TWN Info Service on WTO and Trade Issues (Feb19/06)
12 February 2019
Third World Network

United Nations: US-China trade tensions will have significant repercussions
Published in SUNS #8840 dated 6 February 2019

Geneva, 5 Feb (Kanaga Raja) – Due to the size of the two economies involved, the (trade war and) tariffs that have been imposed by the United States and China (on each other) will have significant repercussions on international trade, according to a new report by the UN Conference on Trade and Development (UNCTAD).

In particular, the implications will be “massive” in the absence of an agreement between the US and China on 1 March, when the US will increase tariffs to 25% (from the existing 10%) on about $200 billion of Chinese imports.

UNCTAD also found that the intended effect of the retaliatory tariffs imposed by the US on China has not resulted in increased domestic production but will rather lead to diversion of trade to third countries.

In its Key Statistics and Trends in Trade Policy 2018 report released on Monday (4 February), UNCTAD said that while the brunt of the effects of the tariffs will fall on the two countries directly involved, when it comes to trade nothing happens in isolation.

Trade tensions among major economies are bound to have spillovers, externalities and several ripple effects on many other countries, it said.

In this context, UNCTAD highlighted several concerns for developing countries including the unavoidable impact that ongoing trade tensions will have on global growth, the spillovers that trade tensions could have on monetary policy and currency markets, and the possibility of stagflation, namely, an increase in prices coupled with lower growth.

At a media briefing on 4 February, Ms Pamela Coke-Hamilton, the Director of the UNCTAD Division on International Trade in Goods and Services, and Commodities, highlighted one single lesson that was learned today by citing former US Secretary of State Cordell Hull, seen as the founder of the United Nations as well as introducing the Reciprocal Trade Agreements Act in 1934, as once saying that “we learned that a prohibited protective tariff is a gun that recoils on ourselves.”

[Cordell Hull, Secretary of State under President Franklin D. Roosevelt, envisioned the post-war system, but resigned over ill-health in 1944. He was however a delegate to the San Francisco United Nations Charter Conference i n 1945. By then FDR had died, and Truman had become President. SUNS]

Barring an agreement between the United States and China on 1 March, tariffs will escalate to 25% (on Chinese goods), which is a significant difference from 10% as it currently exists, she said.

“The implications are going to be massive,” she said, pointing out that at the macro-economic level, “we will see an economic downturn especially due to instability in commodities and financial markets.”

“Additionally, there will be increased pressure on global growth as companies will have to impose adjustment costs which will affect productivity, investment and profitability.”

Coke-Hamilton further pointed out that small and lower income countries, which are exposed to external shocks, will find it very difficult to maintain any level of resilience. And the impact on currency markets will also be deleterious. There will be currency wars and devaluation.

Coke-Hamilton further pointed to stagflation, leading to job losses and higher unemployment and “more importantly the possibility of a contagion effect over what we call a reactionary effect leading to a cascade of other trade distortionary measures, because everybody then will get into the game and it will be very difficult.”

The impact on global value chains and intermediate suppliers – the relocation, for example, from East Asian value chains – will result in a reduction of almost $160 billion away from East Asia.

However, the European Union will be able to attract almost $90 billion of those value chains, “which is great for the EU but not for East Asia and others a long the value chain.”

The implications for the multilateral trading system will also be onerous, she said.

Coke-Hamilton highlighted the weakening of the multilateral trading system with significant repercussions for the developing countries particularly as it relates to special and differential treatment and other embedded principles within the multilateral system.

“So there is a move also towards more regional and bilateral trade with actually more than 50% of trade now being done under preferential trade agreements.”

According to Coke-Hamilton, the central message from this report is that the intended effect of the retaliatory tariffs imposed by the US has not resulted in increased US domestic production but rather will lead to diversion of trade to third countries.

If the US tariffs rise to 25%, what will occur is simple, she said, pointing out that they will limit trade from China; however, it will not be effective in protecting domestic firms.

So, suppliers in the rest of the world will be more competitive, and trade diversion effects will be in favour of third countries.

The EU will capture $70 billion of the US-China trade while Japan, Mexico and Canada will each capture over $20 billion.

“And perhaps, the ultimate irony is that Mexico’s capture of almost $27 billion of the US-China trade will represent the equivalent of about 6% of Mexico’s exports,” she said.

Essentially, what UNCTAD is saying is that the impact is going to be significant.

“We are now at February 4. Discussions are taking place between the two par ties [the US and China]. However, if it [US tariffs] does rise to 25% on March 1, the implications for the entire international trading system will be significantly negative,” Coke-Hamilton cautioned.

TRADE TENSIONS AND THEIR CONSEQUENCES

The UNCTAD report examines the repercussions of the existing tariff hikes by the US and China, and the effects of the US tariff increase on Chinese good s scheduled for 1 March.

It noted that the year 2018 has been an eventful one with regard to international trade. While trade continued to substantially outpace GDP growth, the last 12 months have also been characterized by several trade confrontations.

While some confrontations have de-escalated through bilateral arrangements, some have further escalated.

Most notably disagreements between the United States and China have escalated into rounds of retaliatory tariffs.

“Given the size of the economies involved, these tensions are of importance not only for the United States and China, but for all other countries,” it said.

The first round of retaliatory tariffs occurred in early 2018 when China an d the United States imposed tariffs on about US$50 billion of each other’s goods. The confrontation quickly escalated, and in September 2018 the United States imposed 10 per cent tariffs covering about US$200 billion of Chinese imports, to which China retaliated by imposing tariffs on imports from the United States worth an additional US$60 billion.

The report noted that these tariffs were initially due to rise to a much more substantial 25 per cent in January 2019, however, in early December 2018 the United States agreed to freeze the tariff increase until March 1st 2019.

The tariff imposed by the United States and China on each other in 2018 cover more than half of their bilateral trade (the total was valued at about US$6 40 billion in 2017).

Both United States and China tariffs encompass a wide range of products, though most of them are concentrated in the manufacturing sectors.

US tariffs targeted about US$250 billion worth of imports, of which about US$120 billion related to intermediate manufacturing products, US$80 billion of capital manufacturing goods, and about US$50 billion to consumers’ manufacturing goods. Some of the US tariffs also targeted China’s agricultural exports (about US$5 billion).

China’s retaliatory tariffs include about US$50 billion of intermediate manufacturing products and US$20 billion of capital and consumers’ manufacturing goods.

China also targeted almost US$20 billion in agricultural products (largely soybeans) and about US$4 billion in imports of energy products (largely liquefied gas).

The relatively lower amount of trade affected by Chinese tariffs reflects its large bilateral trade surplus with the United States, said UNCTAD.

While US imports of goods from China were in the order of about US$505 billion in 2017, Chinese imports of goods from the United States were about US$130 billion.

The report identified several factors for which current trade tensions will have far-reaching consequences.

A major concern for developing countries is the unavoidable impact that ongoing trade tensions will have on global growth.

“Overall, the global economy remains fragile and confrontations in the area of international trade can have negative spillovers to commodities and financial markets and increase the risk of a global economic downturn.”

More directly, trade frictions weigh on global growth as they impose adjustment costs to international firms which would reflect upon investment decisions, profitability and productivity. In addition, the increase in uncertainty about commitments to trade rules adds to the risk of investing abroad.

These factors will ultimately have negative repercussions for the growth prospects of many countries, especially small and low-income developing countries, as they are generally less resilient to unfavourable global conditions, said UNCTAD.

Another macroeconomic concern is the spillovers that trade tensions could have on monetary policy and currency markets.

Although other factors may be also at play, trade tensions have at least in part contributed to the depreciation of the Renminbi, while contributing to the appreciation of the dollar.

A lower Renminbi has had the effect of making Chinese companies relatively more competitive not only versus US firms but also vis-a-vis firms from the rest of the world.

Currency markets are closely interlinked, and any adjustment in one currency can spread quickly to other currencies.

Indeed, the trade confrontations between the United States and China have already weighed on currency markets by increasing the volatility and downward press ure for many currencies, especially in the riskier emerging markets.

For many developing countries, one important concern is whether trade tensions will affect currency markets in ways that will make their dollar-denominated debt more difficult to service.

Another concern is stagflation – an increase in prices coupled with lower growth. Tariffs can contribute to stagnation as they can reduce efficiency due to the frictions they create while increasing inflationary pressure because some of their costs will be inevitably passed down to consumers.

Given the size of the two countries directly involved, the concern is that these effects will be felt not only domestically but also abroad.

While moderately higher inflation is generally not a problem if it is a result of economic growth, in periods of economic stagnation, inflation often results in job losses and rising unemployment.

Because of the size of the two economies involved, the tariffs implemented by the United States and China will inevitably have significant repercussions on international trade, said UNCTAD.

The impact of tariffs on international patterns of trade depends primarily upon the extent to which United States-China trade will be substituted with product s originating from other countries. Some products may not be easily substituted because of a lack of foreign competitors or because of United States/Chinese suppliers willing to absorb at least part of the additional costs due to ta riffs.

While this implies that even with substantial tariffs some trade will continue to occur between the two countries, some bilateral trade will inevitably be diverted to other countries or lost due to price rises and import substitution effects, said UNCTAD.

The report analyses the amount of trade affected by tariffs across several sectors along with estimates of trade diversion effects (imports diverted to third countries), residual trade (imports still originating from the country affected by the tariffs), and trade losses (imports that would be substituted by the domestic economy or lost due to price increases).

In a sectoral breakdown, it said the effects of US tariffs will be amongst others on various machinery, electrical machinery, office machinery, wood products and furniture, communication equipment, metal products, motor vehicles, rubber/plastics, chemicals and tanning.

The effects of Chinese tariffs will be amongst others on chemicals, vegetable products, motor vehicles, various machinery, precision instruments, paper products and publishing, electrical machinery, rubber/plastics, wood products and furniture, and communication equipment.

In general, the trade diversion effects of tariffs of 25 per cent are orders of magnitude larger than residual trade and trade losses.

For example, of the about US$33 billion of various machinery that the United States imports from China, about US$27 billion would be diverted to third countries, US$4 billion would remain in Chinese firms and US$2 billion would be lost or captured by United States firms.

This suggests that while bilateral tariffs are not very effective in protecting domestic firms, they are very valid instruments to limit trade from the affected country, said UNCTAD.

One effect of United States-China tensions is to make suppliers in the rest of the world more competitive relative to United States and Chinese firms, it added.

“A substantial share of United States-China trade is therefore likely to be captured by other countries whose firms are close competitors of Chinese and United States companies.”

Overall, European Union exports are those likely to increase the most, capturing about US$70 billion of the United States-China bilateral trade (US$50 billion of Chinese exports to United States, and US$20 billion of United States exports to China).

Japan, Mexico and Canada will capture above US$20 billion, while other countries would capture substantially less.

Although these numbers are not very large in relation to global trade (about US$17 trillion in 2017), for many countries they represent a substantial share of exports. For example, the about US$27 billion of United States- China trade that would be captured by Mexico represents about 6 per cent of Mexico’s exports.

Substantial effects relative to the size of their exports are also expected for Australia, Brazil, India, Philippines, Pakistan and Viet Nam.

Still, while United States and Chinese tariffs can be beneficial to some foreign competitors, the overall effects would be more uncertain depending on each country’s economic structure as well as the extent to which tariffs will affect prices, said the report.

A clarifying example of these dynamics is provided by Chinese tariffs imposed on United States soybeans.

Because of the importance of these two markets (China accounts for more than half of global imports of soy-beans and United States is the world’s largest producer of soybeans), the tariffs on soybeans have substantially disrupted world trade of this commodity.

One consequence of such tariffs has been a diversion of trade to favour several exporting countries, in particular Brazil which suddenly becomes the main supplier of soybeans to China.

However, while higher price premiums have been welcomed by Brazilian producers, not everyone has been happy.

One concern of Brazilian soybean producers is that higher prices brought about by the Chinese tariffs may hamper Brazilian procurers’ long term competitiveness.

In a situation where the magnitude and duration of tariffs is unclear, Brazilian producers are reluctant to make investment decisions that may turn unprofitable if tariffs are revoked.

Moreover, Brazilian firms operating in sectors using soybeans as inputs (e.g. feed for livestock) are bound to lose competitiveness because of higher prices due to the increase in demand for Brazilian soybeans from Chinese buyers.

One major concern is that the trade confrontations and bilateral policy actions could spread to other countries, UNCTAD underlined.

Since trade policies implemented by large economies are bound to influence international markets, even the countries not directly involved in the confrontations often find it efficient to adjust their trade policies to maximize opportunities or minimize negative spillovers.

In other words, changes in trade policy in one country often create policy changes elsewhere, eventually resulting in a cascade of distortionary trade policies, said UNCTAD, highlighting in the present context, trade defence measures, which are of concern.

The report cited the example of the tariffs on steel and aluminium products that the United States imposed on March 2018.

Those tariffs exacerbate the problem of global oversupply and consequently contributed to lower prices. To limit the possibility of dumping, several economies including the European Union, India, Canada, Turkey and South Africa have all initiated investigations within the WTO framework to implement temporary tariffs under the Agreement on Safeguards.

EFFECT ON GLOBAL VALUE CHAINS

The report noted that today patterns of trade are greatly shaped by production networks, with assembly done in one country while parts and components originate from elsewhere. In this context, the imposition of a tariff would have far-reaching consequences beyond the country and sector directly targeted.

One important element to consider is the implications of tariffs for international production networks. While trade tensions between the United States and China may promote some domestic re-localization of global value chains, they will largely alter the localization of industries across countries.

For example, US tariffs on China could benefit Mexico as they may result in the relocation of some assembly lines away from China.

Moreover, US tariffs will also have negative implications for East Asian suppliers as they may find themselves unable to be competitive when other processes along the value chain move away from their region.

The report analysed the effects on regional value chains consequent to 25 per cent tariffs on the affected products.

The reported effects include the reallocation of assembly processes away from the United States and China as well as the effects on direct suppliers to those assembly lines.

The results indicate that while both the North American and East Asian value chains will be negatively affected, East Asian value chains will shrink considerably more. Considering both United States and Chinese tariffs, trade would be reduced by about US$160 billion for East Asian regional chains.

For the North American region (that is the countries in the USMCA agreement: United States, Canada and Mexico), the negative effects of Chinese tariffs will be almost entirely compensated by the reallocation of production process away from China into the USMCA area.

For the North America region, the net loss is estimated at US$10 billion of trade.

One reason for such disparity is the larger amount of trade affected by US tariffs, as well as the fact that a large number of US tariffs are targeted to inter mediate products.

Negative effects in East Asia and North America will benefit other countries, in particular the European Union. It is estimated that the European Union will be able to attract about US$90 billion of trade related to value chains.

Other Asian countries and South American countries would also attract some trade related to value chains, while Africa much less so.

EFFECT ON THE TRADING SYSTEM

According to UNCTAD, the ongoing trade tensions not only have implications for the global economy, but more so for the rules governing it.

The very fact that negotiations and settlements on ongoing trade confrontations are taking place at a bilateral level rather than within the domain of the WTO denotes the weakening of the multilateral trading system.

Although the multilateral rules governing international trade are far from perfect and need reform, the rapid weakening of the existing framework can have large repercussions for many developing countries.

In a context where countries are becoming more attentive to national and socio-economic outcomes rather than to multilateral cooperation and development assistance, it is unclear whether rewriting global trade rules may produce a more positive outcome for smaller and low-income countries.

For example, any new trade policy could become a major concern for developing countries if the policy would not be obliging to the principles of special and differential treatment associated with the present multilateral trading system, UNCTAD argued.

Another aspect is that the weakening of the global trade system may further advance regional and bilateral trade integration initiatives.

Although this is not necessarily a negative outcome, such initiatives often give more leverage to economically powerful countries.

The current trade confrontations reflect disagreements in the areas of intellectual property rights, government subsidies, and many other types of non-tariff barriers affecting market access. Trade rules governing these areas are being rethought, wrangled, and likely to be rewritten.

Whether these rules would favour a supportive global environment remains to be seen. What is sure is that these rules will have great importance for the development perspectives of many developing countries, said UNCTAD.