Tariffs on China Are Not the Way to Go

March 18, 2018 Topic: Economics Region: Americas Tags: tariffsChinaWorld Trade OrganizationWTOtrade

Tariffs on China Are Not the Way to Go

Both history and logic tell us that such protectionist measures make little sense.

Despite a litany of warnings from experts and some of his own advisors, President Trump is determined to pursue a series of counterproductive, protectionist measures. Tariffs levied in January on imported solar equipment and washing machines have now been followed by tariffs on steel and aluminum imports. In the coming months, more serious and China-specific actions are likely to be taken based on Section 301 of the Trade Act of 1974 for alleged discriminatory investment practices and IPR violations.

Yet both history and logic tell us that such protectionist measures make little sense. The two percent sell off in U.S. equity markets in response to the steel tariffs illustrates why the financial community also realizes that this is bad for the U.S. economy. Widespread pushback from America’s allies such as Canada, Germany and the UK on the steel tariffs is further weakening America’s global standing. Contrary to President’s Trump’s recent comment that “trade wars are good and easy to win,” it is widely understood that the steel tariffs will raise prices for consumers, reduce competitiveness of firms that need steel to produce other products and do nothing to reduce America’s huge trade deficits. Such actions reflect a fundamental misunderstanding of trade principles.

It is a mistake to assume that trade is a bilateral issue when it is multilateral, especially in an age when production networks dominate the global trading system. Products from one country will likely incorporate components from others. Moreover, it is logical that countries run deficits with some countries and surpluses with others. It is the overall trade balance that actually matters. Product specific tariffs designed to curb a bilateral trade deficit with say China will not lead to an overall reduction in the U.S. trade deficit, it will merely shift it to another country. And interestingly, China’s overall trade surplus last year fell to a decade low of around 1.3 percent of GDP.

It is a mistake to assume that tariffs and quotas will moderate America’s trade deficits when a country’s overall trade balance is determined by its savings and investment rates. America’s long-term decline in household savings rates coupled with huge federal budget deficits have made a trade deficit inevitable. That is why the U.S. has had a current account deficit for forty straight years, in good times as well as bad, and decades before China even became a major export power.

It is a mistake to assume that the U.S. trade deficit with China is the major factor for loss of jobs when the culprit is really productivity increases. Ironically, the tariffs on solar products imports may lead to thousands of jobs lost in the U.S. installation business relative to protecting several hundred jobs in production. The same will happen in the case of steel tariffs.

It is a mistake to assume that America’s punitive tariffs will go unchallenged and that the question is whether one side or the other is in a stronger retaliatory position. History tells us that everyone loses in trade wars and most of them are consumers.

If the logic against such actions is so clear, why is this administration so keen to act on protectionist sentiments that have been around for decades? It’s all about politics of course. President Trump won the presidency because he catered to a wave of populist anxieties in this case about job loss associated with free trade. He is also building on a sense that the global system is somehow not fair and that China has been taking advantage of the situation. His actions have been made easier because the U.S. business community has become markedly more negative in recent years about their economic prospects in China. Moreover, the early January announcement that America’s bilateral trade deficit with China hit an all-time for 2017 made it inevitable that White House would now want to get tough with China.

If logic somehow overrode politics, then how should the White House address concerns that Beijing is not playing by the rules? The current WTO framework was established by the western powers to create a rules-based framework that would apply to all members. Ironically, the U.S. took the lead in negotiating with China to join the WTO to ensure that it would operate within this framework.

This logic remains valid provided there is confidence that WTO’s dispute resolution arrangements are working fairly and expeditiously. Generally, this has been the case but there is room for improvement. China has been the target of a disproportionate number of WTO cases and it has honored such rulings. But WTO guidelines have not evolved rapidly enough in line with trade and investment trends, especially in intellectual property rights, e-commerce and cross border information flows. The response should be to address these issues rather than try to tear down the system.

Some of America’s specific foreign investment related concerns, however, cannot be dealt with effectively within the WTO system especially if they involve concerns about discriminatory practices, security or concerns about transfers of vital technologies. For such issues, as recommended by the US-China Business Council, the priority should be to move forward with the Bilateral Investment Treaty (BIT) that has been under negotiation for years. But the Trump administration has put the BIT on the back burner even though China has been keen to proceed. This is a mistake. Such a treaty would provide the rules-based means to address such issues without resorting to counterproductive, protectionist measures.