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Trade War’s Economic Impact Has Been Minor. That Could Change

Trade war has dominated headlines and businesses’ anxieties for the past year, but it hasn’t left any notable impact on U.S. economic growth. That isn’t surprising: The direct effects of trade barriers are usually rounding errors in an economy as large and relatively closed as the U.S.

The picture, however, could change in the coming year. The accumulating list of irritants and flashpoints between the U.S. and its trading partners could spill over through other, less obvious channels such as confidence, financial markets and investment, compounding other threats such as rising U.S. interest rates and capital flight from emerging markets.

Though trade war has no official definition, it is safe to say the world is pretty close to one right now. President Trump has levied tariffs on solar panels, washing machines, steel, aluminum and much of what the U.S. imports from China, triggering widespread retaliatory tariffs.

Chad Bown, a trade expert at the Peterson Institute for International Economics, estimates that 12% of U.S. imports were covered by tariffs in September. Assuming Mr. Trump goes ahead and hits the remainder of Chinese imports, that will top 20%.

That is a lot, but it isn’t unprecedented. Doug Irwin, author of “Clashing Over Commerce: A History of U.S. Trade Policy,” says that in 1984, President Reagan had imposed trade barriers such as voluntary export restraints on autos and steel on 21% of U.S. imports.

In early December the U.S. agreed not to raise tariffs further while China seeks to respond to longstanding U.S. complaints such as on forced transfer of technology. Yet even if Mr. Trump hits all Chinese imports with a 25% levy, economists at Goldman Sachs say the impact on the U.S. will be modest. Importers may switch from foreign to domestic goods where ready substitutes are available; they may switch from Chinese to other foreign suppliers. But most have no ready U.S. or foreign substitutes, so the tariff will be passed on to customers, like any tax. In all, Goldman sees a hit to U.S. gross domestic product of less than 0.1% and only slightly more, 0.25%, to China’s.

But the harm could easily be worse. “There aren’t any good parallels in recent history,” says Maurice Obstfeld, chief economist of the International Monetary Fund. “There’s a much more pervasive uncertainty about trade than in past episodes, which were much more localized and contained.”

The current risks are amplified by the readiness of the European Union, Canada, Mexico and China to retaliate. This reflects those nations’ judgment that it is useless to appeal to the U.S.’s traditional support for rules-based trade, and that Mr. Trump will bend only if the U.S. feels pain.

Moving a supply chain or finding new markets takes time and money, and companies are likely to drag their feet on investing in either until they know where the rules of the game will end up. How much that will hamper investment is impossible to know, but Britain offers a clue. It hasn’t raised tariffs since voting to leave the EU in 2016, yet weak business and consumer spending have left its economy about 2% smaller than it otherwise would be, several studies have found. The IMF says enactment of all of Mr. Trump’s tariffs plus proportionate retaliation coupled with spillover to the financial markets would eventually wipe almost 1% off U.S. GDP.

A trade war, by itself, is manageable; less so when compounded with other problems. The U.S. economy had the wind at its back for the past year thanks to a tax cut, federal-spending boost, rebound in oil prices and rising stock wealth. These are fading: Oil fell by a third in the past two months, and the stock market has wobbled. Meanwhile, the choppy stock markets and rising corporate-bond yields suggest investors are becoming more risk-averse. Lenders may quickly flee heavily indebted countries or companies hit by protectionist barriers.

Foreign economies have already stumbled. Should China be dragged down by tariffs, that could ricochet into oil and commodity prices and, much as in 2015, hobble U.S. exports and shale-oil drilling. Should a crisis arise in the eurozone or an emerging market, the ability of the U.S. and its allies to respond will have been eroded by the mistrust sown by trade war.

For now these are possible but not probable paths. The Trump administration’s goal is to rewrite the rules of trade, and it believes it has been vindicated in the revamped treaties it has negotiated with South Korea, Mexico and Canada. For now a truce prevails among the U.S., the EU and Japan.

Yet the days of ever-freer trade are clearly over, and that will cost Americans in many subtle ways. Products such as Ford Motor Co.’s Focus sedan that can no longer be profitably imported or made in the U.S. will simply no longer be offered, leaving Americans with less choice. U.S. exporters of soybeans and the like will have to accept lower prices or higher transport expenses to establish new markets. These effects may not show up in GDP — but they are real.
Source: Dow Jones

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