Is Donald Trump right to impose tariffs on Beijing for lack of trading reciprocity? Is it true that tariffs have boosted the US economy? And what are the consequences of American tariffs for the European Union, Italy in particular? Against the backdrop of a stalemate in the US-China negotiations, ISPI analyses the motivations and reasons behind Trump’s tariffs, their effects and their most controversial aspects.
Before Donald Trump's protectionist moves, the United States had one of the lowest average tariffs of any G20 country (3.36%). However, his 25% tariff on China's $250bn imports will raise that to 5.67%, one of the highest averages among industrialized countries, though still considerably lower than those applied by developing G20 countries such as China and India (see graph). The European Union, along with Canada and Australia, remains one of the areas most open to free trade, even if it does apply relatively high tariffs on a wide range of goods such as agricultural products (over 15% on average) and those of the automotive sector (10%). These tariffs continue to have their critics, not least the Trump administration itself.
Apart from tariffs, the main issue in international trade today is that of “non-tariff barriers” (technical, administrative, legislative and phytosanitary measures); indeed these, rather than tariffs, are the real impediment; they continue to grow, and now affect more than 70% of world trade. All G20 countries, including the pre-Trump United States, have made extensive use of these barriers to defend not only sensitive sectors, but also traditional sectors such as agriculture and heavy industry.
China faces more outstanding disputes at the WTO for breach of trade rules than any other country. With specific reference to its trade with the United States, the 2018 report of the US Trade Representative Office (USTR) focuses primarily on forced transfers of technology and intellectual property. Despite Beijing's repeated promises to change its behaviour, especially at the local level, the country’s authorities continue to make approval of foreign investment conditional on technology transfer. Further constraints on foreign investment in China include the obligation to set up joint ventures in certain sectors (e.g. pharmaceuticals, automotive and electronics), and trade licensing processes and other bureaucratic requirements that are not always transparent. We should also mention Chinese subsidies to local manufacturers, often not notified to the WTO. This policy has encouraged overproduction in various sectors such as steel and aluminium, sectors where China, despite not having any particular comparative advantage, produces about half of world production and has played a primary role in distorting international prices, often through practices that amount to dumping. Finally, there are also considerable restrictions in the service sector, from banking, where non-transparent discriminatory requirements restrict foreign banks’ expansion in China, to the particularly intrusive state controls on telecommunications and forced use of Chinese technology there.
The United States has not followed the WTO procedure for the adoption of trade restriction measures. That procedure is quite specific: when one member state considers itself discriminated against by another, friendly consultations should be the first recourse. If they fail, the aggrieved party may request the establishment of a panel within the WTO’s Dispute Settlement Body which may then authorize trade restriction measures. When the US imposed tariffs on steel and aluminium in March 2018, however, it did so unilaterally without passing through the WTO; instead, it invoked the "national security exception" provided for in Article 21 of the GATT. According to a recent WTO ruling, that article recognises the right of each member state to react to national emergency situations as it sees fit, but does not – as the US administration argues – mean that the Organization has no part to play in assessing the legitimacy and proportionality of the counter-measures taken. For the second wave of tariffs – on $250bn of imports from China – which began in July 2018 and continued until May 2019, Trump appealed to Article 20 of GATT which condemns unfair trade practices, such as infringement of intellectual property rights and theft of foreign technology. The United States initiated consultations on the subject on March 23, 2018; not receiving a satisfactory response, it requested the establishment of a panel, which was in fact set up on January 16, 2019. Again, however, the tariffs were applied without a pronouncement by the WTO on their legitimacy or reasonableness as counter-measures.
In the first six months of 2019 the US trade deficit with China was 10% lower than in the same months of the previous year, a reversal of its sustained growth throughout 2018 when it increased by 11.75%. It should be noted, however, that the recent reduction in the deficit is linked to a decline in total trade between the two countries. Comparing the first six months of 2018 with those of 2019, in fact, we see that while US imports from China have fallen by 12%, exports there have declined even more (-19%), with negative effects on the US economy’s most productive and dynamic sectors such as high-tech manufacturing (-36%).
What has contributed most to US economic growth since the start of the Trump presidency has been the increase in private consumption and investment (see graph). That increase was in turn driven by tax cuts and low interest rates. The healthier trade balance in the first quarter of 2019 certainly contributed – about one third – to GDP growth in the same period, but for some very specific reasons: previously, in the second half of 2018, US imports had increased more than expected because American retailers, producers and consumers were stocking up on Chinese products with another round of tariff rises in prospect. Such import purchases were cut back in the first quarter of 2019, which in turn increased GDP growth from an accounting point of view. However, this momentum seems fading away with net exports giving a negative contribution to GDP growth in the second quarter of 2019. In addition, according to IMF estimates, a prolonged trade war between Beijing and Washington could reduce US growth in the two-year period 2019-2020 by 0.3% – 0.6%, and Chinese growth by 0.5 – 1.5%.
According to the Federal Reserve, tariffs have so far contributed only 0.1% to the rise in consumer prices, and 0.4% to that of capital goods; the hit has mainly been taken by US importers, who have chosen to cut profit margins rather than pass the rises on to consumers, and there have been no substantial price reductions by Chinese exporters. However, this small increase in inflation does not yet show the tariffs’ probable medium- and long-term effects. Imports from China are indeed an important part of total US imports of consumer and capital goods, semi-finished goods and components of finished products made in the USA. The 25% levy on $250bn of imports from China could result in a further 0.3% increase in consumer prices and 1% in those of capital goods as soon as 2020.
Rather than replacing Chinese products with American ones, the US will import more from third countries (trade diversion). It is estimated that of the $250bn of Chinese goods subject to US tariffs, 82% will now come from other countries, 12% will continue to come from China, while only 6% will be replaced by US local production. Against this “re-patriated” 6%, however, there will be the effects of Chinese retaliation on American exports to China: of the $110bn of such exports affected by Beijing’s tariffs, only 10% will continue to come from the US while 85% will be replaced by production from other countries. The European Union will benefit most from this trade war between China and the United States, picking up $70bn of the bilateral trade between China and the United States ($50bn from the United States and $20bn from China). Mexico will benefit from US tariffs by replacing $27bn of Chinese exports to America, some 6% of Mexico’s total exports. These windfalls to third countries might, however, be diminished if political and commercial uncertainties lead, as the IMF forecasts, to a 0.5% reduction in world growth this year (2019-2020) – not to mention possible commercial retaliation against them (see the case of Italy, below).
The first reason Trump puts forward to justify tariffs against the European Union is the huge trade deficit between the two sides of the Atlantic (€139.1bn in the EU’s favour in 2018). Germany alone accounts for one third of this, and it is therefore no accident that the country is in the American president’s sights. One of the most incriminated sectors is the automotive industry, where Trump attributes the €31bn US trade deficit to the particularly high tariffs applied by Europeans (US tariffs is 2.5%, while EU tariffs is 10%). That is only a partial view, however; it ignores the fact that the US car market is dominated by SUVs and pick-up trucks, on which the US tariff is 25%. To form a more objective judgement we should look at the whole range of trade between the US and the EU: the average European tariffs against the United States is lower, both on agricultural goods (6.8% vs. 13.8%) and on non-agricultural goods (3.9% vs. 4.4%).
The other reason for the clash between Washington and Brussels is the systematic public support given by European governments to their national champions. One blatant case is Airbus, a long-standing issue between the USA and Europe before WTO panels, which in May 2018 did indeed recognize that some EU subsidies to Airbus are incompatible with WTO rules. However, Boeing in the United States has also been heavily subsidized by the federal government, to the extent that in 2005 the WTO found against the US for not having taken the necessary measures to remove the distorting effects of the subsidies.
Finally, Europe’s numerous non-tariff barriers are also a matter of dispute. Although the US takes the lead in terms of measures adopted and notified to the WTO , it should be borne in mind that EU regulations throw up various de facto obstacles (technical, phytosanitary, &c.) that are not not always communicated to the competent bodies of the WTO.
Given Italy’s trade surplus (€26.4bn in 2018), any US action against the EU could only have a negative impact on Italian exports. However, the impact must be assessed sector by sector. US tariffs since 2018 on steel and aluminium (which apply to Italy, among others) for example did not result in lower Italian exports of these products. Indeed, between 2017 and 2018 exports of steel increased by 13.9% while aluminium 22.4% mostly because, despite the tariffs, US steel and aluminium producers cannot instantly replace such imports due to high costs of production and the need to commission new plants. A second wave of tariffs, which could be imposed this summer as a countermeasure to the public subsidies to Airbus, could affect $21bn of European products (see list). A list recently increased with additional $4bn of products (see list). The impact on Italy would be relatively modest (see graph), although some sectors such as the food and drink sectors could be significantly affected (roughly 81% of beverage exports and 75% of food exports).
The effect of higher tariffs on European cars would be greater: tariffs would have a direct impact on Italian vehicle exports (€5bn of a European total of €50bn) and on the entire automotive sector, for Italy is one of the main suppliers of components to the German car industry which accounts for about half of European car exports to the United States. A heavier impact on Italian exports, however, would be caused by the resulting chill in the global economy: any escalation of the trade war between China and the USA could have direct and indirect effects on world economic growth and hence on demand for Italian exports in our main customer countries: according to estimates by the Italian Export Credit Agency (SACE), exports might fall by 0.8% in 2019 and by 1.7% in 2020.