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Game of Trade

World Development Indicators, World Bank

On the 2th of March, the US Tweeter-in-Chief laid out a simple plan: don’t trade anymore – we win big!

To be fair, the bold measures the American administration recently took against Chinese imports did not come unexpected, given the electoral promise of Donald Trump to beat China all the time.

Interestingly enough, Larry Kudlow – the Chief Economic Adviser - recently argued that ultimately the president is a free-trader.

So, let’s recap what we know about the trade war the two biggest world economies seem to be starting – if they haven’t yet.

[endif]--It all began in the 70s, a decade that started with the pivotal decision of Nixon to abandon the fixed rate regime and ended with Deng Xiaoping rising to the helm of the People’s Republic of China. In the following years, the Asian juggernaut went through a long period of reforms towards the open market and created SEZs (Special Economic Zones, focused on export production, free from much of the oppressive Communist red tape), which started an impressive technological catchup. On the other side of the Pacific, the US undertook an unprecedented financial liberalization process and kept being the world champion of openness and globalization.

All of this led us to the current, allegedly unsustainable situation. The US has an overall trade deficit of $570 billion, two thirds of which comes from China. The Chinese trade surplus towards the US has been growing for decades (except for a setback due to the Great Recession), reaching 375$ billion – and still counting. Moreover, Beijing allegedly steals hundreds of billions of intellectual rights from Washington. Many argue that nothing but unfair practices from the second economy of the world cause this imbalance. More importantly, this did not happen without cost. There is a vast literature stating that manufactured goods imported from China deeply affected the US economy. Indeed, the areas in which manufacturing production is more concentrated (Midwest and Southeast) experienced substantial reduction in employment and income following the impact of the Chinese trade shock. The distress not only involved the manufacturing sector but had a negative fallout for all workforce of those more sensitive areas. This, in turn, contributed significantly to the growth of inequality in the States and changed the perception of Americans toward globalization. ![endif]--

Source: World Development Indicators, World Bank

Many studies have shown that the most affected zones saw a polarization of the electoral preferences, penalizing the most centrist candidates and awarding the hard-liners at both extremes of the political spectrum. However, this phenomenon was not enjoyed equally by the Democrats and the Republicans, as the 2016 presidential elections exemplarily witnessed. In a recent research note, Autor et al. (2017) estimated that, had the China trade shock been 50% lower in some key states (Michigan, Pennsylvania and Wisconsin), today, we would have a Clinton in the White House again.

Henceforth, Donald Trump is stuck in a catch-22: in order not to let down his core supporters and to satisfy his promises, he must turn against the deficit that made him US President.

The damage has been done. Following the infamous March 2 Tweet, the White House announced tariffs on aluminium (10%) and steel (25%), exempting some key Western partners: a measure clearly conceived against Chinese exports – which, however, account only for 1% of those imports. Such tariffs, given their unilateral nature, undermine the WTO principle of multilateral negotiation and give scope for retaliation.

Indeed, on April 2nd, China raised tariffs from 15% to 25% on various products such as pork, fruit and wine, which accounted for $3 billion of imports in 2017. The White House proceeded with publishing a list of potential imported goods amounting to $50 billion (including aeronautics, ICT, robotics and machinery) which may be targeted with tariffs in the near future. Beijing did not hesitate to threaten further retaliation tariffs, this time aiming at the core US exports to China: aircrafts, cars, soybeans, beef and many industrial components, amounting to $50 billion as well.

China has recently showed an outstanding ability to use targeted trade policy. The distension of relations with North Korea and the diplomatic opening of Kim Jong Un, in fact, followed an export freeze that brought the Korean leader on bended knees to Beijing. Indeed, the reduction in Chinese exports of oil, coal and other goods went well beyond the targets stipulated by the UN sanctions. Xi Jinping and his cohort had become well aware of their power and will not hesitate to employ it against the protectionist offences from the White House.

Analyzing the list of potential targeted US exports, we can recognize a pattern. Tariffs on soybeans, one of the most important US exports to China, are going to put pressure on rural voters, which are core supporters of Donald Trump.

On the first round of tariffs, for example, American ginseng was targeted – a good produced in Wisconsin, where Trump won over Clinton by a margin of 1%. Pork exports were sanctioned as well – something that would affect the Iowa farmers, a state where Republicans made remarkable gains from 2012 to 2016, and now risk losing.

The point is, China knows where it would hurt.

Source: Financial Times

Would this conflict continue and increase in intensity, China seems to be in much better shape than the US. In the long run, its Belt and Road initiative would create an ever-stronger network of trade partners. This network may not overshadow the US yet, as it is still the biggest economy of the world. However, US has little room to improve its current position with its current trade partners. Beijing’s incremental opening to the world could lead it to pair up with the EU Commission, which is always eager to strike trade deals and promote free trade.

Moreover, Xi Jinping has no electorate to respond to – even more so after the last Communist Party Congress – and can afford to endure the negative fallouts of a protectionist escalation. Trump, on the other hand, must worry about the midterm elections and the 2020 re-elections, where the effect of the retaliation tariffs will certainly weigh in.

Finally, The Federal Reserve is an independent body, while the PBOC is controlled by the Communist Party. Should the conflict spread to monetary policy, Beijing could also resort to a competitive devaluation of the renminbi, while Washington could not.

As a net exporter, China will suffer more in the short run from a reduction in trade volumes than the US. Such a setback in production would contribute to the Chinese GDP slowdown that Xi Jinping is struggling to postpone.

From a strictly economic point of view, current account deficits are not to be fought with tariffs or other protectionist measures: as a matter of fact, a current account deficit stems from disproportionate domestic investments with respect to national savings. If Trump really wants to achieve positive net exports, he should focus on balancing these two.

However, Washington cannot easily reduce the domestic investments, given the uncontestable primacy of US financial assets in terms of liquidity and safety. The situation is doomed to worsen, as the Fed has engaged itself in a series of rate hikes and consequently attracted investors.

Addressing public savings, there is indeed some room for improvement – the administration could just start reducing its budget deficit and downsizing its public debt. Unfortunately, the recent tax reform goes exactly in the opposite direction.

Ultimately, there are the private savings – whose ratios have been falling for years. On top of that, it is not clear how the government could increase them – or whether it should, given the squeeze in consumption that would follow.

However, Trump may be simply playing hardball on trade just to get some edge in negotiations. According to this narrative, he would not be really concerned about the balance of trade or the Chinese exports, but just wanted to strike an easy win to cash out at the midterm elections. China could make some concessions – for example, on the intellectual property issue. This could all be a simple skirmish intended to reduce the (already decreasing) margin the Democrats have and keep the Republican president afloat for a little longer.

This will not be costless. The unilateral tariffs the two super economies are proposing represent a dangerous precedent in international negotiations, undermine the world equilibria based on multinational trade and its intergovernmental organization, the WTO. The relationship between the two most important players of the global stage has not been under such a strain for many years.

It is reasonable to suppose that the escalation could eventually stop before the two powers find themselves in an all-out trade war - a war with long-lasting scars.

In the game of thrones, there is no middle ground: you win or you die. But the game of trade is no tv-show – we might all be worse off.




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