21 May 2018
The danger is escalation
On 2 March 2018 Donald Trump tweeted: “Trade wars are good, and easy to win”, and announced his intention to start one by imposing a 25% tariff on steel imports and 10% on aluminium. He later backtracked and targeted China specifically. Trump’s case against China is not only the $100bn trade imbalance with that country but also a claimed widespread theft of US intellectual property (eg. the pirating of Hollywood movies) and making it a condition of any China/USA joint enterprise that any associated intellectual property is shared with the Chinese partner.
The threat to impose tariffs on imports from the UK and Europe has merely been deferred, however, and even if Trump’s measures were confined to Sino-American trade only, there would still be a severe effect on global trade. UK business, currently in the process of seeking new markets, needs to be concerned. The fall-out will affect businesses of all sizes and types, enmeshed as they are in global supply chains.
Trump’s electoral base is inherently isolationist and protectionist and he takes the simple view that, with a trade deficit of $500bn pa, he cannot lose. Economists point out that trade deficits are in fact extremely hard to correct, because every measure taken entails a chain of consequences that are difficult to predict. Christine Lagarde, President of the International Monetary Fund, has commented that the experience of the 1930s is that trade wars are unwinnable. American protectionist policies introduced in the late 1920s sparked off a round of retaliation by its trading partners. Increased tariffs caused a rise in the cost of living and a reduction in exports. The knock-on effects were that reduced trade with America made it more difficult for debtors of the USA to earn dollars with which to repay loans. Most economists agree that this was a significant contributory factor in a catastrophe that caused world trade to shrink by 66% between 1929 and 1934, with the attendant unemployment and poverty.
The World Trade Organisation under pressure
To avoid the need to obtain WTO approval, Mr. Trump has given national security as the reason for his strategy. The WTO has a long and successful history. Since 1948 (originally as GATT) it has worked to establish a rules-based system of international trade and a gradual reduction of tariffs and other barriers to prevent powerful countries from bullying and exploiting others. It now has 160 participating countries. Over eight rounds of negotiations tariffs have been gradually reduced and there has been an unprecedented expansion in global trade which most agree has been responsible for a spectacular rise in standards of living worldwide.
The organisation provides a legal structure where norms and procedures are agreed and trade disputes resolved. It has been instrumental in preventing the outbreak of any significant trade war in the last 70 years, but it is fair to say that it is now under pressure. It is failing to cope with China’s aggressive state capitalism, there has been no new round of trade negotiations for more than 20 years, and the USA is undermining its judicial processes by declining to appoint any judges to its court.
Can Trump win?
These days no mainstream economists believe that protectionism can be effective. It is far too simplistic to regard a trade deficit as bad. Advanced economies like the USA buy in goods and commodities which they cannot produce more cheaply domestically. This keeps prices down for the benefit of both consumers and industry. It also generates dollar income for its trading partners, which they can then use to buy the goods that the USA is effective at producing. The USA invests its surpluses in overseas investments, generating income which more than compensates for the $500 bn trade deficit, and this also benefits the economies of the countries in which it invests. It is a virtuous circle.
Also consider this: as tariffs reduce imports, foreign traders earn fewer dollars, the dollar becomes scarcer and its value goes up. This makes US exports more expensive, so they also reduce and the trade balance worsens.
The Iranian dimension
A new threat to trade has now emerged in the shape of Mr. Trump’s decision to withdraw from the JCPOA[i] and to impose the most severe sanctions on Iran. Many British and European companies are now legally doing business with Iran, directly or indirectly. The USA will bar its citizens from doing business with any company that deals with Iran, and will impose sanctions on any bank that facilitates funds transfers to or from Iran by excluding it from dollar exchange transactions. If your business is involved in a supply chain that includes China or Iran this is a good time to investigate other sources or other markets.
To be positive, this country’s many SMEs and owner-managed businesses have plenty of scope to improve their export performance. If your market in general shrinks, a good defence is to grab a larger share of it, and you can do this by looking overseas. If you would like to discuss how to begin or boost your export drive please contact me or alternatively fill out our contact form.