Amid the rise in tariffs from 10% to 25% on $200bn of US imports from China, we need to ask whether policy-makers are targeting the country or the deficit (or both), as this has implications for the next steps.
If US tariffs are driven by superpower rivalry and the desire to slow down the rise of its main competitor, then the situation can escalate. China cannot be expected to abandon some of the key elements of its successful industrial policy, so no deal is likely unless the US moderates its demands. Alternatively, if the bilateral deficit is the target, then the tariffs are already working and the additional measures will help.
Whether the US keeps talking, or puts tariffs on the remaining $300bn of Chinese exports partly depends on how much damage to its own economy it is prepared to accept. It could boost inflation and knock 0.2% off US growth.
The initial tariffs on the first $50bn of imports had limited impact, as the US could source similarly priced goods elsewhere. The latest $200bn will have more of an effect, although a lot are industrial inputs (like semiconductors or auto parts), so they might squeeze corporate profitability more than sending consumer prices higher. However, it is going to be even harder to find substitutes for the final $300bn, so the boost to consumer prices will be more direct.
We already have a case study to support this conclusion. When the US raised tariffs on washing machines in January 2018 consumers felt prices rise by the full amount of the tariff (partly because there is no realistic substitute). This suggests that consumers will pay the price if the US puts tariffs on items like smartphones.
So the limit on US escalation will be how much pain it is prepared to accept in return for further handicapping its main strategic rival.
Alternatively, if the US mainly cares about its trade deficit, then a shrinking imbalance with China will be replaced by a larger imbalance elsewhere. In this case, Mexico, Japan, Germany or Vietnam could be next under the spotlight.
Of course it is possible that the US wants to undermine Chinese growth and reduce its overall trade deficit. As President Trump appears to pay almost no attention to detail and to have no-one to advise him on the basic economic causes of the US trade deficit, it is quite possible that he fights a trade war on many fronts at the same time.
The next key moment is the 18 May deadline for deciding on tariffs on automobile imports, which could affect up to $375bn of trade. This would push up prices to US consumers and probably prompt retaliation from the European Union.
The most recent IMF World Economic Outlook report made two directly relevant points. Firstly, a country’s trade deficit is largely the result of domestic economic conditions, so if you use tariffs to shrink a bilateral deficit with one country, the deficit with others will increase. Secondly, lower tariffs boost trade, global productivity and prosperity.
The key point is that even if China agrees to buy more American goods – or if tariffs cut US imports from China – the overall US deficit will be little-changed.
From earlier comments, we know that President Trump equates a trade deficit with “losing”. So even if it is not as much of a loser against China, it will become a bigger loser against, say, Vietnam or Mexico.
China stands out as having the largest imbalance, by far, but the bad news for Asia is that seven of the top twelve contributors to the US deficit are from the region.
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