President Trump’s recent decision to impose tariffs on imports of steel and aluminum was met with Chinese tariffs on U.S. products and agricultural goods. In turn, this has escalated with each country identifying additional barriers to trade. To prevent a damaging trade war, and for our mutual long-term benefit, the United States and China need to negotiate a free trade agreement.

President Trump has singled out China for a number of trade issues he says have hurt U.S. industry, including the U.S.-China trade deficit, piracy of intellectual property, and what he has identified as pressure placed on U.S. firms to share technology for access to the Middle Kingdom’s growing market.

While the President has much support on these fronts, the trade deficit, for example, is often misunderstood since it is not simply a function of exports and imports. Trade deficits reflect a combination of factors, including savings rates and investment flows. And because there is little correlation between high tariffs and deficits, raising tariff levels is a poor remedy.

For example, Germany, Switzerland and Singapore have low tariffs, yet they consistently run trade surpluses. On the other hand, Brazil and India both are considered highly protectionist, yet both countries persistently run trade deficits.

Without confidence in the direction of trade policy, companies often delay purchases. And that’s what many businesses are doing now.

Furthermore, an understanding of value-added is essential to understanding the reality of what appears to be a trade deficit.

For example, not long ago Apple’s 4G iPhone was assembled in China at a cost of approximately $180. The microchips were made in the United States, the hard drive and display in Japan, and the memory in Korea. China’s value-added, which involved labor and no components, amounted to $7.10 per unit or just less than 4 percent of the import cost, according to research conducted by the University of California Irving. Nevertheless, the entire import price of $180, not $7.10, was added to the U.S.-China trade deficit every time an iPhone 4 was shipped to the United States.

A study conducted by the U.S. International Trade Commission over a decade ago estimated that Chinese value-added on its exports amounted to an average of 50 percent of the total value. Although it certainly is much higher today, the real value-added portion should be calculated when determining a trade deficit. If not, the figures will continue to be distorted.

A U.S.-China free trade agreement that incorporates the many complexities of trade and investment, as well as updates its data-collecting infrastructure, would go a long way to ensuring a stable, predictable and mutually beneficial trading relationship. Without confidence in the direction of trade policy, companies often delay purchases. And that’s what many businesses are doing now — holding off on international business decisions until they have a better understanding of what’s next.

In The Spotlight

“Since no investor wants to take unnecessary risks, businesses and investors generally thrive in a stable trading environment because it fosters certainty. When a proposed tariff is introduced, it makes companies less likely to invest until trade stability is restored. This can ultimately slow the growth of corporations and put a drag on the economy,” says Jim Trubits, Vice President of Mohawk Global Trade Advisors based in Syracuse, New York.

In addition to policies that encourage a wait-and-see attitude, new tariffs can turn a profit into a loss. “In order to reduce costs and remain domestically and globally competitive, years ago many American firms began co-producing their components and products in China. The President’s proposed 25 percent duty on many of these co-produced goods will make them less competitive — or worse,” Trubits says.

“A free trade agreement is a very specific agenda. While a good thing, I'm not sure the Trump administration would go for. But any platform to discuss a mutually preferential agreement with less costly terms and a degree of stability would be a good start,” said Benjamin Leffel, China expert, PhD student, and former teaching assistant “counterweight” to Peter Navarro, the Director of the White House National Trade Council.

“I don’t believe Peter Navarro ever fully appreciated what trade dialogues can achieve,” said Leffel. “I believe his worldview supports the use of protectionist policy as a tool, and I also believe he minimizes the global economic shocks that can potentially result from such policy,” he continued. Like President Trump, Navarro may believe that trade wars are winnable.

Technological advances in telecommunications, transportation and finance have led to the integration of national markets through international trade and foreign investment. This process, known as globalization, has lifted millions of people out of poverty and significantly boosted American and global standards of living. In fact, it may have benefited the United States and China more so than other countries.

Turing our backs on this engine of growth, instead of updating and enforcing global rules of engagement, could be a tremendous mistake. History tells us that resorting to protectionism by raising barriers to trade and investment is not a viable solution.

On June 17, 1930, American President Herbert Hoover signed the Smoot-Hawley Act that raised U.S. tariffs nearly 60 percent. Within two years following the act’s implementation, U.S. exports decreased by nearly two-thirds.

In anticipation of Smoot-Hawley’s passage, France, Italy, India and Australia passed their own protectionist legislation. Others, such as Spain, Switzerland and Canada, followed suit. The result: export markets dried up, domestic industries slowed down, and the unemployment rate in the United States rose to 25 percent in 1933.

A trade war has no victors — only losers.


John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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