Author: Dr Shane Oliver, Head of Investment Strategy and Chief Economist, published on 21 June 2018.
In this week’s Oliver’s Insights, Shane Oliver takes a look at the risks of a full-blown trade war, particularly between the US and China.
The key points are as follows:
- Us actions in recent weeks have increased the risk of a full-blown trade war – primarily between the US and China – with a more significant economic impact.
- So far the bulk of the tariffs are just proposed so there is still room for a negotiated solution (which remains our base case with a 55% probability).
- But there is now a stronger risk (say around 30% probability that some of the tariffs go into force before a negotiated solution is reached (which would be a short-lived negative for share markets) or a full-blown US-China trade war is not averted (15% probability) with deeper share market downside.
- Key to watch for is the re-start of US-China negotiations ahead of the July 6 implementation of 25% tariffs on $US34bn of imports from China.
The threat of a full-blown trade war has escalated in the last few weeks with the G7 meeting ending in disarray over US tariffs on imports of steel and aluminium from its allies and more importantly President Trump threatening tariffs on (so far at least) $US450bn of imports from China, and China threatening to retaliate. Our base case remains that a negotiated solution will ultimately be reached, but the pain threshold in the US is clearly higher than initially thought and the risks have increased.
Background on trade wars and protectionism
A trade war is a situation where countries raise barriers to trade, with each motivated by a desire to “protect’’ domestic workers, and sometimes dressed up with “national security” motivations. To be a “trade war” the barriers need to be significant in terms of their size and the proportion of imports covered. The best-known global trade war was that of 1930 where average 20% tariff hikes on most US imports under Smoot-Hawley legislation led to retaliation by other countries and contributed to a collapse in world trade.
A basic concept in economics is comparative advantage: that if Country A and B are both equally good at making Product X but Country B is best at making Product Y then they will be best off if A makes X and B makes Y. Put simply free trade leads to higher living standards and lower prices, whereas restrictions on trade lead to lower living standards and higher prices. The trade war of the early 1930s is one factor that helped make The Great Depression “great”. As RBA Governor Philip Lowe has observed “Can anyone think of a country that’s made itself wealthier or more productive by building walls?”
Access for US exports to China and stronger protection of US intellectual property. His comments at the recent G7 meeting where he proposed completely free trade suggest he secretly does support free trade (although it’s a bit hard to know for sure!)