Economic pain without any gain

Evidence is piling up that American protectionism is lowering global economic growth compared with what it would’ve been without all the trade uncertainty that comes with it. It could also be hurting the very people it professes to help.

The practice of shielding a country’s industry from foreign competition through tariffs and other barriers to free trade brings large, ostensible gains to relatively small industries or segments of the population. But at the same time it delivers a small, hard-to-quantify loss for every member of a large and silent majority. When all of those small losses are added up, they invariably far outweigh the ostensible gains. In the run-up to the 2016 US presidential election, we highlighted this danger in our report Trade of the century, and sadly it’s now coming to fruition.

According to research carried out by the Federal Reserve (Fed), trade-policy uncertainty in the first half of 2018 lowered the level of global GDP growth by 0.8% into the first six months of 2019. That drag would have started to ease if it weren’t for an escalation in trade tensions between May and August this year. However, the renewed uncertainty may push GDP growth down further in the second half of 2019 and into 2020. The Fed study also estimated that trade uncertainty has caused a drag of 1.8 percentage points on investment growth for the average US company.

Unexpectedly, the US may have scored an own goal of sorts with its tariff policy. According to a study published by America’s National Bureau of Economic Research (NBER), the negative impact on demand from trade uncertainty is greater in the US and other advanced economies than it is in emerging market economies. This tallies with evidence that China has actually increased its share of global trade in 2019. It is adept at ‘transhipping’ — using affiliates in other countries to export the end product.

The NBER found that US tariffs have almost completely passed through into domestic prices, meaning the full impact has so far fallen on domestic consumers and importers. There has so far been no impact on the prices for foreign exporters. US producers have also raised their prices in response to reduced competition from importers. As America’s supply-chain network has been disrupted, competition from imported varieties of goods has fallen and domestic prices have gone up. The NBER estimates that US real incomes (income after inflation) fell $1.4 billion per month over the final half of 2018.

Out of pocket

Put another way, rising tariffs are taking money out of US consumers’ pockets. As trade negotiations broke down in May and tariffs on $200 billion of Chinese imports increased from 10% to 25%, the typical US household incurred an annual cost of $831, according to research by the Federal Reserve Bank of New York. That’s $106 billion in total — or 0.8% of all US household spending, which is a pretty significant amount.

Most of this cost is from what economists call a ‘deadweight loss’, which occurs when you have to buy a substitute good from a less efficient producer at a higher price. Even if the government passed back the proceeds from the tariffs to consumers, it would only offset a small amount of the cost.

In other words, it’s economic pain without any gain. And this pain may be about to spread. We’ve noted that the anti-trade rhetoric emanating from the White House in August was more focused on the EU. Tariffs on cars and aeroplanes are a distinct possibility. Against the threat of further escalation, investors are likely to continue to demand extra compensation for the risks to future earnings.

Stocks with international earnings most sensitive to the ebb and flow of the business cycle are most at risk. Although the American economy is being hurt by its own trade policy, continental European, Asian and emerging equity markets are among the most vulnerable to a spread of the tariff war. We continue to see US equity markets as one of the best places for stable and reliable earnings growth — the tech sector in particular. 

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