In an attempt to escape from the latest Brexit news, this week’s blog examines the trade war between the USA and China. Until recently, economics textbooks glossed over tariffs, quotas and protectionism; they were mentioned as possible approaches to improving a country’s balance of payments but it was accepted that although there were customs unions in existence, such as the EU, with a common external tariff (i.e. all products entering the union paid the same tariff, irrespective of where the goods entered the customs union, tariffs were not changed frequently as an economic weapon. This was because the accepted view among economists and (most) politicians was that world free trade was beneficial, allowing goods and services to be made in the countries most suited to their production (lowest opportunity cost in economic terms) and then traded for products made overseas, thereby allowing consumers to benefit from lower prices and an increased standard of living.
However all of that has changed with the imposition of tariffs by the USA on Chinese goods and retaliation by China, followed by retaliation for the retaliation by the USA! The crisis began in July, after months of negotiations, when the USA imposed 25% tariffs on an initial $34 billion of Chinese goods, including machinery, electronics, cars and computer components such as hard drives. China then retaliated and the following month the USA placed 25% tariffs on a further $16bn of Chinese goods which were matched by reciprocal Chinese tariffs on American goods such as cars. Then in September, President Trump imposed further 10% tariffs on $200 billion of Chinese goods and has threatened to increase this to 25% next year. China has retaliated with tariffs on $60 billion of US goods. The rationale for the American tariffs was two-fold – firstly that, according to President Trump, China had an “unfair” trade surplus in goods of $376 billion with the USA, thereby hitting American jobs, and secondly that China engaged in unfair trading practices, frequently involving foreign firms being forced to share their technology with Chinese ones.
The effects of the tariffs will depend on many factors. It is possible that businesses might find a way round the tariffs. For example, US soya producers have complained about the tariffs on their products but there is already evidence that they have been able to increase their exports to Brazil and Brazilian firms have exported to China. However many US businesses have expressed concern over the rise in costs of components imported from China and the effect they will have on consumer prices in the US. On the other hand, President Trump has argued that the tariffs will persuade US firms to produce more in the US to avoid the tariffs but others suggest that US firms will still produce overseas, where manufacturing costs are cheaper, but in countries other than China. A key factor will be the price elasticity of demand for the goods affected. This will determine whether producers can pass on the tariff, whether they will have to absorb some or all of it and whether they will need to cut output with subsequent effects on output and employment.