffs on December 15, while the Global Times – a nationalist tabloid affiliated with the People’s Daily, a Communist Party mouthpiece – tweeted that Beijing was insisting US tariffs must be rolled back as part of any trade deal.

On December 2, the Trump administration expanded the scope of its trade rows by hitting Brazil and Argentina with steel tariffs and proposing levies against France, including slapping punitive duties of up to 100 per cent on imports of some products.

Tariffs have historically been a tool for governments to collect revenue, but they are also used as a weapon to protect domestic industries and production in a trade war.

At issue, however, is who pays for such tariffs. Trump, the self-styled “Tariff Man”, believes they work not only as leverage over an opponent in negotiations, but also raise revenue for state coffers. He repeatedly asserts that “China is paying for it”.

But tariffs are not paid by either the Chinese or American governments – they are paid directly by importing companies in both countries. US tariffs are paid by US-based companies to American customs for the goods they import from China. The additional costs would be borne by one or all three parties involved in the process: manufacturers, importers and consumers.

On the surface, both governments are net winners as they receive more revenue from the additional duties. Given that the US imports much more than China, Washington can pocket more than Beijing through the mutual imposition of punitive tariffs.

The US has slapped tariffs on US$550 billion worth of Chinese products. China, in turn, lashed back at US$185 billion worth of American products, with the total of both figures equivalent to about the entire trade volume between the two countries. In 2017, the year before the trade war, US imports from China were worth US$505.47 billion, while China imported US$129.89 billion of American goods, according to US figures. Washington has also imposed a much higher rate of tariff than Beijing’s reciprocal levies.

Trump believes trade wars are designed to protect American interests and provide advantages to its domestic businesses. In practice, however, it is rare that any one party can win in such mutually destructive wars, which would ultimately hurt companies and consumers, importers and exporters, as well as wholesalers and retailers – though the damage to each victim might vary in degree.

Trump is obviously wrong to suggest only China pays all US tariffs. In practice, tariffs are split between lower profit margins for wholesale importers, retailers, and manufacturers, and higher prices for consumers.

For example, American companies essentially have three options to deal with rising costs from the additional levies. They can absorb the extra expense by decreasing their own profit; increase retail prices to transfer the additional cost to consumers; or shift their suppliers from China to other countries which manufacture similar products and substitutes.

Beijing’s insistence that all tariffs be rolled back as part of the “phase one” deal, and Washington’s disagreement in this regard, clearly suggests the US has the upper hand in this fight. Obviously China would suffer much more than the US in this war in terms of declining GDP growth due to higher prices for imported goods and lower prices for exported goods.

China’s worst nightmare is that US importers’ shifting of suppliers from China to other countries would trigger an exodus of industries from the world’s manufacturing hub. Under such conditions, Beijing should make substantive concessions to warrant Washington’s agreement to remove the tariffs.

Trump has the motivation to keep the tariff war in the headlines in the run-up to the 2020 US elections, but while doing so could have benefits for the president, it could also hurt his constituencies.

However, higher government revenue from the tariffs and gains for local manufacturers would not fully offset the total income loss in a trade war – not to mention the conflict’s indirect effects, including rising investment and consumption uncertainty and elevated market volatility that would affect the overall business environment and thus drag on growth.

For instance, the cost advantage of Chinese imports helped many US companies to run profitably. Tariffs can make domestic industries less efficient and innovative by reducing competition, while this reduction – coupled with rising prices – also hurts local consumers. They can also distort market competition by favouring certain industries, or geographic regions, over others.

America’s import-oriented manufacturing and export-oriented agricultural sectors have all been hurt by rising costs from the tariff hikes imposed by both governments. Trump has, in collaboration with Congress, had to give them aid in the form of economic subsidies to ease their losses.

In a globalised economy, the contagion of a trade war can undoubtedly grow to affect many aspects of the American and Chinese economies, in ways that are hard to measure quantitatively. Likewise, their trade war can also expand to affect other countries not initially involved in the fight.

America’s own historical experiences should be a warning. The 1930 enactment of the Smoot-Hawley Tariff Act – which raised tariffs on agricultural and industrial goods by some 20 per cent and also prompted retaliation from foreign governments – led to a 66 per cent decline in world trade between 1929 and 1934, seriously exacerbating the Great Depression in the US and a recession in Europe.

It was then US President Franklin D. Roosevelt’s pro-trade policy and the enactment of the Reciprocal Trade Agreements Act in 1934, which helped reduce tariffs and remove barriers, that revived global trade.
Obviously, the tussle over tariffs has become the last innings of the marathon negotiation between the world’s main economic rivals – even though they are a double-edged sword, just as likely to injure the wielder while killing the opponent.

Moreover, any attempts to further hike punitive tariffs would devolve into a mutually destructive cycle of retaliation, and eventually drag the US and China into a full-blown trade war. Such a scenario would lead to the decoupling of the world’s two largest economies and a disruptive shake-up of the global supply chain, which would create a long-term threat not only to global prosperity, but also to world peace. 

Source: SCMP