The Market Is Spooked, but the Trade War Might Not Be So Bad


By Matthew C. Klein, Barron's 

May 14, 2019


The U.S.-China trade talks have reached an impasse. American imports of Chinese goods worth roughly $200 billion will now be taxed at a 25% tariff rate, up from 10%. On Monday, the Chinese government responded by announcing it would raise tariffs on its imports of certain U.S. agricultural products, which were worth about $60 billion. The escalation sent stocks sharply downward, with the Dow Jones Industrial Average and the S&P 500 each dropping 2.4%


The incremental impact on both countries should be tiny: The U.S. economy produces about $21 trillion of goods and services each year, while the Chinese economy produces about $14 trillion. Goldman Sachs estimates the current tariff regime would subtract about 0.15 percentage point from U.S. growth at most.


Even in an extreme scenario where trade breaks down completely between the two countries, the impact wouldn’t be that large. The U.S. imported about $560 billion worth of goods and services from China in 2018, or a bit less than 3% of U.S. gross domestic product. About a fifth of the value of those imports, however, can be attributed to components and software from other countries, including the U.S. itself, which means actual import dependence is even lower. (U.S. exports to China were worth about $180 billion.)


Suppose, however, that punitive tariffs were applied to goods imports from all countries. What would this “de-globalization” mean for the U.S. economy?


From one perspective, the answer is: not much. Excluding petroleum and agricultural products, the U.S. imports about $2.2 trillion a year in goods from the rest of the world—about 10% of total U.S. spending. Raising the cost of those goods would have an impact, but it would be small compared with other changes in taxation and government spending in the past few years. Moreover, the government could help offset the aggregate impact of the effective tax increase with broad-based tax cuts or higher spending.


The full impact wouldn’t be felt directly by consumers. Most goods traded across borders are not sold directly to consumers, but are inputs to businesses. The cost of the higher prices from the tariffs will therefore be split between the businesses that use foreign goods as inputs and the consumers of the resulting end products. Just like any other policy that raises costs—such as a higher minimum wage or taxes on greenhouse-gas emissions—the most straightforward consequences should be slightly lower profit margins and a temporary pop in inflation.


Those sound bad, but the overall economic impact may be somewhat more ambiguous. After all, higher input prices can also spur additional investment in productivity improvements that ultimately lead to higher wages. Moreover, the U.S. runs a massive trade deficit, particularly in capital goods, high-tech manufacturing, and motor vehicles—even as the American manufacturing sector continues to operate with substantial spare capacity relative to previous history.


That suggests shifts in spending...


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