Executive Summary
Over the last two years, the United States has carried out one of the most massive swings in foreign economic policy since the trade wars of the 1930s, abandoning the multilateralism forged after World War II and adopting a new strategy of going it alone. The implications for U.S. and global economic growth are enormous, and the consequences for U.S. firms’ ability to access foreign markets are sweeping. Regardless of whether the shift toward unilateralism is short-lived, its macroeconomic effects are likely to be long-lasting. First, trade policy uncertainty has risen in a way that may not be easily or quickly reversed. This has already had a substantial impact on growth due to the depressing effect on firm activity, and it is likely to continue. Second, the tilt toward unilateral protectionism is likely to reduce U.S. firms’ ability to access many foreign markets for a long time to come.
Since January 2018, the United States has carried out one of the most massive swings in foreign economic policy since the trade wars of the 1930s, abandoning the multilateralism forged after World War II and adopting a new strategy of going it alone. The implications for U.S. and global economic growth are enormous, and the consequences for U.S. firms’ ability to access foreign markets are sweeping.
The defining characteristic of this shift has been uncertainty. The U.S. has:
- Unilaterally raised tariffs on hundreds of billions of dollars’ worth of imported goods, on many by as much as 30 percent.
- Further threatened to increase tariffs on billions of dollars more goods from places as diverse as the European Union, Guatemala, Japan, Mexico, Turkey, and Vietnam, sometimes for reasons unrelated to trade relations.
- Withdrawn from the 12-nation Trans-Pacific Partnership (TPP) pact, which it previously led.
- Threatened to withdraw from trade agreements even with close allies.
- Gutted the arbitration body that helps enforce member obligations under the World Trade Organization (WTO), which may soon throw more than 70 years of global goods market integration into a tailspin.
- Concluded a contentious set of negotiations to close the United States-Mexico-Canada (USMCA) trade agreement this month, but added to its foundational provisions a 16-year sunset clause when it will expire unless renewed, with reviews stipulated every six years.
What are the macroeconomic effects of these shifts in trade policy? In some ways, it can be hard to see the extent. After all, the U.S. average effective tariff (the “AVE”) is still only 2.7 percent based on recent Census data (using year-to-date through August to compute the ratio of duties collected to overall imports for 2019). While tariffs produce large costs for buyers, they are to some degree offset by increased tariff revenue for government coffers and profits for protected industries. The overall loss to U.S. gross domestic product (GDP) from tariffs in 2018 and the first half of 2019, estimated using standard workhorse models, without accounting for complexities like uncertainty, amounts to a few tenths of one percent – which may sound small, but can represent an average cost of hundreds of dollars per year for a U.S. household.
Yet while the average effective tariff seems low, it is nearly double its level in 2017. In fact, the AVE has reached a level not seen for 25 years and conceals enormous variation across goods. The average U.S. tariff on imports from China, the source of almost one-fifth of U.S. imports, now surpasses 20%, including on many inputs into production. It is still an open question as to how much of the tariffs are passed on to the final prices retail consumers pay, but studies show that virtually the full cost of the tariffs so far has been reflected in increased prices paid by importers on the goods as they cross the border.
One study estimates that tariffs imposed in 2018 alone generated an increase in how much firms in the U.S. pay for raw materials (what’s called the Producer Price Index) by 1%. That is equivalent to about 6 months of inflation in a typical year. Part of the rise is because when U.S. firms are protected from foreign competitors by the tariffs, they raise their prices when selling to other U.S. firms. So the low average tariff rate conceals many large distortions affecting the sourcing and cost of goods that are widespread and difficult to measure, affecting both households purchasing imported final goods and firms importing machines, materials, and other inputs.
Perhaps most crucial for firms is the fact that this new unilateral path of U.S. trade policy going forward is extremely uncertain. The chart below shows one measure of trade policy uncertainty compiled by a team from Northwestern University Kellogg School of Business, Stanford Graduate School of Management, and University of Chicago Booth School of Business. Trade policy uncertainty peaked this past August, hitting a point about twice as high as any other reading in the 34 years for which data exist.
Recent studies show that this trade policy uncertainty may have effects on the economy at least as large as the costs arising from the tariffs themselves. Independent research from the Federal Reserve Board of Governors estimates that tariffs imposed in 2018 and the first half of 2019 will result in U.S. real GDP being 1 percentage point smaller in 2020 than it would have been without the new tariffs and trade policy uncertainty. That’s equivalent to a loss of about $1700 per U.S. household on average. This is driven by dampened industrial production, as firms cut back on investment in the face of increased risk stemming from heightened uncertainty.
Some observers argue that the recent weakening of the Chinese RMB against the U.S. dollar offsets the costs of the tariffs, but this is misleading. Strengthening of the dollar against the Chinese RMB or other currencies may mitigate the direct costs of tariffs, while still exposing firms to significant challenges. The recent dollar strengthening against the RMB does not make up for the loss that results from distorting buying and sourcing decisions (if tariffs increase the prices of certain goods we want, this can lead us to buy other less-preferred goods that are not targeted by tariffs). Strengthening of the dollar presents an additional challenge to U.S. firms that export, as their domestic costs go up relative to rivals in foreign markets. Currency adjustments also do not eliminate the uncertainty about the future path of trade policy that is weighing on firms’ willingness to invest.
Increased uncertainty in trade policy from unilateral protectionist actions is not just a U.S. phenomenon. According to the Global Trade Alert, state interventions to impede imports increased fairly steadily across the globe over the last 10 years, and far outpaced liberalizing actions. The data suggest these protectionist efforts have accelerated since 2017. The same Federal Reserve Board study mentioned above also found that the increase in trade policy uncertainty from just the first half of 2018 led to a 0.8 percentage point drop in global GDP — about $700 billion — one year later, compared to what it would have been without the increased uncertainty, again through a drop in industrial production and associated investment. The International Monetary Fund has also forecasted global GDP being 0.8% lower in 2020 than it would be otherwise, due to tariffs and uncertainty stemming from the U.S.-China trade war weakening business confidence and dampening productivity.
Regardless of whether the shift toward unilateralism in U.S. trade policy is short-lived, its macroeconomic effects are likely to be long-lasting. First, trade policy uncertainty has risen in a way that may not be easily or quickly reversed. This has already had a substantial impact on growth due to the depressing effect on firm activity, and it is likely to continue.
Second, the U.S. tilt toward unilateral protectionism is likely to reduce U.S. firms’ ability to access many foreign markets for a long time to come. As the United States has been withdrawing from, renegotiating, and scaling down trade agreements, other countries have been busy forging them without us. While other countries’ tariffs toward the U.S. have largely stayed the same or even increased due to retaliation, tariffs between many of our trading partners have been coming down.
The other 11 countries in the TPP decided to move forward with the agreement; seven (Australia, Canada, Japan, Mexico, New Zealand, Singapore, and Vietnam) already have put it into force. Since 2016, the European Union has launched or put into force agreements with six large economies in the Asia-Pacific Rim region (Australia, Canada, Indonesia, Japan, New Zealand, and Vietnam), five of them TPP members. China is racing to finalize the Regional Comprehensive Economic Partnership (RCEP) with 15 countries in the region, including seven TPP members. It will be signed as early as February, forming the world’s largest free trade area. All of this preferential access for foreign rivals puts U.S. firms and farms at a disadvantage when exporting to these markets, as higher trade barriers can limit or diminish their market share.
The new U.S. strategy of one-on-one trade negotiations has, at best, met with uneven success. The bilateral “skinny deal” with Japan, which the U.S. signed in October, falls short of export access offered under TPP for some goods, like U.S. dairy and automotive exports, and leaves out other goods, like aircraft. This occurs as China and 13 other countries will soon gain preferential access to the Japanese market under RCEP. The skinny deal may also may violate WTO rules governing preferential trade agreements. And while the threat of auto tariffs may have gotten Japan to engage in these bilateral negotiations, this strategy has not been effective with the EU, where talks to advance the Trans-Atlantic Trade and Investment Pact with the United States effectively collapsed this year.
Looking forward, the prospect of further trade frictions looms large, so uncertainty will continue to eat away at investment and economic growth. The U.S. trade agreement with China this month appears to promise a rollback of some of the new tariffs and restrictions, but the outcome even for this remains uncertain, since again it is a “skinny deal” and also may involve scheduled purchases of specific goods, leaving it vulnerable to challenges at the WTO. In addition, the trade war has disrupted ties central to sustaining progress in ongoing talks between the U.S. and China’s governments on economic and security issues.
Any agreement is unlikely to eliminate the uncertainty introduced by breaking from earlier U.S. commitments under the WTO during the spat. Furthermore, a ruling from the WTO on the second half of the decades-long Boeing-Airbus dispute presents another danger to U.S. economic relations with Europe if the U.S. uses it as an opportunity to levy new tariffs against imports from the EU. Yet, more tariffs on more countries may be the general direction we are headed: A sweeping interagency report released by the Department of Defense in fall 2018 ostensibly lays a foundation to impose tariffs on large swaths of intermediate goods that so far have escaped direct hits from the trade war. The more recent threat from the U.S. to eliminate exemptions from steel and aluminum tariffs for Argentina and Brazil is another example.
Overall, if we take stock of this shift to unilateralism in U.S. foreign economic policy, the benefits are still uncertain and the fallout is already breathtaking in scope. The complete path and consequences remain to be seen, but have the potential to last for decades.