Trade Wars

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.

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What’s in store for the UK economy in 2018?

Santa has been and gone, the sleigh is parked in the long-stay car park, the reindeer are out to graze for a few months and it is time to think about what 2018 will have in store for the UK.

However economic forecasting is difficult. Unlike the natural sciences, such as physics and chemistry, we cannot base our predictions on previous laboratory experiments. Furthermore, although economists frequently assume “ceteris paribus”, the real world is not like this. For example, we do not know what the outcome of the Brexit negotiations will be, whether the bitcoin bubble will burst, and, if it does, what the impact will be, whether there will be a new Prime minster  or a general election this year or even what will happen to oil prices.

In an article published in the last week of 2017, The Times examined predictions made by key economic bodies (the Bank of England, the CBI, the Office for Budget Responsibility, the Institute of Financial Studies and the British Chambers of Commerce) a year ago for the economy in 2017. As the table below indicates, the results are not encouraging.

  Growth Inflation Unemploy-ment Wage Increase House-hold Spending Increase
End 2016 Figure 1.9% 0.7% 4.9% 2.8% 2.8%
Highest prediction for 2017 1.6% 2.7% 5.4% 2.75% 1.5%
Lowest prediction for 2017 1.1% 2.1% 5.1% 2.1% 0.6%
Actual figure for 2017 (latest estimate) 1.7% 3.1% 4.3% 2.5% 1.0%

 

The UK’s growth performance has dropped from first place among the G7 in 2016 to close to the bottom and, in addition to the data above, we should note that share prices in the USA and the UK are at record highs, as is employment in the UK. However particularly worrying is the fall in real incomes which has impacted on consumption growth.   UK productivity growth has been low, with businesses tending to increase labour rather than spending on capital. Although the very latest figures show an improvement, this is because hours worked have dropped rather than output increasing. In addition, house price growth, particularly in London, has slowed.

In thinking about what might happen to the UK in 2018, there is the old saying that “when America sneezes, the world catches a cold”. This is still applicable but we might include China since the performance of the world’s largest economies will have both direct and indirect effects on the UK, since their faster growth will directly impact on our export sales and indirectly as rapidly growing demand for raw materials overseas pushes up prices for UK firms and consumers. On the other hand, we do not know whether President Trump’s desire to implement policies  focussing on “putting America first”, will have an impact on the rest of the world.

The IMF is positive about the prospects for the world economy in 2018. It predicts that world GDP will grow by 3.7% and this recovery is likely to continue for a further four years. This faster growth is the result of the three main economic areas (North America, Asia and Europe) all recovering rapidly at the same time. Businesses in the USA and France are confident following the election of business-friendly Presidents Trump and Macron, and this confidence should have a positive impact on investment. In addition, even though there have been interest rate rises in the USA and the UK, the level of world interest rates and the positive effects of QE continue to facilitate growth. The IMF therefore expects that average unemployment in the G7 will drop below 5% this year for the first time since the 1970s while inflation will remain below 2%.

Time to feel sorry for economic forecasters.