The attached note looks at the latest round of tariff increases announced by the US and China. The key points are as follows:
- The trade war between the US and China has returned after talks to resolve their trade differences broke down.
- Our base case remains that a deal will be reached to resolve the issues, but the risks to global growth are now higher (given the escalation in tariffs from the US) and share markets may need to fall further in the short term to remind both sides of the need for a deal.
After taking a back seat over the last six months as negotiations appeared to make progress the US/China trade war is back on with President Trump – “tariff man” – ramping up tariffs on Chinese imports again and threatening more and China moving to retaliate. This note takes a simple Q & A approach to the key issues.
What is a trade war?
A ‘Trade War’ is where countries raise barriers to trade with each other (such as tariffs or quotas on imports or subsidies to domestic industries) usually motivated by a desire to “protect” domestic jobs often overlaid with (or dressed up by) “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 US imports led to retaliation by other countries and contributed to a plunge in a world trade.
What is so good about free trade and wrong with protectionism?
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 of if Country A makes product X and Country B makes product 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.
It often strikes me as perverse that some want to protect local industry, but they don’t buy local themselves. The experience of heavily protecting Australian industry in the post WW2 period was that it was just leading to higher prices and lower quality products and Australians were voting with their wallets to buy better value foreign made goods anyway. We and many other countries started to realise this in the 1980s and so cut protection. We might have protected lots of manufacturing jobs if we stayed at the levels of protection of 45 years ago, but we would have become a museum piece as would the US.
Fortunately, despite the loss of jobs in manufacturing (from 25% of the workforce in 1960 to around 8% now) other jobs have come along in the services sector where Australia’s and America’s relatively highly-skilled but highly-paid workforce have a comparative advantage compared to workers in less developed countries.
In short, if you want to support your country’s products buy them, but trade barriers don’t work.