A trade war will damage important sectors of the US economy

A trade war will damage important sectors of the US economy

There is an increasing possibility that we are moving inexorably towards a global trade war, writes David Birnbaum. Should there be a trade war, the responsibility will lie with the United States and, more precisely, with its President and his America First policy. And the implications would not just hit trade, but also social issues and security.

The US Government has taken the position that any country that enjoys a favourable balance of trade with the US is an enemy to be stopped at all costs. In pursuit of this goal, long-term relationships, even free trade agreements (FTA) and trade preference agreements (TPA) mean little. Everything can be discarded to gain some minor trade advantage.

To a large degree, the US is in a very powerful position. As of 2016, the US accounted for almost 25% of world GDP. The US is both the world's largest importer and second largest exporter. Perhaps more important, of all the major trading countries, the US is the least dependent on foreign trade with total imports and exports accounting for less than 20% of GDP. The argument, you-need-us-more-than-we-need-you has real validity.

The global economy as of 2016: Top 12 trading nations

% Global GDP0.2470.1490.0460.0660.010.030.0330.0190.0250.020.0060.0140.664
% Global Trade0.1160.1150.0750.0390.0340.0330.0330.0280.0270.0250.0240.0240.573
Trade % of GDP0.1990.3280.6930.2531.3920.4630.4260.6390.4680.5181.650.7270.424

However, despite the US seemingly having undoubted advantages, there are other aspects to consider.

A trade war will damage important sectors of the US economy. For example, while not major exports (accounting for only 5.5% of total US exports), meat and agricultural products have political influence far greater than their economic contribution. The farm lobby has immense influence in Congress. Coincidentally, most US farms are located in the red (Republican) states; and ironically the five countries that the US government has labelled America's greatest trade enemies are also the world's largest importers of these products. 

US exports of agricultural products and meat (in $000)

WorldChinaMexicoJapanKoreaCanadaTotalMarket Share
Soybeans and Others2774489314909267201346815822535887895887895887890.707
Prepared Fruit5048296266891401325517595266903170068231533960.625

Of even greater importance than agriculture and meat are machinery, aircraft and vehicles. Annoying the farmers will cause serious political issues. Annoying Boeing, GE and the other major exporters will cause serious disruption to the US economy. These top four items account for over 42% of all US product exports and, once again, the major importers are the very countries targeted by the US government as the largest trade enemies.

US exports of top four products (in $000)

WorldChinaMexicoJapanKoreaCanadaTotalMarket Share
Electronic goods1671970012275894740748574499380453309812388816762211220.456

These problems, together with the data, are no secret. These and more are well known to US government professionals. I am quite certain that the US Secretaries of State, Treasury and Commerce, as well as the US Trade Representative would like nothing more than to negotiate with US trade partners; make the best deal possible and, to paraphrase the late Senator George Aiken, declare victory and go home.

Unfortunately, the decision does not rest with them but rather with the President, whose single strategy is to push to the bitter end – whatever the fight and whatever the harm. To our trading partners, tweets by the president represent US policy and must be taken seriously. The very act of threatening a trade war brings that trade war closer to reality.

There are now two serious, possibly existential, problems that are becoming apparent, even now in the early stages of the trade fight.

1: In international politics, irrational behaviour is often an infectious disease.
Threatening the government of Mexico has been counterproductive. The Mexican Government is moving towards the conclusion that while the end of the North American Free Trade Agreement (NAFTA) would cause serious problems to its economy, the cost of even a failed economy is less than the cost of kowtowing to the Gringos. At this point every Mexican office holder is aware that any perception of compromise with the US will be the end of his career. Today Mexican political parties are vying with one another to prove that they hold the United States in greater contempt than the opposition.

2: The US's international partners are beginning to move towards a global trading world, minus the US. Once countries are forced to recognise that they cannot count on the US, it is an easy move to 'We do not need the US,' and from there an even easier move to 'We do not want the US.'

Because the US has renounced its global responsibilities, China has taken the role of international leader, not only in trade, but also in the environment and even global security.

The decision to walk away has forced our trading partners to move forward without the United States. For example, where once US farmers looked forward, and invested heavily ahead of the increase in exports that would have resulted in duty free access to major Asian economies such as Korea and Japan through the Trans-Pacific Partnership (TPP), that advantage died with the change in US policy.

What is worse, the situation has not reverted to the pre-TPP world where everyone was subject to import tariffs. Rather, the TPP countries may well go ahead with TPP sans America, with the result that US farmers will be at a greater disadvantage to big agricultural exporters such as Australia and New Zealand who will ship their products with zero tariffs.

The US administration might possibly frighten Canada and Mexico, but these threats go both ways. The end of NAFTA brings the end of duty free access not just for Mexican and Canadian exports, but also for US exports to both Mexico to Canada. The immediate result is the return of duties on US farm product exports to Mexico: 25% for beef, 45% for turkey and some dairy products, 75% for chicken, potatoes, high-fructose corn syrup.

China is in an even stronger position. In fact, once pushed beyond its limits the country might well see economic benefits in a trade war with the US. As with the United States, China too is moving away from an export based economy. A trade war with the United States in 2006, when trade accounted for 64% of China's GDP could have proved catastrophic – but not so in 2016, when reliance on foreign trade was cut nearly in half to 33%. 

China trade as a percent of GDP ($bn)

PCT of GDP0.380.420.510.590.620.640.610.560.430.490.480.450.430.410.360.33

Going forward China will almost certainly become the world's largest trading nation, ranked number 1 in both exports and imports. As world leader, they will have little interest in catering to US demands.

In the event of a fight, retaliation by China might well include more than the US Government has bargained for, or even considered. The Trump administration might be willing to flush America's soybean farmers together with Boeing commercial jets down the toilet, despite the disruption to the US economy. However, it may not have considered the effects when the PRC government decides that US/China joint ventures are contrary to Chinese law and should therefore be closed.

A trade war will change the world economy. When the dust settles there will undoubtedly be new winners and losers. One thing is certain. The world community will hold the US responsible. It will be a very long time before the word of the United States government will be accepted, not just in trade, but in social issues and security.

The nightmare scenario

Far worse than its effects on the US position in international trade will be the negative impact on its domestic economy.

Countries import goods because the value and prices available from foreign countries are better than what is available at home. Any policy limiting imports would by definition increase the retail price for the previously imported products. The result will be that even if local production could be made available on a timely basis to replace the lost imports, the additional cost will come directly out of consumers' pockets.

More importantly, what we define as exports usually include imported components used as parts for domestic manufacturing. When we consider the US's four top export products, we see that imported parts and components are greater than the sum total of exports. Failure to import parts will not only reduce exports; it will markedly reduce production for domestic sales.

Big 4 export products vs imported parts for those products (in $000)

Product ExportsImport Parts
Electronic Goods76221122149385315

It is almost impossible to calculate the impact that Trump's America First policy will have on the US economy. However, these are some of the major considerations:

  • Unemployment: Reduced exports plus reduced domestic production must lead to higher unemployment.
  • Recession: Reduced production will result in a reduction in Gross Domestic Product.
  • Inflation: Rising prices will result in a cost-push inflation.
  • Stagflation: Inflation at a time of recession. We have to go back almost 30 years to the last instance. This is the nightmare for the economy because any effort to move the economy forward will automatically increase inflation, while any effort to reduce inflation will add to the recession.
  • Stock market collapse: Earnings from export driven companies tank because the US is locked out of its previous overseas markets. Earnings for domestic market companies tank because high unemployment reduces sales, which leads automatically to corporate downsizing, which in turn increases unemployment.
  • The value of the dollar falls precipitously as foreign investors, governments and banks rush to pull their money out of dollars into the new safe-haven currency – very possibly the Chinese RMB.

When the full extent of the US economic decline hits home, the US government should go to its foreign friends and allies for help. Sorry, I forgot.