Fears of U.S. protectionism have risen over the last year, as President Donald Trump has enacted tariffs on
various countries. What are tariffs, and what is behind this fear?
Think of tariffs this way: a tariff is a tax on foreign imports
and can be enacted on a specific good or country. Tariffs
are primarily used to protect domestic industry, but also
can be used to influence another country’s economic
behavior. There are a variety of tariffs a government can
employ, ranging from a fixed fee levied against a specific
product to local content rules, which require foreign-owned
companies to use a certain percentage of locally sourced
components to manufacture its products.
Tariffs often are extremely complex. Let’s look at the auto
industry. Recent stories have compared the European
Union (EU) and U.S. tariffs on cars at 10% and 2.5%,
respectively. However, this is a bit of an oversimplification
due to the numerous tariffs related to automobiles. There
are different tariff rates based on vehicle type (cars, trucks,
motorcycles) and even vehicles vs. auto parts. In addition,
other countries employ barriers to trade that impact the
U.S. auto industry. Japan has no tariff on auto imports,
but makes it very difficult for foreign automakers to receive
certification and establish dealership networks.
Historically, real global gross domestic product (GDP)
growth has been highly correlated to world trade volume
(chart). Because of the integrated nature of the global
economy, tariffs can be extremely disruptive. If a tariff
increases the cost of a good, the demand for that good
could wane. Suddenly, corporations’ decisions on capital
spending (capex) become less clear. Corporate initiatives
like building a new factory, investing in new technologies,
or adding significant headcount are put on hold until
market clarity returns. The longer-term concern on tariffs
is export growth may eventually slow, which can hamper
global economic growth.
The correlation between real global GDP growth and World trade volume
Source: “OECD Total: Real Gross Domestic Product/World Trade Volume,” Organization for
Economic Cooperation and Development, Netherlands Bureau for Economic Policy Analysis/Haver
Analytics, June 2018. Past performance is not a guarantee of future results.
What will this round of tariffs do to growth?
Trump has imposed several tariffs this year to address what he
deems as unfair trade practices against the U.S.
The Trump Tariffs
China (round 1)
China (round 2)
Most of these U.S. tariffs have elicited a similar retaliatory
response from affected countries. While constant talk of tariffs
has probably made some U.S. industries nervous, such as
agriculture, the economic impact has been relatively minimal
up to this point. By our calculations, recently enacted tariffs
could cut U.S. GDP growth by 0.2%, which we believe the U.S.
economy can easily absorb. Also, enacted tariffs have had
a negligible benefit to job growth in the affected industries.
President Trump has threatened to put a 10-25% tariff on an
additional $200 billion in Chinese goods and said he could
follow that with another $200-250 billion. Our estimates
point to a 0.3% reduction in Chinese GDP growth stemming
from the recently enacted tariffs. There is some evidence
business confidence has dipped slightly however, we believe
significantly more tariffs would have to be enacted before there
is a meaningful economic impact.
Is the U.S. headed for a full-blown trade war?
Currently, the U.S. and China are engaged in a trade stare
down, which we believe will linger in the near term and will
likely get worse before it gets better. Both sides are likely to
increase the number of tariffs and other harmful actions,
which could result in a further increase in market volatility.
Ultimately, we believe the U.S. and China will come to trade
agreement, but it probably will be a little more painful before
both sides come to a resolution at the negotiating table.
In late July, Trump and European Commission President
Jean-Claude Juncker agreed to forestall threatened U.S.
tariffs on imports of EU automobiles. The agreement includes
negotiations on eliminating non-auto industrial tariffs and
a promise to keep tariffs at bay unless one side withdraws
from negotiations. In addition, the EU agreed to increase
imports of U.S. soybeans and liquefied natural gas. While the
agreement appears to have averted a trade crisis with the EU
for now, Trump could enact these tariffs later if he believes the
negotiations are unproductive.
At the same time, North American Free Trade Agreement
(NAFTA) negotiations are ongoing. Trade representatives
from the U.S. and Mexico have been speaking positively about
the possibility of a deal to rework the agreement. Meanwhile,
relations between the U.S. and Canada are uncharacteristically
strained following a contentious G7 summit in June. While
we believe that a NAFTA deal will be reached at some point, a
failure on this front would impact U.S. manufacturing supply
chains and be extremely disruptive.
A brief history of U.S. tariffs and their impact*
U.S. tariffs date back to colonial times. The Tariff Act of 1789 was one of the first major statutes passed by the U.S. Congress.
Numerous presidents have used tariffs as part of their foreign and economic policies, leading up to Trump. Here are a few of the
more notable U.S. tariffs and their economic impact:
The Tariff Act of 1789
First U.S. tariff designed to
raise revenue for the federal
Revenue Act of 1913
Slashed basic tariff rates
from 40% to 25%. To offset
the lost revenue from tariffs,
the U.S. re-imposed the
federal income tax under
the authority of the 16th
Smoot-Hawley Tariff of 1930
Act raised tariffs by an
average of 59% on more than
25,000 imports. By 1934,
global trade had decreased
more than 60%.
President George W. Bush
levied tariffs on steel and
lumber imports in early 2002.
The S&P 500 lost more more
than $2 trillion in market
capitalization during the first
year of those tariffs.
*Source: Barrons; “Mr. Trump, Meet Smoot and Hawley”
Ivy Live - August Highlights: Political Mayhem and the Markets
Thursday August 16, 2018
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