Tag: trade wars

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‘Liberation day’: or start of a Trump slump?

On April 2nd, Donald Trump announced sweeping new ‘reciprocal’ tariffs. These would be in addition to 25% tariffs on imports of cars, steel and aluminium already announced and any other tariffs in place on individual countries, such as China. The new tariffs would apply to US imports from every country, except for Canada and Mexico where tariffs had already been imposed.

The new tariffs will depend on the size of the country’s trade in goods surplus with the USA (i.e. the USA’s trade in goods deficit with that country). The bigger the percentage surplus, the bigger the tariff. But, no matter how small a country’s surplus or even if it runs a deficit (i.e. imports more goods from the USA than it sells), it will still face a minimum 10% ‘baseline’ tariff.

President Trump states that these tariffs are to counter what he claims as unfair trade practices inflicted on the USA. People had been expecting that these tariffs would reflect the tariffs applied by other countries on US goods and possibly also non-tariff barriers, such as the ban on chlorine-washed chicken or hormone-injected beef in the EU and UK. But, by basing them on the size of a country’s trade surplus, this meant imposing them on many countries with which the USA has a free-trade deal with no tariffs at all.

The table gives some examples of the new tariff rates. The largest rates will apply to China and south-east Asian countries, which supply low-priced products, such as clothing, footwear and electronics to the US market. In China’s case, it now faces a reciprocal tariff rate of 34% plus the previously imposed tariff rate of 20%, giving a massive 54%.

What is more, the ‘de minimis’ exemption will be scrapped for packages sent by private couriers. This had exempted goods of $800 or less sent direct to consumers from China and other countries from companies such as Temu and Alibaba. It is also intended to cut back on packages of synthetic opioids sent from these countries.

The US formula for reciprocal tariffs

As we have seen, reciprocal tariffs do not reflect countries’ tariff rates on the USA. Instead, rates for countries running a trade in goods surplus with the USA (a US trade deficit with these countries) are designed to reflect the size of that surplus as a percentage of their total imports from the USA. The White House has published the following formula.


where:

When the two elasticities are multiplied together this gives 1 and so can be ignored. As there was no previous ‘reciprocal’ tariff, the rise in the reciprocal tariff rate is the actual reciprocal tariff rate. The formula for the reciprocal tariff rate thus becomes the percentage trade surplus of that country with the USA: (exports – imports) / imports, expressed as a percentage. This is then rounded up to the nearest whole number.

President Trump also stated that countries would be given a discount to show US goodwill. This involves halving the rate from the above formula and then rounding up to the nearest whole number.

Take the case of China. China’s exports of goods to the USA in 2024 were $439bn, while its imports of goods from the USA were $144bn, giving China a trade surplus with the USA of $295bn. Expressing this as a percentage of exports gives ($295/$439 × 100)/2 = 33.6%, rounded up to 34%. For the EU, the formula gives ($227bn/$584bn × 100)/2 = 19.4%, rounded up to 20%.

Questioning the value of φ. Even if you accept the formula itself as the basis for imposing tariffs, the value of the second term in the denominator, φ, is likely to be seriously undervalued. The term represents the elasticity of import prices with respect to tariff changes. It shows the proportion of a tariff rise that is passed on to consumers, which is assumed to be just one quarter, with producers bearing the remaining three quarters. In reality, it is highly likely that most of the tariff will get passed on, as it was with the tariffs applied in Donald Trump’s first presidency.

If the value for φ were 1 (i.e. all the tariff passed on to the consumer), the formula would give a ‘reciprocal tariff’ of just one quarter of that with a value of φ of 0.25. The figures in the table above would look very different. If the rates were then still halved, all countries with a tariff below 40% (such as the EU, Japan or India) would instead face just the baseline tariff of 10%. What is more, China’s rate would be reduced from 54% to 30% (the original 20% plus the baseline of 10%). Cambodia’s would be reduced to 13%. Even if the halving discount were no longer applied, the rates would still be only half of those shown in the table (and 37% for China).

Are the tariffs justified?

Even if a correct value of φ were used, a percentage trade surplus is a poor way of measuring the protection used by a country. Many countries running a trade surplus with the USA are low-income countries with low labour costs. They have a comparative advantage in labour-intensive goods. That allows such goods to be purchased at low cost by Americans. Their trade surplus may not be a reflection of protection at all.

Also, if protection is to be used to reflect the trade imbalance with each country, then why impose a 10% baseline on countries, like the UK, with which the USA has a trade surplus? By the Trump administration’s logic, it ought to be subsidising UK imports or accepting of UK tariffs on imports of US goods.

But President Trump also wants to address the USA’s overall trade deficit. The US balance of trade in goods deficit was $1063bn in 2023 (the latest year for a full set of figures). But the overall balance of payments must balance. There were thus surpluses elsewhere on the balance of payments account (and some other deficits). There was a surplus on the services account of $278bn and on the financial account of $924bn. In other words, inward investment to the USA (both direct and portfolio) and the acquisition of dollars by other countries as a reserve asset were very large and helped to drive up the exchange rate. This made US goods less competitive and imports relatively cheaper.

The USA has a large national debt of some $36 trillion of which some $9 trillion is owed to foreign investors (people, institutions or countries). Servicing the debt pushes up US interest rates. This helps to maintain a high exchange rate, thereby making imports cheaper and worsening the trade deficit. The fiscal burden of servicing the debt also crowds out US government expenditure on items such as defence, education, law and order and infrastructure. President Trump hopes that tariffs will bring in additional revenue to help finance the deficit.

Effects on the USA

If the tariffs reduce spending on imports and if other countries do not retaliate, then the US balance of trade should improve. However, a tariff is effectively a tax on imported goods. It is charged to the importing company not to the manufacturer abroad. As we saw in the context of the false value for φ, most of the tariff will be passed on to American consumers. Theoretically the incidence of the tariff is shared between the supplier and the purchaser, but in practice, most of the higher cost to the importer will be passed on to the consumer. As with other taxes, the effect is to transfer money from the consumer to the government, making people poorer but giving the government extra revenue. This revenue will be dollars, not foreign currency.

As some of the biggest price rises will be for cheap manufactured products, such as imports from China, and various staple foodstuffs, the effects could be felt disproportionately by the poor. Higher import prices will allow domestic producers competing with these imports to raise their prices too. The tariffs are thus likely to be inflationary. But because the inflation would be the result of higher costs, not higher demand, this could lead to recession as real incomes fell.

American resources will be diverted by the tariffs from sectors in which the USA has a comparative advantage, such as advanced manufactured goods and services, to more basic products. Tariffs on cheap imports will make domestic versions of these products more profitable: even though they are more costly to produce, they will be sold at a higher price.

The tariffs will also directly affect goods produced by US companies. The reason is that many use complex supply chains involving parts produced abroad. Take the case of Apple. Even though it is an American company which designs its products in California, the company sources parts from several Asian countries and has factories in Vietnam, China, India, and Thailand. These components will face tariffs and thus directly affect the price of iPhones, iPads, MacBooks, etc. Similarly affected are other US tech hardware manufacturers, US car manufactures, clothing and footwear producers, such as The Gap and Nike, and home goods producers.

Monetary policy response. How the Fed would respond is not clear. Higher inflation and lower growth, or even a recession, produces what is known as ‘stagflation’: inflation combined with stagnation. Many countries experienced stagflation following the Russian invasion of Ukraine, when higher commodity prices led to soaring inflation and economic slowdown. There was a cost-of-living crisis.

If a central bank has a simple mandate of keeping inflation to a target, higher inflation would be likely to lead to higher interest rates, making recession even more likely. It is the inflation of the two elements of stagflation (inflation and stagnation) that is addressed. The recession is thus likely to be deepened by monetary policy. But as the Fed has a dual mandate of controlling inflation but also of maximising employment, it may choose not to raise interest rates, or even to lower them, to get the optimum balance between these two targets.

If other countries retaliate by themselves raising tariffs on US exports and/or if consumers boycott American goods and services, this will further reduce incomes in the USA. Just two days after ‘liberation day’, China retaliated against America’s 34% additional tariff on Chinese imports by imposing its own 34% tariff on US imports to China.

A trade war will make the world poorer, especially the USA. Investors know this. In the two days following ‘liberation day’, stock markets around the world fell sharply and especially in the USA. The Dow Jones was down 9.3% and the tech-heavy Nasdaq Composite was down 11.4%.

Effects on the rest of the world

The effects of the tariffs on other countries will obviously depend on the tariff rate. The countries facing the largest tariffs are some of the poorest countries which supply the USA with simple labour-intensive products, such as garments, footwear, food and minerals. This could have a severe effect on their economies and cause rapidly increasing poverty and hardship.

If countries retaliate, then this will raise prices of their imports from the USA and hurt their own domestic consumers. This will fuel inflation and push the more seriously affected countries into recession.

If the USA retaliates to this retaliation, thereby further escalating the trade war, the effects could be very serious. The world could be pushed into a deep recession. The benefits of trade, where all countries can gain by specialising in producing goods with low opportunity costs and importing those with high domestic opportunity costs, would be seriously eroded.

What President Trump hopes is that the tariffs will put him in a strong negotiating position. He could offer to reduce or scrap the tariffs on a particular country in exchange for something he wants. An example would be the offer to scrap or reduce the baseline 10% tariff on UK exports and/or the 25% tariff on UK exports of cars, steel and aluminium. This could be in exchange for the UK allowing the importation of US chlorinated chicken or abolishing the digital services tax. This was introduced in 2020 and is a 2% levy on tech firms, including big US firms such as Amazon, Alphabet (Google), Meta and X.

It will be fascinating but worrying to see how the politics of the trade war play out.

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Articles

White House publications

Questions

  1. What is the law of comparative advantage? Does this imply that free trade is always the best alternative for countries?
  2. From a US perspective, what are the arguments for and against the tariffs announced by President Trump on 2 April 2025?
  3. What response to the tariffs is in the UK’s best interests and why?
  4. Should the UK align with the EU in responding to the tariffs?
  5. What is meant by a negative sum game? Explain whether a trade war is a negative sum game. Can a specific ‘player’ gain in a negative sum game?
  6. What happened to stock markets directly following President Trump’s announcement and what has happened since? Explain you findings.
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‘Tariff is the most beautiful word.’ Not for economists!

In an interview with Joe Rogan for his podcast, The Joe Rogan Experience, just before the US election, Donald Trump stated that, “To me, the most beautiful word – and I’ve said this for the last couple of weeks – in the dictionary today and any is the word ‘tariff’. It’s more beautiful than love; it’s more beautiful than anything. It’s the most beautiful word. This country can become rich with the use, the proper use of tariffs.”

President-elect Trump has stated that he will impose tariffs on imports of 10% or 20%, with 60% and 100% tariffs on imports from China and Mexico, respectively. This protection for US industries, combined with lighter regulation, will, he claims, provide a stimulus to the economy and help create jobs. The revenues will also help to reduce America’s budget deficit.

But it is not that straightforward.

Problems with tariffs for the USA

Imposing tariffs is likely to reduce international trade. But international trade brings net benefits, which are distributed between the participants according to the terms of trade. This is the law of comparative advantage.

In the simple two-country case, the law states that, provided the opportunity costs of producing various goods differ between the two countries, both of them can gain from mutual trade if they specialise in producing (and exporting) those goods that have relatively low opportunity costs compared with the other country. The total production and consumption of the two countries will be higher.

So if the USA has a comparative advantage in various manufactured products and a trading partner has a comparative advantage in tropical food products, such as coffee or bananas, both can gain by specialisation and trade.

If tariffs are imposed and trade is thereby reduced between the USA and its trading partners, there will be a net loss, as production will switch from lower-cost production to higher-cost production. The higher costs of less efficient production in the USA will lead to higher prices for those goods than if they were imported.

At the same time, goods that are still imported will be more expensive as the price will include the tariff. Some of this may be borne by the importer, meaning that only part of the tariff is passed on to the consumer. The incidence of the tariff between consumer and importer will depend on price elasticities of demand and supply. Nevertheless, imports will still be more expensive, allowing the domestically-produced substitutes to rise in price too, albeit probably by not so much. According to work by Kimberly Clausing and Mary E Lovely for the Peterson Institute (see link in Articles below), Trump’s proposals to raise tariffs would cost the typical American household over $2600 a year.

The net effect will be a rise in inflation – at least temporarily. Yet one of Donald Trump’s pledges is to reduce inflation. Higher inflation will, in turn, encourage the Fed to raise interest rates, which will dampen investment and economic growth.

Donald Trump tends to behave transactionally rather than ideologically. He is probably hoping that a rapid introduction of tariffs will then give the USA a strong bargaining position with foreign countries to trade more fairly. He is also hoping that protecting US industries by the use of tariffs, especially when coupled with deregulation, will encourage greater investment and thereby faster growth.

Much will depend on how other countries respond. If they respond by raising tariffs on US exports, any gain to industries from protection from imports will be offset by a loss to exporters.

A trade war, with higher tariffs, will lead to a net loss in global GDP. It is a negative sum game. In such a ‘game’, it is possible for one ‘player’ (country) to gain, but the loss to the other players (countries) will be greater than that gain.

Donald Trump is hoping that by ‘winning’ such a game, the USA could still come out better off. But the gain from higher investment, output and employment in the protected industries would have to outweigh the losses to exporting industries and from higher import prices.

The first Trump administration (2017–21), as part of its ‘America First’ programme, imposed large-scale tariffs on Chinese imports and on steel and aluminium from across the world. There was wide-scale retaliation by other countries with tariffs imposed on a range of US exports. There was a net loss to world income, including US GDP.

Problems with US tariffs for the rest of the world

The imposition of tariffs by the USA will have considerable effects on other countries. The higher the tariffs and the more that countries rely on exports to the USA, the bigger will the effect be. China and Mexico are likely to be the biggest losers as they face the highest tariffs and the USA is a major customer. In 2023, US imports from China were worth $427bn, while US exports to China were worth just $148bn – only 34.6% of the value of imports. The percentage is estimated to be even lower for 2024 at around 32%. In 2023, China’s exports to the USA accounted for 12.6% of its total exports; Mexico’s exports to the USA accounted for 82.7% of its total exports.

It is possible that higher tariffs could be extended beyond China to other Asian countries, such as Vietnam, South Korea, Taiwan, India and Indonesia. These countries typically run trade surpluses with the USA. Also, many of the products from these countries include Chinese components.

As far as the UK is concerned, the proposed tariffs would cause significant falls in trade. According to research by Nicolò Tamberi at the University of Sussex (see link below in Articles):

The UK’s exports to the world could fall by £22 billion (–2.6%) and imports by £1.4 (–0.16%), with significant variations across sectors. Some sectors, like fishing and petroleum, are particularly hard-hit due to their high sensitivity to tariff changes, while others, such as textiles, benefit from trade diversion as the US shifts demand away from China.

Other badly affected sectors would include mining, pharmaceuticals, finance and insurance, and business services. The overall effect, according to the research, would be to reduce UK output by just under 1%.

Countries are likely to respond to US tariffs by imposing their own tariffs on US imports. World Trade Organization rules permit the use of retaliatory tariffs equivalent to those imposed by the USA. The more aggressive the resulting trade war, the bigger would be the fall in world trade and GDP.

The EU is planning to negotiate with Trump to avoid a trade war, but officials are preparing the details of retaliatory measures should the future Trump administration impose the threatened tariffs. The EU response is likely to be strong.

Articles

Questions

  1. Explain why, according to the law of comparative advantage, all countries can gain from trade.
  2. In what ways may the imposition of tariffs benefit particular sections of an economy?
  3. Is it in countries’ interests to retaliate if the USA imposes tariffs on their exports to the USA?
  4. Why is a trade war a ‘negative sum game’?
  5. Should the UK align with the EU in resisting President-elect Trump’s trade policy or should it seek independently to make a free-trade deal with the USA? is it possible to do both?
  6. What should China do in response to US threats to impose tariffs of 60% or more on Chinese imports to the USA?
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Worries about the Chinese economy

According to the IMF, Chinese GDP grew by 5.2% in 2023 and is predicted to grow by 4.6% this year. Such growth rates would be extremely welcome to most developed countries. UK growth in 2023 was a mere 0.5% and is forecast to be only 0.6% in 2024. Advanced economies as a whole only grew by 1.6% in 2023 and are forecast to grow by only 1.5% this year. Also, with the exception of India, the Philippines and Indonesia, which grew by 6.7%, 5.3% and 5.0% respectively in 2023 and are forecast to grow by 6.5%, 6.0% and 5.0% this year, Chinese growth also compares very favourably with other developing countries, which as a weighted average grew by 4.1% last year and are forecast to grow at the same rate this year.

But in the past, Chinese growth was much higher and was a major driver of global growth. Over the period 1980 to 2018, Chinese economic growth averaged 9.5% – more than twice the average rate of developing countries (4.5%) and nearly four times the average rate of advanced countries (2.4%) (see chart – click here for a PowerPoint of the chart).

Not only is Chinese growth now much lower, but it is set to decline further. The IMF forecasts that in 2025, Chinese growth will have fallen to 4.1% – below the forecast developing-country average of 4.2% and well below that of India (6.5%).

Causes of slowing Chinese growth

There are a number of factors that have come together to contribute to falling economic growth rates – growth rates that otherwise would have been expected to be considerably higher as the Chinese economy reopened after severe Covid lockdowns.

Property market
China has experienced a property boom over the past 20 years years as the government has encouraged construction in residential blocks and in factories and offices. The sector has accounted for some 20% of economic activity. But for many years, demand outstripped supply as consumers chose to invest in property, partly because of a lack of attractive alternatives for their considerable savings and partly because property prices were expected to go on rising. This lead to speculation on the part of both buyers and property developers. Consumers rushed to buy property before prices rose further and property developers borrowed considerably to buy land, which local authorities encouraged, as it provided a valuable source of revenue.

But now there is considerable overcapacity in the sector and new building has declined over the past three years. According to the IMF:

Housing starts have fallen by more than 60 per cent relative to pre-pandemic levels, a historically rapid pace only seen in the largest housing busts in cross-country experience in the last three decades. Sales have fallen amid homebuyer concerns that developers lack sufficient financing to complete projects and that prices will decline in the future.

As a result, many property developers have become unviable. At the end of January, the Chinese property giant, Evergrande, was ordered to liquidate by a Hong Kong court, after the judge ruled that the company did not have a workable plan to restructure around $300bn of debt. Over 50 Chinese property developers have defaulted or missed payments since 2020. The liquidation of Evergrande and worries about the viability of other Chinese property developers is likely to send shockwaves around the Chinese property market and more widely around Chinese investment markets.

Overcapacity
Rapid investment over many years has led to a large rise in industrial capacity. This has outstripped demand. The problem could get worse as investment, including state investment, is diverted from the property sector to manufacturing, especially electric vehicles. But with domestic demand dampened, this could lead to increased dumping on international markets – something that could spark trade wars with the USA and other trading partners (see below). Worries about this in China are increasing as the possibility of a second Trump presidency looks more possible. The Chinese authorities are keen to expand aggregate demand to tackle this overcapacity.

Uncertainty
Consumer and investor confidence are low. This is leading to severe deflationary pressures. If consumers face a decline in the value of their property, this wealth effect could further constrain their spending. This will, in turn, dampen industrial investment.

Uncertainty is beginning to affect foreign companies based in China. Many foreign companies are now making a loss in China or are at best breaking even. This could lead to disinvestment and add to deflationary pressures.

The Chinese stock market and policy responses
Lack of confidence in the Chinese economy is reflected in falling share prices. The Shanghai SSE Composite Index (an index of all stocks traded on the Shanghai Stock Exchange) has fallen dramatically in recent months. From a high of 3703 in September 2021, it had fallen to 2702 on 5 Feb 2024 – a fall of 27%. It is now below the level at the beginning of 2010 (see chart: click here for a PowerPoint). On 5 February alone, some 1800 stocks fell by over 10% in Shanghai and Shenzhen. People were sensing a rout and investors expressed their frustration and anger on social media, including the social media account of the US Embassy. The next day, the authorities intervened and bought large quantities of key stocks. China’s sovereign wealth fund announced that it would increase its purchase of shares to support the country’s stock markets. The SSE Composite rose 4.1% on 6 February and the Shenzhen Component Index rose 6.2%.

However, the rally eased as investors waited to see what more fundamental measures the authorities would take to support the stock markets and the economy more generally. Policies are needed to boost the wider economy and encourage a growth in consumer and business confidence.

Interest rates have been cut four times since the beginning of 2022, when the prime loan rate was cut from 3.85% to 3.7%. The last cut was from 3.55% to 3.45% in August 2023. But this has been insufficient to provide the necessary boost to aggregate demand. Further cuts in interest rates are possible and the government has said that it will use proactive fiscal and effective monetary policy in response to the languishing economy. However, government debt is already high, which limits the room for expansionary fiscal policy, and consumers are highly risk averse and have a high propensity to save.

Graduate unemployment
China has seen investment in education as an important means of increasing human capital and growth. But with a slowing economy, there are are more young people graduating each year than there are graduate jobs available. Official data show that for the group aged 16–24, the unemployment rate was 14.9% in December. This compares with an overall urban unemployment rate of 5.1%. Many graduates are forced to take non-graduate jobs and graduate jobs are being offered at reduced salaries. This will have a further dampening effect on aggregate demand.

Demographics
China’s one-child policy, which it pursued from 1980 to 2016, plus improved health and social care leading to greater longevity, has led to an ageing population and a shrinking workforce. This is despite recent increases in unemployment in the 16–24 age group. The greater the ratio of dependants to workers, the greater the brake on growth as taxes and savings are increasingly used to provide various forms of support.

Effects on the rest of the world

China has been a major driver of world economic growth. With a slowing Chinese economy, this will provide less stimulus to growth in other countries. Many multinational companies, including chip makers, cosmetics companies and chemical companies, earn considerable revenue from China. For example, the USA exports over $190 billion of goods and services to China and these support over 1 million jobs in the USA. A slowdown in China will have repercussions for many companies around the world.

There is also the concern that Chinese manufacturers may dump products on world markets at less than average (total) cost to shift stock and keep production up. This could undermine industry in many countries and could initiate a protectionist response. Already Donald Trump is talking about imposing a 10% tariff on most imported goods if he is elected again in November. Such tariffs could be considerably higher on imports from China. If Joe Biden is re-elected, he too may impose tariffs on Chinese goods if they are thought to be unfairly subsidised. US (and possibly EU) tariffs on Chinese goods could lead to a similar response from China, resulting in a trade war – a negative sum game.

Videos

Articles

Questions

  1. Why is China experiencing slowing growth and is growth likely to pick up over the next five years?
  2. How does the situation in China today compare with that in Japan 30 years ago?
  3. What policies could the Chinese government pursue to stimulate economic growth?
  4. What policies were enacted towards China during the Trump presidency from 2017 to 2020?
  5. Would you advise the Chinese central bank to cut interest rates further? Explain.
  6. Should China introduce generous child support for families, no matter the number of children?
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The ECB loosens monetary policy – again

Growth in the eurozone has slowed. The European Central Bank (ECB) now expects it to be 1.1% this year; in December, it had forecast a rate of 1.7% for 2019. Mario Draghi, president of the ECB, in his press conference, said that ‘the weakening in economic data points to a sizeable moderation in the pace of the economic expansion that will extend into the current year’. Faced with a slowing eurozone economy, the ECB has announced further measures to stimulate economic growth.

First it has indicated that interest rates will not rise until next year at the earliest ‘and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. The ECB currently expects HIPC inflation to be 1.2% in 2019. It was expected to raise interest rates later this year – probably by the end of the summer. The ECB’s main refinancing interest rate, at which it provides liquidity to banks, has been zero since March 2016, and so there was no scope for lowering it.

Second, although quantitative easing (the asset purchase programme) is coming to an end, there will be no ‘quantitative tightening’. Instead, the ECB will purchase additional assets to replace any assets that mature, thereby leaving the stock of assets held the same. This would continue ‘for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation’.

Third, the ECB is launching a new series of ‘quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years’. These are low-interest loans to banks in the eurozone for use for specific lending to businesses and households (other than for mortgages) at below-market rates. Banks will be able to borrow up to 30% of their eligible assets (yet to be fully defined). These, as their acronym suggests, are the third round of such loans. The second round was relatively successful. As the Barron’s article linked below states:

Banks boosted their long-term borrowing from the ECB by 70% over the course of the program, although they did not manage to increase their holdings of business loans until after TLTRO II had finished disbursing funds in March 2017.

Whether these measures will be enough to raise growth rates in the eurozone depends on a range of external factors affecting aggregate demand. Draghi identified three factors which could have a negative effect.

  • Brexit. The forecasts assume an orderly Brexit in accordance with the withdrawal deal agreed between the European Commission and the UK government. With the House of Commons having rejected this deal twice, even though it has agreed that there should not be a ‘no-deal Brexit’, this might happen as it is the legal default position. This could have a negative effect on the eurozone economy (as well as a significant one on the UK economy). Even an extension of Article 50 could create uncertainty, which would also have a negative effect
  • Trade wars. If President Trump persists with his protectionist policy, this will have a negative effect on growth in the eurozone and elsewhere.
  • China. Chinese growth has slowed and this dampens global growth. What is more, China is a major trading partner of the eurozone countries and hence slowing Chinese growth impacts on the eurozone through the international trade multiplier. The ECB has taken this into account, but if Chinese growth slows more than anticipated, this will further push down eurozone growth.

Then there are internal uncertainties in the eurozone, such as the political and economic uncertainty in Italy, which in December 2018 entered a recession (2 quarters of negative economic growth). Its budget deficit is rising and this is creating conflict with the European Commission. Also, there are likely to be growing tensions within Italy as the government raises taxes.

Faced with these and other uncertainties, the measures announced by Mario Draghi may turn out not to be enough. Perhaps in a few months’ there may have to be a further round of quantitative easing.

Articles

Videos

ECB publications

Questions

    • Investigate the history of quantitative easing and its use by the Fed, the Bank of England and the ECB. What is the current position of the three central banks on ‘quantitative tightening’, whereby central banks sell some of the stock of assets they have purchased during the process of quantitative easing or not replace them when they mature?
    • What are TLTROs and what use of them has been made by the ECB? Do they involve the creation of new money?
    • What will determine the success of the proposed TLTRO III scheme?
    • If the remit of central banks is to keep inflation on target, which in the ECB’s case means below 2% HIPC inflation but close to it over the medium term, why do people talk about central banks using monetary policy to revive a flagging economy?
    • What is ‘forward guidance’ by central banks and what determines its affect on aggregate demand?
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Trade wars looming

According to the law of comparative advantage, trade can benefit all countries if they export goods which they can produce at lower opportunity costs than their trading partners. Trade enables all countries to consume beyond their production possibility frontier. What is more, trade can increase competition, which encourages firms to be more efficient.

That trade is beneficial has been generally accepted by governments around the world since the Second World War, with the General Agreement on Tariffs and Trade (GATT) and then the World Trade Organization (WTO) advocating the dismantling of trade barriers. Countries have participated in a series of trade ’rounds’, such as the Uruguay Round (1986–94) and most recently the Doha Round (2001–15). But since the financial crisis of 2008, there has been waning enthusiasm for freer trade and growing calls to protect strategic and/or vulnerable industries. To some extent this mirrors the growth in protection after the Great Depression of the early 1930s as countries sought to boost their own industries.

After some progress in the Doha round talks in Nairobi in December 2015, the talks effectively marked the end of a fourteen-year road for the round (see also). There was a failure to agree on a number of items and chances of resurrecting the talks seem slim.

The classic response to calls for protection is that it can lead to a trade war, with a net loss in global output as less efficient domestic industries are shielded from competition from lower-cost imports. Consumers lose from no longer having access to cheaper imported goods. Trade wars, it is argued, are a negative sum game. Any gains to one country are more than offset by losses elsewhere. In fact, it is likely that all countries will lose.

One argument for protection recognises the efficiency gains from free trade, but argues that current trade is distorted. For example, countries may subsidise the export of products in which they have a comparative disadvantage and dump them on the rest of the world. The WTO recognises this as a legitimate argument for tariffs, if they are used to offset the effect of the subsidies and make import prices more reflective of the cost of production.

But increasingly arguments go beyond this. Industries that are regarded as strategic to a country’s future, such as the steel industry or agriculture, are seen as warranting protection. With protection, investment may flow to such industries, making them more efficient and even gaining a comparative advantage at some point in the future.

Then there is the question of income distribution. Trade with poor countries may help to close the gap somewhat between rich and poor countries. The reason is that poor countries, with an abundance of labour, are likely to have a comparative advantage in labour-intensive products. The demand for exports of such products will help to drive up wages in such countries. However, income distribution within the rich countries may become less equal. Cheap imports from developing countries may depress the wages of unskilled or low-skilled workers in the rich countries.

Another argument concerns the devastation caused to communities by the closure of plants which are major employers. Workers made redundant may find it hard to find alternative employment, especially if their skills are specific to the plant that has closed. At least in the short term, it is argued that such industries warrant protection to allow time for alternative employers to be attracted into the area.

Arguments such as these are being used today in many countries as they struggle with slowing growth in China, a glut of global resources and overcapacity in certain industries.

The steel industry is a case in point. The announcement by Tata Steel that it intends to close the Port Talbot steel works has been met with consternation and calls for protection against subsidised Chinese steel imports. The USA already imposes tariffs of 256% on corrosion-resistant Chinese steel. The EU has proposed raising tariffs on Chinese steel to the full amount of the subsidy, but the UK has blocked this, not wishing to trigger a trade war with China. In the meantime, China has announced the imposition of a tariff of 46% on a particular type of hi-tech steel imported from the EU.

On the other side of the Atlantic, there have been growing protectionist calls from presidential front runners. Donald Trump and Ted Cruz on the Republican side, and Bernie Sanders and now Hilary Clinton on the Democratic side, are opposed to the trade agreement that President Obama has been seeking with the EU – the Transatlantic Trade and Investment Partnership (TTIP). Donald Trump has proposed imposing tariffs of 45% on all Chinese imports.

The following articles look at the growing calls for protection, especially against China, and at the arguments about what should be done to protect the UK and EU steel industry.

Articles

Defiant China slaps steel tariffs on Britain as trade war looms The Telegraph, Ambrose Evans-Pritchard (1/4/16)
China’s soaring steel exports may presage a trade war, The Economist (9/12/15)
Trade, at what price? The Economist (30/3/16)
Free trade in America: Open argument The Economist (2/4/16)
Can the British steel industry be saved? Financial Times (2/4/16)
Steel crisis: UK government plays down China tariff fears BBC News (2/4/16)
The dogmas destroying UK steel also inhibit future economic growth The Observer, WIll Hutton (3/4/16)
UK accused of leading efforts to block limits to Chinese steel dumping The Guardian, Frances Perraudin (1/4/16)
There’s always an excuse to justify suspending free trade – Tata is the latest The Telegraph, Allister Heath (1/4/16)
Can one of the world’s top economies live without making steel? Bloomberg, Thomas Biesheuvel (1/4/16)
Trade policy is no longer just for political nerds: it matters in the UK and US The Guardian, Larry Elliott (27/3/16)
Steel shrivels while Britain’s balance of payments crisis grows The Observer, WIlliam Keegan (3/4/16)
Trump’s tariff plan could boomerang, spark trade wars with China, Mexico Reuters, David Lawder and Roberta Rampton (24/3/16)
Analysis: A Trump trade war could cost the U.S. millions of jobs Daily Herald (Chicago), Jim Tankersley (3/4/16)

Questions

  1. What is meant by the ‘law of comparative advantage’? Does the law imply that countries will always gain from totally free trade?
  2. Demonstrate the gains for each of two countries which choose to trade with each other (see, for example, pages 711–3 in Economics, 9th edition).
  3. What is meant by ‘strategic trade theory’? How would such theory relate to the case of steel production in south Wales?
  4. What are the arguments for and against the EU imposing tariffs on Chinese steel imports equal to the subsidy given by the Chinese government?
  5. Is protectionism always a negative sum game? Explain.
  6. Assess the validity of various arguments for protection.
  7. Why did it prove impossible to complete the Doha round?
  8. What is meant by the ‘Transatlantic Trade and Investment Partnership (TTIP)’? Why is there so much opposition to it?
  9. Are bilateral trade deals, such as the TTIP, the best way of moving forward in reaping the gains from freer trade?