Perspective - Economics
Who will pay as US-China trade wars intensify?
The GDP impact of escalating trade tensions will be more severe on China but US consumers will pay as companies pass on higher costs.
16 May 2019
The latest developments suggest that trade tensions between the US and China will be more protracted than previously expected. The US recently announced it is raising tariffs on $200 billion of imports from China to 25% from 10%, and China has responded by increasing tariffs on $60 billion of imports from the US.
The US had warned Beijing not to respond to the tariff increase whilst threatening to extend tariffs to the remaining $325 billion of imports from China. China’s decision to press ahead suggests that it sees little prospect of a favourable outcome from the talks in the near term.
In terms of the impact on GDP, we would expect both countries will be worse off, with US and Chinese GDP lower by 2020 compared to a baseline of no tariffs. However, the impact will be greater on China given its higher dependence on trade. Japan and Europe will also experience declines in GDP.
Trump may be reluctant to escalate tensions further
Although the prospects do not look good at present, we still believe that President Trump will be reluctant to escalate trade tensions further with a blanket 25% tariff. An extension of tariffs would mean pushing up prices on a wide range of consumer goods which will feed through into inflation. While Trump has said that “China will pay” for the tariffs, the evidence suggests that it is the US consumer who is paying as companies pass on the higher costs.
When tariffs are imposed on Chinese goods, US importers have to pay higher costs which they can either absorb into their margins or pass on to consumers. Consumer price index (CPI) inflation in the US has remained relatively low since the tariffs were imposed. This has given the impression that companies have absorbed the tariffs into their profit margins.
However, this is difficult to prove as the tariffs mainly hit intermediate goods used in production processes and capital goods. Only about 25% are on consumer goods. Although US imports from China have fallen, it has been difficult for US importers to find alternatives in many cases as most of the imports are highly specialised products.
US companies raising prices as tariffs weaken China’s competitiveness
US companies have been complaining about higher costs. For example, the CEO of automaker Ford said that steel tariffs would add an additional $1 billion in costs. This has occurred despite the company buying much of its metal supply from domestic producers.
What seems to have happened is that domestic companies have raised their prices as the tariffs have weakened the competitiveness of Chinese suppliers. The latter have not been cutting their prices. Generally, companies are passing these costs on to the consumer.
If the US were to put tariffs on the remaining $325 billion of imports from China then households would be hit further, especially as consumer goods account for a larger part of this tranche of imports. With presidential elections fast approaching in 2020, Trump will wish to avoid hitting consumers with tariffs.
Consequently we anticipate a deal at the end of the year and a reversal of some of the recent tariff hikes. Inflation will be higher in the near term and growth slightly weaker. The danger is that the trade tension and volatility will be ratcheted up before a deal is agreed, hitting growth and inflation further.
Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.