What Happens Next In The Global Trade War: A Q&A With Goldman Sachs

Today, according to Politico, the White House will unveil its plan to hit China with tariffs and other trade restrictions, one day ahead of schedule as President Trump is slated to outline the results of U.S. Trade Representative Robert Lighthizer’s investigation into allegations that China violates U.S. intellectual property rights by forcing American companies to transfer valuable technology to Beijing.

Lighthizer’s office has determined that the US loses at least $30BN a year to China’s alleged forced technology transfers, and the administration is weighing a package of tariffs equivalent to that amount of Chinese imports; according to Reuters it could be as high as $60Bn.

While it is still unclear what Chinese imports might be targeted, Goldman notes that unlike the steel and aluminum tariffs, which were 25% and 10%, respectively, the affected categories of imports from China are likely to face a much higher level of tariffs, potentially approaching 100%.

In advance of Trump’s announcement, China hinted that its countertariffs will be aimed at Trump’s support base, including levies targeting U.S. agricultural exports from farmbelt states in retaliation to the mounting trade offensive from Washington. This confirms what has been widely suggested, namely that Chinese retaliation is virtually assured, with Goldman adding that in some recent cases China has announced its own protective actions within days of a US action but usually covering a fraction of the value of products targeted by the US. With China-focused investment and visa restrictions still on the horizon, it is possible that the announcement of those measures several weeks from now could prompt a further counter-response from China.

The launch of trade war with China does have a silver lining: it suggests that trade policy risks might soon reach a near-term peak. According to Goldman, while NAFTA renegotiation remains a risk and adverse headlines are a clear possibility, a US withdrawal from NAFTA looks unlikely. There are additional trade remedy cases in the pipeline in the US, but these cover only a few billion in imports in total and are in line with similar cases considered by other administrations.

And now the bad news: Goldman also notes that with the economy humming along, once things start deteriorating, it is likely that only then will Trump’s trade war start to escalate aggressively:

We also note that the economic cycle, not the political cycle, has tended to drive trade restrictions in the US. Taking the solar panel, steel, aluminum, and forthcoming China-focused announcements together, the Administration will likely have announced tariffs covering at least $100bn in goods at a time that the jobless rate is at 4.1%. Either the Trump Administration is acting differently from prior administrations—clearly a possibility—or we should expect even more substantial trade restrictions when the unemployment rate eventually begins to rise.

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Below, we present the full Q&A with Goldman’s chief political economist Alec Phillips on what “the Next Shots in the Trade War” will be.

Q: When will tariffs on imports from China be announced and when will they take effect?

A:Tariffs look likely to be announced by Friday, March 23, but the broader Section 301 process is likely to take several weeks longer. As we noted last week, the US Trade Representative (USTR) is likely to release its Section 301 report on China’s practices regarding intellectual property and technology transfer in the near term along with, we believe, a recommendation to impose tariffs on a variety of goods imported from China. Various media reports suggest the announcement will be made Thursday, March 22, or Friday, March 23. This fits with the timing of two other events this week: (1) the testimony of Trump Administration trade officials (USTR Lighthizer testifies in the House Ways and Means Committee on March 21 and in the Senate Finance Committee on March 22, and Commerce Secretary Wilbur Ross testifies in the Ways and Means Committee on March 22) and (2) the House is likely to vote on spending legislation by March 22, which needs to pass Congress by the end of March 23 to avoid a government shutdown. The White House might seek to delay the announcement until the end of the week to avoid some of these events.

We also expect the tariffs to take effect with a greater delay than the recently announced steel and aluminum tariffs, which are scheduled to take effect March 23, roughly two weeks after the President formally approved them. The tariffs appear likely to cover a much wider range of products than the steel and aluminum tariffs announced two weeks ago and therefore could be subject to a public comment period—typically at least 30 days—before they take effect. In addition, we expect that the White House will seek to use the proposed tariffs to enter consultations with Chinese officials over policy changes, which would be difficult to accomplish quickly.

Q: How might these tariffs compare to the recently announced steel and aluminum tariffs?

A:Tariffs on imports from China are likely to be applied at a much higher tariff rate and cover a greater amount of imports. The products initially targeted in the steel and aluminum case totaled around $46 billion in imports in 2017, but only $38 billion once Canada and Mexico are excluded. At tariff rates of 25% and 10% respectively, this would amount to roughly $7 billion in tariffs if imports remained at current levels.

By contrast, we expect tariffs on Chinese-manufactured products to cover a somewhat greater amount of imports (in dollars) and be applied at a much higher rate. Media reports suggest that tariffs could reach $60 billion annually. While there has been some confusion as to whether this applies to the value of goods covered by the tariffs, or to the amount that the tariffs would in theory raise in revenue, the simple answer might be that it applies to both. The USTR might be considering the tariffs under its Section 301 recommendation to be similar to the retaliatory tariffs that other administrations have levied on imports as a result of trade disputes. These are often set at 100% for a specific reason. When a country is trying to offset the economic damage caused by another trading partner’s policies, it is aiming for a specific dollar amount. Rather than estimate the elasticity of demand at lower tariff rates, countries often set the rate at a prohibitively high level, which essentially blocks imports of covered products from covered countries. It seems likely that the tariff rates could be set at high levels— substantially higher than the 10% or 25% on steel and aluminum and potentially approaching 100%—which would effectively block trade in the affected categories. If so, reports of $60bn in tariffs and $60bn in goods covered could very well both be correct. However, we would note that if implemented, the actual tariff revenue collected as a result of the actions would be insignificant since few imports would actually come in under such a high tariff.

Q: What goods are likely to be targeted?

A:We think a focus on consumer products and goods available from multiple sources is likely, but it is unclear what categories will be targeted. In a recent US Daily we outlined a framework that the White House might use to consider where to apply tariffs. This includes targeting categories where most imports go toward final consumption rather than intermediate inputs, where there is a large tariff differential, where there is a bilateral trade deficit, and where supply could be diverted from other countries (including domestically) without substantially impacting consumers. If this were the strategy followed, categories affected could include power tools, household appliances and certain consumer electronics, furniture, apparel, and jewelry, among several other categories.

However, some media reports also suggest that the tariffs could fall heavily on “technology” and “telecommunications” products. This is intuitive, given the large amount of such products that China exports to the US and the importance of intellectual property to those industries. However, we note that the sum of all imports of “technology and telecommunications” related products was nearly $200 billion in 2017, so either the scope of the tariffs would be substantially broader than what media reports suggest, or at most a subset of such products might be targeted.

Q: Will the Section 301 recommendations be limited to tariffs?

A: No, but that looks likely to be the initial focus. We continue to expect restrictions on inbound investment by Chinese companies (and possibly individuals) to be announced as part of the response to the Section 301 report’s findings. In addition, greater visa restrictions for Chinese travelers have also been mentioned as a potential response in some press reports. However, it is unclear whether either of these will be announced in any detail this week along with the tariff announcement. Instead, it is possible that the investment restrictions, for example, could be announced “in concept” this week, with details to be determined later. It is also possible that this week’s announcement could be limited to tariffs with no explicit mention of other restrictions.

Q: Where do the steel and aluminum tariffs stand?

A:The tariffs are set to take effect March 23 but the requests for exclusions will continue. The 25% tariff on steel products and 10% tariff on aluminum products are scheduled to take effect Friday, March 23. At this point Canada and Mexico are explicitly exempt from the tariffs according to the presidential order, while Australia is expected to be exempt from the tariffs but this has not been formally announced yet. The EU and several other countries are seeking exemptions as well though the probability of these being granted looks somewhat low in the near-term, we believe.

A product-specific exemption process is also underway, but is likely to take several weeks—the Department of Commerce has indicted it hopes to rule on exemptions within 90 days—and is likely to be cumbersome, as exemptions are being considered on a company-specific basis. This could prove quite difficult to administer in practice, as US customs officials are unlikely to be able to easily determine which goods are exempt and which are not. This could simply result in at least a temporary delay of steel and aluminum imports more generally as customs officials try to determine the status of each shipment.

Q: How will trading partners respond to the proposed tariffs?

A:They are likely to retaliate, and quickly. In the past, when trading partners responded to a sudden change in trade policy (such as imposition of a tariff or cancellation of a prior agreement), a first response of some sort often came within a matter of days. In 2009, China began an investigation into US chicken parts dumping two days after President Obama imposed tariffs on Chinese tires, and last month China announced an investigation into US sorghum exports two weeks after the Administration announced tariffs on Chinese solar panels and washing machines. We note that in both cases, the US exports that China targeted were worth only a fraction of the imports targeted by the US, but focused on politically sensitive agricultural sectors. Other countries have been quick to retaliate against the US as well; in 2009, Mexico announced retaliatory tariffs a week after the US prohibited funding for a cross-border trucking deal. More recently, the EU announced a list of retaliatory tariffs within days of the Trump Administration’s announcement on steel tariffs, which it looks likely to implement assuming the tariffs go into effect on EU exports.

That said, some trading partners have in some cases waited for the WTO to rule before imposing retaliatory tariffs. These cases were generally drawn out and often spanned several years. These cases often involve an issue that is less clear cut than an increase in tariffs, such as a regulatory or tax dispute. For example, in July 1999, the WTO ruled in favor of the US in a beef-related case, and the US implemented tariffs about two weeks later. After the WTO ruled against the US and allowed Canada and Mexico to impose $1 billion in tariffs in response to the US country of origin labeling (COOL) rules, Congress repealed the offending rules within two weeks to avoid announced retaliation by Canada and Mexico. By contrast, the EU has responded more slowly in some cases; it postponed imposing retaliatory tariffs on the US following two adverse WTO rulings involving the 2002 steel tariffs and a long-standing tax-related dispute in 2002.

Q: What other trade policy risks are on the horizon?

A: There are far fewer additional trade restrictions left in the pipeline than have already been announced. Most significant trade actions require a long administrative process involving multiple stages and often multiple government agencies (USTR, Department of Commerce, the US International Trade Commission, etc). For this reason, one can look at the pipeline of upcoming cases to see what sort of tariffs might be imposed. At the moment, there are a number of antidumping and countervailing duty (AD/CVD) cases under review at the Department of Commerce and International Trade Commission. However, together these cases represent about around $3 billion in imports, and they do not represent a meaningful acceleration in AD/CVD activity as far as we can tell.

NAFTA negotiations are likely to go on hiatus ahead of the Mexican presidential election in July and the US midterm election in November. This leaves little time to reach an agreement before the window effectively closes on reaching an agreement; most observers expect talks to effectively come to a halt after April. From the US perspective, the timing of congressional consideration of a renegotiated NAFTA agreement is relevant; even if an agreement were reached next month, the President would need to wait 90 days (or possibly 180 days depending on the details of the agreement) to sign it under the timeline required by the Trade Promotion Authority (TPA, or “fast track”) process, another 30 days to submit the text to Congress, and then up to 90 days to for congressional consideration. In theory, if an agreement were reached in the near-term, it could be sent to Congress later this year and passed later this year, possibly after the mid-term election in a “lame duck” session of Congress. However, we expect that the more likely scenario is that the negotiations will fail to conclude over the next month and will pause until later this year.

We also note that President Trump has formally requested an extension of TPA to 2021. This extension will take effect automatically unless either chamber of Congress votes by a simple majority to block the extension before July 1, 2018. While this could lead to a debate in Congress over trade policy, it looks unlikely to end the TPA process, which we expect to continue until July 2021.

Q: So does this mean that trade-policy related risks have peaked?

A:We are probably approaching peak trade risk in the near-term, but note that trade tensions could escalate even further over the remainder of President Trump’s term if the economy slows. It is certainly possible that the Trump Administration could retaliate against the retaliatory measures that other countries might soon implement in response to impending tariffs. However, we think the odds are against this and even if it does happen we would expect that the amount of trade affected would be smaller—for example, it seems unlikely that the Administration would impose tariffs on another $60bn in goods in response to any trade restrictions China imposes as a result of the Section 301 tariffs.

However, we note that trade tensions typically respond not to the political cycle but to the economic cycle. For example, in the past AD/CVD and “safeguard” cases have become more frequent when the unemployment rate has risen, but do not vary much by proximity to the next election. With the unemployment rate approaching 4% we would normally expect relatively little action on trade protection. Instead, the actions already taken—the steel and aluminum tariffs as well as the recent safeguard decisions on solar panels and washing machines—represent some of the most substantial trade protections in decades, measured by the amount of imports covered. Tariffs on imports from China would roughly double this amount. Either the Trump Administration is acting differently from prior administrations—clearly a possibility—or we should expect even more substantial trade restrictions when the unemployment rate eventually begins to rise.