Companies have forgotten how much the global trade regime matters to daily firm operations. If it did, in fact, collapse, the result would be a disaster. The global trade rules are like air. They have existed for so long that companies and consumers take them for granted. They don’t even notice them any longer. But, like air, if it suddenly went away, firms and consumers would discover to their great dismay that they actually like and need air (or the global trade system) very, very much. Why do firms need the WTO? Start with the obvious issues. Right now, 164 countries are constrained in what they can do with tariffs rates. Up until this past year, WTO members did not just randomly hike tariffs overnight. Keeping tariffs consistent has allowed firms and customers to have stability and reduce risk.
Arbitrary or capricious rule changes are a significant danger for foreign firms looking to diversify out of China into other markets in Asia. It certainly does no good to open a new warehouse or building, only to have a regulatory change that renders it unusable or be saddled with new requirements on staffing that drive costs into the red. Most of the markets in the region that are currently expecting to capitalize on the trade war struggle with at least some—and usually all—of these problems. An honest assessment of market conditions in hopeful “winners” could bring about some necessary changes. There is certainly an opportunity for many markets to capture new gains from trade in areas that have not been “in play” for years. But absent some significant improvements in the ease of doing business in a remarkably short period of time, many of the locations that expect a windfall from relocations are likely to be bitterly disappointed.
This has been an interesting, mixed, two weeks in trade. On the one hand, the system continues to receive new shocks, particularly from US President Donald Trump. On the other hand, trade integration is also moving forward. The net result continues to highlight the increasingly unsettled global environment. Firms need to focus on how to mitigate the risks facing their business operations.
Let’s start with the bad news. Two separate hearings have wrapped up in Washington. The first focused on product categories for an additional $16 billion in 25% tariff rate hikes against goods coming from China. Regular readers may recall that the Americans first produced a list of items totaling $50 billion for new tariff increases. The list was revised on the basis of hearings. The first $34 billion in tariffs have already gone into force (and were met with retaliation by China on a similar amount). But $16 billion in products were contested, resulting in a new list from the USTR. Now that hearings on the revised list of products has been completed, tariffs can be imposed at any time. Expect them to be announced on Friday (since this seems to be the preferred approach of the Trump administration). These new Section 301 tariffs will likely be met with $16 billion in matched retaliatory tariffs by China.
Hence, writes Lighthizer, the need for another $200 billion in products on today’s list. Why? Because China cannot respond in the same measured way to a trade escalation of this magnitude. China does not import $250 billion in goods trade from the United States and cannot match US tariff escalation dollar-for-dollar. Therefore, it seems clear that Lighthizer believes that China will now respond “appropriately” to the original set of American complaints under the Section 301 report and stop counter-retaliating. This line of argument, however, remains deeply flawed for at least four reasons. First, simply because the Chinese cannot retaliate using tariffs to match the US escalation does not mean that the Chinese cannot retaliate. They have myriad tools at their disposal to respond, as we have pointed out in previous Talking Trade posts. These include targeting US services, US companies on the ground in China, US investments and so forth.
Now that tariffs have been imposed, negotiations have not started. Instead, Trump seems determined to continue to escalate. Rather than make movements towards resolving issues, he has now threatened to impose tariffs on every product imported from China—all $500 billion. Since China does not import an equivalent amount of goods from the United States, it cannot simply match tariff rate hikes to tariff rate hikes. It will end up getting creative instead, assuming President Trump follows through on his threats and keeps ratcheting up tariffs on Chinese made goods. China could respond in many ways. It can scrupulously enforce myriad domestic laws against American companies in China that are currently only weakly followed now. It could much more rigorously check for compliance with every regulation, type of paperwork and so forth.