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With Donald Trump headed back to the White House, we’re about to stress-test the question: just how dependent is the world trading system on the US?
The distortive threat that the tariffs from his first term posed to the production networks that had been built up since the end of the cold war are obvious, but the impact of what he is contemplating now will go way beyond his previous actions.
High tariffs on Chinese imports (and duties on steel and aluminium from other trading partners) in Trump’s first term as president caused disruption to bilateral trade. But it’s now well-established that companies responded to the China tariffs by routing goods into the US via so-called “connector countries” such as Vietnam and Mexico. Governments including Mexico, Canada and Australia also managed to negotiate deals to ameliorate the impact of the steel and aluminium duties. The US’s trade deficit with China shrank: its overall deficit did not.
This time round, Trump has been threatening not just 60 per cent tariffs on China but blanket 10 or 20 per cent duties on all trading partners. His aim is to cut the US’s overall trade deficit, which he regards as intrinsically bad for the country in profit-and-loss terms. This is intuitively appealing but economically illiterate.
Trying to use tariffs to close an overall deficit is far more damaging than to manage a bilateral relationship or, as the Biden administration has done, selectively to protect key industries such as electric vehicles. For all his protectionist instincts and actions, Joe Biden was a relatively good president for world trade. His fiscal stimulus — together with the low-interest rate policy of the Federal Reserve — helped demand and hence cross-border trade recover from the Covid shock. A bit of macroeconomic demand can outweigh quite a lot of microeconomic inefficiency.
Using trade tools to achieve macroeconomic objectives such as reducing a current account deficit rarely works. Exchange rates can adjust by appreciating to offset the effect of the tariff. The fact that the dollar rose on Wednesday on the news of Trump’s re-election could reflect a variety of things, but the likelihood of tariffs being imposed is certainly one of them.
The Peterson Institute think-tank in September modelled the impact of Trump’s across-the-board tariffs, and found that the exchange-rate effect tended to outweigh the tariff effect on trade flows. Its projections show a slight narrowing in the overall deficit over the next four years, but then a widening as the real exchange rate appreciates.
It’s quite possible to imagine an enraged President Trump demanding higher and higher tariffs as the medicine fails to work and the deficit remains. Crushing domestic demand and plunging the US into recession will certainly reduce net imports, but at a terrible cost. He will, as was once said of an invading Roman army destroying everything in its way, make a desolation and call it peace. Trump may also resort to trying somehow to force the dollar lower, worsening the inflationary impact of the tariffs and requiring the Federal Reserve — assuming it’s still an independent central bank by then — to raise interest rates.
From the point of view of the global economy and trade, a determined attempt to prevent the US being a globally important source of net import demand would come at a particularly bad time. China, with the travails of its domestic property market hampering Beijing’s attempts to switch its growth model to one dependent on domestic demand, is veering towards the old export-driven model that characterised the 1990s and 2000s.
Brad Setser, a former US Treasury and US trade representative official now at the Council on Foreign Relations think-tank, argues that, properly measured, China is showing a sustained shift towards a larger trade surplus. US import growth, Setser says, is currently driving growth in global trade.
China is frequently referred to as the engine of global economic growth, but the supply engine can’t run without the fuel of demand. As long as China and similar economies are running surpluses and the US (plus some smaller economies such as the UK) equivalent deficits, it is hard for real decoupling to occur.
Now, having China as a chronic surplus country that saves too much and the US as one that saves too little is few people’s idea of an optimal world economy. Setser calls it “unhealthy globalisation” — it keeps the world economy and trade going but not in a balanced way. Still, it’s better than a crunching global recession.
The world can live with China-specific tariffs of the kind Trump imposed during his first term. It can survive with the US abrogating its former role as a leader of global rule-setting in trade. (Biden’s enthusiasm for the WTO barely exceeded Trump’s.) It can live with the inefficiencies of walling off favoured industries from global competition. But it cannot live with all the big economies simultaneously making their primary goal of economic policy a determined drive to increase exports and cut imports without incurring serious damage.