Is the focus on tariffs on goods missing the point? Part one

One of the significant risks to global growth this year just got bigger. Last week, the US increased tariffs by 25% on $325bn worth of Chinese goods. But, in reality, it’s a tax on US consumers who have to pay it to the US government, and will therefore slow economic growth in the US. By raising the end price of the goods by the tax rise, the effect is to lower households’ purchasing power and so crimp their ability to buy other goods and services.

The paradox of tariffs

Moreover, it also impacts directly on US firms – and those in other countries – by lowering demand for the goods they make in China which are then shipped to the US. To be clear, these firms manufacture or produce their goods in China because it is more cost efficient (supply chain productivity) for their US customers for them to do so. Thus, it is simply not the case that Chinese owned firms alone make goods shipped to the US from China.

For instance, Walmart, the biggest US retailer, makes some of its goods in China as it is cheaper for them to do so. But the reason they do so is that they can sell these goods more cheaply to US consumers than if they had made them in the US. This results in more income left over for US consumers to spend on other goods, including those made in the US – also sold by Walmart and other US firms.

A brake on global economic growth

The imposition of these tariffs (or taxes) means that the US and China will see slower economic growth. Moreover, since they are the two biggest economies in the world and the largest importers, overall global growth will slow purely as a result of its direct impact on them. A second-round effect, however, is that other countries will sell less to both the US and China and their growth rates, in turn, will be slower as well, compounding the negative impact of the tariffs on global activity. Slower growth in global trade reduces the rate of technology transfer and productivity gains by also lowering the pace of innovation.

Whilst the tariffs may divert some purchases which would have come from China to other countries, it would not reduce the overall US trade deficit as those same goods would simply come from another country where the tariff was lower. Moreover, research shows that trade balances are not determined by tariffs but economic factors, such as productivity, investment flows etc.

In other words, all of the nuance and subtlety is lost in the debate over the bilateral trade balance as an indicator of economic prowess, as seen by the current US administration. The economic impact of increasing protectionism is to exacerbate the slowdown underway in global trade, particularly goods trade.

Read part 2 next week.