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  • Writer's picture Chris Jernstrom

(Trade) War, What is it Good For? – A Primer on Global Trade

Over the first half of 2018, the United States’ trade policy has taken center stage as the Trump Administration has moved from hypothetical talk of a trade war to firing the initial salvos of what is shaping up to be a global trade conflict. While initially billed as a U.S./China conflict, it has spread to include almost all our major trading partners, including Canada, Mexico, and the European Union. Let’s take a deeper dive into the U.S. trade policy and the impacts that could arise from the ongoing conflicts.

What are Tariffs?

You’ll hear the word tariff used frequently in the news media recently and it refers to taxes the U.S. is placing on select imported goods. Tariffs are the same as customs duties and while commonly referred to in relation to imports, tariffs can also be applied to exported goods.

A point President Trump often raises is that the United States is getting taken advantage of by our trading partners, such as China, by allowing their exported goods to enter the U.S. unencumbered (with low to no tariffs) while high tariffs are placed upon our exports as they enter their country.  While there is some truth to the difference in average U.S. tariff rates vs. other countries, the differences are relatively minimal, as seen in Exhibit A.

Exhibit A: Tariff Rates of Major Trading Partners

Source: World Integrated Trade Solutions, The World Bank

History of Tariffs and Ttrade

Historically, tariffs have been used for two primary functions: generating government revenue and protecting domestic industries from international competition. For many developing economies without strong personal and corporate tax infrastructure and collection, tariffs are one of the few means by which the government can generate funds for public services. The U.S. itself relied heavily on tariffs during the first 100 years of existence to fund the government.

While revenue generation is still a major use of tariffs for developing economies, most developed nations, like the U.S., now use tariffs for the second primary function of protecting domestic industries from international competition. The idea is that if we place high tariffs on imports, it helps increase the competitiveness of domestic producers by making their products more attractively priced within the country.

Free-trade Organizations

Trade has always played a role in the U.S. economy but has accelerated over the past 50 years, rising from 10% of GDP (Gross Domestic Product) in 1968 to over 26% in the latest figures published by The World Bank (2016). While global trade has been growing for the past 50 years, the U.S. trade balance has more recently accelerated into deficit territory. The “trade balance” is the difference between the total amount of imports versus the total amount of exports. The last time the U.S. had a trade balance close to zero was in the early 1990s. Since then, both imports and exports have grown rapidly, however, imports have grown more quickly, increasing the U.S.’s trade deficit as you can see in Exhibit B.

Exhibit B: U.S Imports, Exports, and Trade Balance Since WWII

Source: Federal Reserve Bank of St. Louis

The growth in the U.S. trade deficit cannot be blamed on any single occurrence, yet many experts point to the growth in free-trade organizations as being the prime culprit.  Some trade organizations you’ll hear of often are the World Trade Organization, the North American Free Trade Agreement, and the Trans-Pacific Partnership.

World Trade Organization Known commonly as WTO, the World Trade Organization was formed in 1995 as an intergovernmental organization to regulate global trade and currently includes 164 countries. The WTO is a successor to the General Agreement on Tariffs and Trade (GATT) which was one of the first global trade agreements and was signed in 1947, after the conclusion of World War II.

North American Free Trade Agreement Known commonly at NAFTA, the North American Free Trade Agreement became effective in 1994, creating a trade bloc between the United States, Canada, and Mexico.

Trans-Pacific Partnership Known commonly as TPP, the Trans-Pacific Partnership is a trade agreement signed in 2016 by twelve countries including the U.S., Japan, and Australia. However, the TPP was not ratified as the U.S. withdrew from the partnership in early 2017.

A large part of President Trump’s message is these trade organizations have been detrimental to American businesses and we should move away from them in favor of bilateral trade agreements, which are agreements only between two countries, rather than a group of countries.

Impact of the Current Trade War

The lasting impact of the current trade war will be largely influenced by how long the new tariffs stay in place and whether they continue to grow to include a wider array of goods. Economists generally agree the longer and larger the tariffs are, the greater the negative impact to the U.S. and global economy. Contrary to President Trump’s statements that, “…trade wars are good, and easy to win”, they are unfortunately neither.

While the bulk of the recent tariff activity is impacting some of our largest trading partners (see Exhibit C below for our primary import/export partners), the biggest risk from the tariffs in my opinion is the crisis of confidence it causes to the global business community. The business community looks for stable trade rules in order to implement future plans. This planning includes decisions to hire additional workers, build new factories, and allocate research and development funds. The uncertainty of future tariffs therefore impacts not only businesses currently producing tariff-impacted goods but all businesses involved in the import and export of goods.

Exhibit C: Top Trading Partners of the U.S.

Source: World Integrated Trade Solutions, The World Bank (as of 2016)

To conclude, my hope is the current trade war is short-lived and we can resume our push towards a cooperative global trade framework. As we are all interested in making the U.S. more competitive globally, we would be better served by focusing our efforts on more effective areas, such as improving our education system, rather than the mutually destructive act of exchanging trade tariffs with our trading partners.


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