Trump and Trade
Rob Carnell – Chief International Economist
…Threats or all-out trade war?
January 2017
Photo source: Somodevilla/Getty Images
Raoul Leering – Head of International Trade Analysis
Verbally, Trump has announced an all-out attack on Free Trade, but will he do it?
2
Executive summary
If the US implements the threat of a 45% tariff on China and 35% on Mexico, we forecast the US loses 0.75% GDP over 2 years. Imposition of a blanket 10% tariff for imports from all countries we forecast will cost 1% of US GDP over the same time span.
We think that Trump will not impose huge import tariffs for now, because he has better options to live up to his promise that he will bring back jobs to the US
Just threatening to impose high tariffs could do the job, because Mexico is 20 times as dependent on US demand than vice versa China is 5 times as dependent on US demand than vice versa
This gives the US a very strong position in (re)negotiating trade deals
Tariffs will favour domestic US industry, but will hurt American exports
But if negotiations fail, high tariffs are likely
Key themes in this presentation
Trump: tough talk on tradePossible implications of Trump’s trade rhetoric
Our base case
3
Costs of trade war
Slides 4-7
Slides 16-20
China
Does China qualify as a manipulator of its currency? We take a look at the criteria
Mexico
Trade facts on…
Slides 12-15
How has trade with China and Mexico actually developed
Slides 8-11
Blaming trade
Economic theory tells us that there’s a ‘net gain’ from engaging in trade. But what about those who lose out?
Can the loss of US manufacturing jobs push people towards populism?
Trump has been happy to threaten China and Mexico, but what will be the cost for the US of a trade war. We look at different scenarios and estimate the cost to US GDP
Slides 21-24
Statements on trade made by Trump and his campaign team so far
People in Trump’s trade team – their stances on China all point towards tough policies
How much power does Trump actually have over trade?
We see Trump avoiding huge import tariffs for now… But he has to live up to his promise of bringing back US jobs
Trump: tough talk on trade
5
Campaign statements of Trump and his team…
…And how they raise the prospect of a trade war
Impose a 45% import tariff on Chinese goods.
Brand China “a currency manipulator” on day one
A tax of 35% on American companies that offshore production of products that they subsequently sell on the American market
Withdrawal of Pacific trade agreement TPP on day one in office
Rip up NAFTA if renegotiations are not satisfactory
A general import tariff of 5% to 10% on all imports except energy
6
Trump’s key figures talking tough
Wilbur Ross
US Secretary of Commerce
• Investor and vocal critic of NAFTA• China world’s biggest “trade cheater”• Sees tariffs as “a sanction”
Robert Lighthizer
US Trade Representative
Dan DiMicco
Trade Advisor to Trump – former CEO of Nucor Steel
Peter Navarro
Director of National Trade Council
• Lawyer who served under Reagan• Accused China of unfair trade
• Economist and strong China critic• Author of Death by China
• Author of Steeling America’s Future • Labelled China as destructive
Thoughts that Trump’s campaign rhetoric would not be matched with protectionist actions are running into trouble…now that he has named his trade team. Four of the most important members of that team have strong views on China and trade.
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Trump and Trade – How much power does he have?
NAFTA Implementation Act 1993• Power to withdraw from Nafta with
6 months notice• Power to put Mexico and Canada on
WTO tariffs• Impose additional duties after
consulting Congress
Trade Expansion Act 1962Section 232 (b)
Trade Act 1974Section 122
Trading with the enemy Act 1917(and International emergency economic powers act 1977)
• Impose tariffs / quotas to offset national security impacts
• Unlimited powers to limit trade…
…seize / freeze assets of all kinds
• for use in times of war)
• Impose tariffs or quotas of up to 15% for 150 days to address serious balance of payments deficits
• …or both
Although there are “checks and balances” in terms of the President’s powers on taxation and spending, which are ultimately controlled by Congress, he does have significant executive powers on Trade.
Is Trump right to be tough on trade?
9
It is understandable that trade is the scapegoat for job losses…
Economic theory shows that the gains from trade outweigh the losses…
…every trade deal will generate some “losers” and the ”pain” or “welfare losses” felt by these people (lost jobs or lower wages)…
…may outweigh positive feelings about the gains, which will tend to be more diffuse and less noticeable
Individual perception is the key here, not actual GDP results
…But…
Welfare gain from
lower prices, more choice &
extra jobs in competitive
sectors
Welfare loss from
reduction of well paying jobs in uncompetitive
sectors
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…because of the decline in manufacturing jobs….
Loss of US manufacturing jobs was one of the key battlegrounds of the latest US election.
0
5
10
15
20
25
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71 74 77 80 83 86 89 92 95 98 01 04 07 10 13
US
Mfg jobs as % of total employment
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… which are jobs worth fighting for
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200
400
600
800
1000
1200
1400
1600
1800
0
200
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600
800
1000
1200
1400
1600
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02 04 06 08 10 12 14
Manufacturing
All industry
other services
Financial
$ Sectoral weekly wages
Next to finance, a manufacturing job is still your best chance to ensure a good standard of living
So a populist rejection of “free trade” is understandable though the decline in manufacturing may partly be due to other factors as well – such as automation / roboticisation that drive up productivity
Protecting manufacturing jobs appears to be popular with voters – though this is likely to come at some cost to GDP and corporate profits – stock valuations
Some facts on China and Mexico
Trade with China more of a “problem” than Mexico
Imports
Exports
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5
10
15
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85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
China
Mexico
NAFTA starts China WTO accession
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5
10
15
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85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
Mexico
China
NAFTA starts China WTO accession
% total US imports
% total US exports
China in WTO (11 Dec 2001)• Chinese import penetration to the US
tripled since WTO membership.• US exports to China only doubled and
from a lower base − so in levels, the trade imbalance has still grown.
• US trade balance with China should be a bigger headache for US politicians than the trade balance with Mexico.
NAFTA (came into force 1 Jan 1994)• Import penetration to the US from
Mexico doubled in the first 10 years after NAFTA, but there has not been much growth since.
• US exports to Mexico also doubled in share, but the value added is 1.5 times smaller than of Mexican exports to the US.
• So it is not surprising that much research shows that Mexico benefits a lot more from Nafta than the US and Canada in terms of GDP and real wages.
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Is China manipulating its currency? Yes, but up!China meets only one of the three criteria for being a currency manipulator
Criteria 1:
Using 2% GDP to buy foreign currencies – NO!
…The CNY is actually losing competitiveness
(see graph)
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60
80
100
120
140
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94 97 00 03 06 09 12 15
China United States Japan
2000 = 100 Real Broad Effective Exchange Rate
A manipulator sells its currency for an equivalent of 2% GDP. This is not true for China. On the contrary: China has intervened to keep the CNY strong and prevent capital outflow.
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2,5
3
3,5
4
4,5
10 11 12 13 14 15 16
USD trillions China FX Reserves
China actually manages its currency against a basket of 23 other trading partners and currencies − what happens to USD/CNY is not their prime concern and may be driven by other countries’ currency movements
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So, no surprise China doesn’t qualify as manipulator
0
1
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3
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5
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10 11 12 13 14 15 16
% GDP China current account Criteria 2: Current account surplus > 3% GDP – NO!
0
100
200
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500
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86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
$bn China / US Trade surplusCriteria 3:
Trade surplus with US > $20bn – Yes, since 1992
Manipulators have a current account surplus of 3% or more. Not true for China now and has not been true for much of the last decade.
Manipulators have a trade surplus of more than USD20bn with the US.This is true for China, but this is a pointless, arbitrary amount. For one, it is unrelated to the size of the US economy (China already surpassed it in 1992)
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What if US brands China a currency manipulator?
Source: Netherlands Bureau for Policy Analyses (CPB) Calculations: ING Global Markets Research
The rules can be tweaked though. In the end naming a country a currency manipulator is a political judgement
If China were to be named a currency manipulator, there will be no immediate sanctions against China
The Commerce Department is supposed to spend a year trying to resolve the situation through negotiations – only then could sanctions (e.g. tariffs) be considered
This is really just a jaw-boning exercise to pressure China on trade
Economic costs for the US if Trump
follows up on his threats
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Implications of a tariff war
Source: Netherlands Bureau for Policy Analyses (CPB) Calculations: ING Global Markets Research
It will cause damage to US because trade partners will retaliate
US exports are hit because China and Mexico are the second and third most important buyers of US exports (next slide)
Competitiveness of multinationals like Apple that offshored production will suffer as imported intermediates rise in price.
US suppliers of Mexican exporters suffer (every $ of Mexican exports to the US contains 40 cents of US inputs).
That would hurt other US companies − those that produce in China to service the growing Chinese demand.
Hurting the Chinese economy will hurt the world economy
Consumers and producers will be deprived a broad product choice and obliged to pay higher prices for those imports that are indispensable
US begins trade war
China & Mexico retaliate
Trade barriers disrupt worldwide
value chains
China could close off
markets for FDI
US and world economy affected
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Scenario 1A tariff of 35% and 45% on Mexico and China will cost the US 0.75% GDP
*ING- calculations based on J.W. Mason (2016); see annex
Domestic US producers will benefit from
Chinese and Mexican goods becoming more
expensive by imposing tariffs of 45% and
35%, respectively.
At the same time though US exports will be
hit if we assume that China and Mexico will
retaliate with the same tariffs
Calculations* show that the GDP loss of
lower US exports is 4 times as large as the
gain of extra domestic production that
substitutes imports
On balance US GDP will be 0.75% lower after
2 years of tariffs*
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Scenario 2General 10% tariff. Costs for the US would be 1% GDP
A 10% general import tariff leads to roughly the same extra domestic production as the 45% tariff on China and 35% on US offshored production for US market
But export damage is 20% larger with a general tariff of 10% because in this case the US will face tariffs from a wider range of export destination markets: like Canada, Japan and the EU.
On balance US GDP will be roughly 1% lower two years after imposing a general 10% tariff.
Our base case
Trump can live up to his promise to boost US jobs with a stick and carrot approach:
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No tariffs, Trump favours case by case approach
Source: IMF WEO & WTO Calculations: ING Global Markets Research
Trump will continue to threaten with tariffs but not impose them: too costly
Stick: Threatening is enough. Before taking office Trump already arm twisted Ford and others with the threat of tariffs, to forgo plans of offshoring jobs to Mexico.
Carrot: Trump can, in cooperation with State government politicians encourage companies to stay in the US with tax-cuts. Interventions that make companies forgo concrete offshoring plans are tangible results for Trump that will probably impress the Trump voter more (more media impact) than tariffs whose “effect” has to be estimated by economists.
There are grounds for the US to want to
(re)negotiate new or existing trade deals. The benefits of NAFTA have been
unevenly distributed. US has not gained
as much from NAFTA as Mexico, which shows significant gains (GDP and wages).
Trump could gain trade concessions from Mexico because the Mexican
economy is 20 times as dependent on
the US then vice versa. So mutal tariffs hurt both countries but Mexico a lot
more (see Figure).
Although less, the same holds for China
(see Figure). So Trump also has a strong
position in negotiations with China.
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Base case continued
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VS-China VS-Mexico
Mutual GDP-dependency on bilateral exports
Share in Chinese GDP earned by selling Chinese goods/ services to the US
Share in US GDP earned by sellingto Mexico
Share in US GDP earned by sellingto China
Share in MexicanGDP earnedby selling tothe US
Renegotiation of existing trade deals (NAFTA, TPP) and a bilateral deal with China would be a visible policy
Imposition of a 10% tariff for imports from all countries, we forecast, will cost 1% of US GDP over the same time span
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Conclusions
We think that Trump will not impose huge import tariffs
But Trump has to live up to his promise that he will bring back jobs to the US
Just threatening to impose high tariffs could do the job because Mexico is 20 times as dependent on US demand then vice versa (China 5 times). This gives the US a very strong position in (re)negotiating trade deals
But if negotiations fail, high tariffs are likely
If US implements a 45% tariff on China and 35% on Mexico, we forecast the US loses 0.75% GDP over two years
3. Price elasticity of the American consumer demand with respect to
Chinese and Mexican goods: 1.0.
4.Price elasticity of the Chinese and Mexican consumers with respect
to American goods: 1.5.
Note: Mexican and Chinese consumers respond apparently stronger to
price changes. This could be caused by the fact that the share of the
population with low income is larger than in the US and they are more
price sensitive.
5. Percentages of imported goods from Mexico and China that are
substituted by American goods: 50% and vice versa for China and
Mexico.
6. Contributions of exports to Mexico and China to US GDP:
respectively 0.6% and 0.7%. Source: WIOD, RUG
7. Chinese imports represents 1.9% of US GDP, Imports from Mexico
represent 0.8% of US GDP (Source: WIOD = value added of imports
and exports data base)
US Macro multiplier for demand impulses: 1.5 after two years
Assumptions:
1. The 35% tax on Mexican imports concerns non-oil goods only
2. Both Mexico and China retaliate by imposing same tariffs on US
exports
To calculate the effect on US GDP we need to know what the effect
will be on US substitution for imports and on US exports. We use
elasticities from existing empirical work, summed up in J.W. Mason
(J.W. Mason, 2016, Trump’s tariffs: A dissent).
For the effect on imports we need the:
1. effect of tariffs on the final US consumer price of imported Chinese
and Mexican goods. This “pass through” to consumer prices is 30%.
2. The pass through of tariffs on imported goods from the US to
consumer prices in China and Mexico: 60%.
Note: Chinese and Mexican export products are for markets that are
more characterised by competition on price, which limits the
possibilities to let the consumer pay for the tariff. American exporters
compete more on the basis of quality which gives them more room to
pass on the tariff costs to the Mexican and Chinese consumer.
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Annex 1: US GDP effect of a 35/45% import tariff on Mexican and Chinese imports
These substitutes will be more expensive or of lesser quality since
Chinese products were the first choice. We don’t know how much
more expensive these American substitutes are, so we ignore this.
But we do know that the remaining 85% of the original packages of
Chinese goods that are still bought are 15% more expensive and
similarly the remaining Mexican imports are 11% more expensive.
So imposing 35% and 45% tariffs on Mexico and China leads to the
total import price level to rise with (0.85*0.19*15%) +
(0.89*0.12*11%*0.72 (non offshored production factor) =3.2%. Given
the share of 11% of gross imports in US GDP, the GDP price level will
be pushed up by 0.35%. So real GDP will decline by 0.35% due to
the inflationary effects of the import tariffs. But at the same time
tariff income makes government income rise with the same
amount.
So the net effect on GDP of this tariff war on the import side is
determined fully by the substitution effect: the imposition of the
45% and 35% import tariff on China and Mexico leads to a rise of US
GDP. Chinese imports represents 1.9% of US GDP and imports from
Mexico 0.8%.
8. Share in Mexican imports that will be labelled as offshored
American production. Estimate: 87% (non oil exports of Mexico)* 0.80
(share of US in Mexican imports) * 0.40 (cars and other exports from
Mexico by American companies) = 0.28
Source: trading economics and estimations of ING
Effects on US imports
For the effects of the tariffs on US imports (and import substitution),
we first of all have to realise that a 45% price increase of Chinese
products leads to a rise of the consumer price of only 15% (0.3*45%).
This leads to a 15% decline in US demand for Chinese goods
(15%*1.0). We Follow the assumption of Mason, half of this 15% is
substituted by similar products from other countries (not hit by the
45% tariff) and the other half of this is serviced by domestic
(American) suppliers.
Similarly the 35% price increase of non oil Mexican imports leads to
a rise of the consumer price of 11% leading to decline in demand for
Mexican products by 11%. Half of this is substituted by American
products.
26
Annex 1 (continued)
So a decrease of 15% and 11% in imports from China and Mexico
leads to a rise of US GDP by
(0.5*15%* 0.019 + 11%*0.008*0.5)* 1.5 = +0.28%
The effect on US exports
US exports to China and Mexico equal 0.7 and 0.6 percent of US GDP
respectively. Pass-through for US exports to these countries is 60%.
Price elasticity is around 1.5. This makes the imposition of the same
tariffs by Mexico and China lead to a exports induced effect on US
GDP of:
0.6*45%*1.5* 0.007* + 0.013*1.5*35%*0.6 = 0.70 x 1.5 = -1.05 GDP
Total effect of tariffs
So the net effect of mutual imposition of 35%/45% tariffs by the US,
Mexico and China is a welfare effect after two years of:
0.28%GDP - 1.05%GDP = -0.77%GDP
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Annex 1 (continued)
Effects on US imports
For the effects of the tariffs on US imports (and import
substitution), we first of all have to realise that a 10% price
increase of foreign products leads to a rise of the consumer
price of only 3% (0.3*10%). This leads to a 1.5% decline in US
demand for foreign goods (3%*0.5). This production will be
substituted by similar American products. Since imports
make up 11% of US GDP, this substitution will rise US GDP
initially by 0.17 percentage points (10%*0.3*0.5*0.11= 0.17
higher GDP). Multiply this with the macro multiplier and the
effect on GDP after two years will be 0.26% US GDP.
These substitutes will be more expensive since foreign
products were the first choice. We don’t know how much
more expensive these American substitutes are or made up
of products that are not more expensive but lower in quality.
So we ignore this.
Assumption made: Trading partners of the US will impose 10% tariff
on US goods
To calculate the effect on US GDP we need to know what the effect
will be on US substitution for imports and on US exports. We use
elasticities from existing empirical work, summed up in J.W. Mason
(2016), Trump’s tariffs: A dissent.
To make a calculation of the effects on imports we need the:
1. effect of tariffs on the US consumer price of imported goods. This
so called “pass through” of tariffs to consumer prices is 30%.
2. The pass through of tariffs in the rest of the world to consumer
prices in China and Mexico: 60%.
3. Price elasticity of the American consumer demand with respect
to imported goods: 0.5.
4. Price elasticity of foreign consumers with respect to American
goods: 1.5.
5. Percentages of diminished imported goods that are substituted
by domestic goods: 100% for the US and 50% for rest of the
world (they can still import from other countries without the
10%- tariff).
6. Share of imports in total spending in the US: 15% (Source: World
Bank, 2015)
7. Contributions of exports to US GDP: 13% (Source: World Bank)
8. GDP multiplier is 1.5 for the US (Source: J.W. Mason)
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Annex 2: US GDP effect of a 10% across the board import tariff
This makes the imposition of a 10% tariff on US exports lead
to decline of US GDP by:
0.6*10%*1.5*0.09* = 0.81%GDP * 1,5 = -1.22% US GDP (after
two years approximately).
Total effect of general import tariff of 10%
So the net welfare effect for the US (import substitution
minus loss of exports) of a mutual imposition of a 10% tariff
on imports by the US and the rest of the world is:
0.26% GDP - 1.22%GDP = -0.96%GDP
But we do know that the remaining 98.5% of the original
packages of imported foreign goods that is still bought, are 3%
more expensive. So imposing a 10% tariff on imports will lead to a
rise of the price level of total imports of 2.9% (0.985*3%). Given
the share of 11% of imports in US GDP, the GDP price level will be
pushed up by 0.33%. So real GDP will decline by 0.33% due to the
inflationary effects of the import tariffs. But at the same time
tariff income makes government income rise with the same
amount (in %GDP).
The net GDP effect on the import side is determined fully by the
import substitution effect: +0.26% GDP
The effect on US exports
US exports to the rest of the world equals 9% of US GDP. Pass-
through to the consumer price of the 10% tariff imposed on US
exports to these countries is 60%. Price elasticity of foreign
demand for US exports is 1.5, empirical studies show.
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Annex 2 (continued)
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