Quick summary

Among the many macroeconomic issues blowing across the economic landscape, the gusts of protectionism have been especially notable. Reconfiguring the U.S. trading relationship with the world was a key plank in President Trump’s campaign platform several years ago. He has since held true to that pledge.

This Economic Compass lays out the full story of protectionism, beginning with the era of globalization that it has helped to quash. It probes why public and political attitudes have tilted away from free trade. It also explores how protectionism works, how protectionism interferes with economic growth, and the likely trajectory for trade and tariffs from here.

This summary captures selected highlights from the full report.

Before protectionism: the era of globalization

Over the past 50 years, world trade massively outpaced global economic growth. It has exploded from just 11% of GDP in the 1960s to almost one-third today. This shift embodied the essence of globalization: the ever-deeper integration of nations into a single global market. Within this unified marketplace, goods, services, money and people could cross national borders nearly as easily as they circulated within them.

However, this trend has lately reversed. Protectionism is now emerging as a dominant force on the global economic stage – driven in large part by the actions and policies of the United States.

Trade growth has receded from its pre-crisis peak

Note: As of 2018. World trade measured on exports of goods and services. Source: World Bank, Haver Analytics, RBC GAM.

The rise of protectionism in the USA

Under President Trump, protectionism in the U.S. has largely targeted Mexico, China, Germany and Japan. These are the countries with the largest trade surpluses with the U.S. In fact, China is responsible for a startling 61% of the U.S. trade deficit, making it more relevant than all of the other countries combined. This is why China has been and will likely remain the main focus of U.S. trade actions.

The other three countries lag well behind:

• Mexico captures 12% of the U.S. trade deficit
• Germany represents a similar 12%
• Japan is responsible for 10%.

Interestingly, Canada did not make the list since it does not contribute to the U.S. trade deficit. But Canada has been snared in the U.S. trade web deficit largely due to its membership in the same trade accord as Mexico: NAFTA.

U.S. trade deficit with China tops the list

Source: Census Bureau, Haver Analytics, RBC GAM

How tariffs do economic damage

Both positive and negative things happen when a country puts tariffs on foreign imports. A tariff is essentially a tax applied to foreigners, and so at least initially a tariff increases government revenue without impoverishing domestic households or companies. Also, domestic companies capture a larger share of production with foreigners squeezed out. For the same reason they can also charge a higher price on the products they sell.

However, this glimmer of good is easily outweighed by the bad. The main negative is that products become more expensive to buy. Why? It’s a two-part answer:

• Prices of foreign products rise to cover the cost of the tariff they pay.
• Domestic producers often charge higher prices as well because of less competition. And, if producers ramp up production for a new product to fill a gap in the market, they must cover those costs.

Other economic detriments associated with protectionism include:

• Less selection, with fewer products coming from abroad.
• Less specialization, as domestic firms work to fill the product void left by foreign companies. Domestic firms are less able to specialize in what they are truly good at – which in turn hurts productivity.
• Stronger currency for the tariff issuer, since the exchange rate reflects the perceived competitive advantage of one country over another.
• Damage to global supply chains as tariffs impact trading partners across borders.

Can we actually see any damage being done today? The answer is “yes.”

• The rate of global trade growth is slowing. Tariffs are like sand in the gears of trade.
• The cost of items subject to tariffs have gone up by far more than have other goods. For example, the cost of washers and dryers in the U.S. has increased by 9.2% since the end of 2017, compared to a 0.2% drop in the price of consumer goods overall. The costs of steel and aluminum have also risen much faster than normal.
• The U.S. manufacturing leading indicator has fallen more aggressively than have other sectors. Manufacturing is a sector highly oriented toward trade.

U.S. manufacturing and non-manufacturing diverge recently

Note: As of Jun 2019. Source: ISM, Haver Analytics, RBC GAM

Trade war fallout: U.S. and China

In brief, China’s economy is likely to suffer more from the ongoing trade dispute than the U.S., despite the presumption of roughly proportionate tariffs. The most likely estimates place the economic damage in the range of:

• 3% to 0.6% of GDP for the U.S.
• 4% to 0.8% GDP for the China.

Why is China more vulnerable?

• China sells more to the U.S. than the U.S. sells to China.
• The restriction of technological exports would hurt China more than the U.S.
• The U.S. continues to wield much more control over the global financial system than does China.

As discussed in the full report, the GDP impact estimates are not likely enough by themselves to drive the U.S. or China into recession. It should be further noted that the damage is spread over a multi-year period rather than all accruing right away.

U.S. versus China: China more vulnerable

Source: RBC GAM

Looking ahead

Recessions rarely happen from protectionism alone. They usually require a confluence of factors. This perfect storm could yet occur given simultaneous worries about the business cycle and geopolitical tensions with Iran. But it is not pre-ordained.

Trade winds and trade wars can change track over time. The bulk of the tariffs and trade barriers are unlikely to remain forever. Those in place will likely last for several quarters or even years – but not necessarily longer than that. The U.S. views most of these actions as a pressure tactic to achieve other trade goals:

• Securing the updated NAFTA accord
• Negotiating new trade deals with Europe and Japan
• Refashioning its relationship with China.

Most countries are bending to U.S. demands, however reluctantly. The “x factor” is China. An economic superpower in its own right, China is being asked to change the very foundation of its economic model. It is less certain to bend than other nations, leaving the possibility of some tariffs lasting longer.

With the ascent of China, the world is shifting once again to a more multi-polar era. The ultimate question, perhaps, is whether or not China will eventually outrun the U.S. altogether. Much depends on how quickly Chinese productivity growth can continue to converge upon U.S. levels.

But from a purely demographic perspective, the answer is “probably not”: the Chinese outlook actually looks rather challenging. The net result leaves China well ahead from a population perspective, but with a substantially reduced advantage relative to today.

Source: RBC GAM

For the future, it appears the friction between the U.S. and China will continue for many years, if not decades, to come. But no matter how the contest between these super-powers plays out, two things are likely: 

1. The multi-polar era will persist for a long time.
2. The U.S. could enjoy something of a second wind as the coming century unfolds.

For a more comprehensive economic analysis, read the full Economic Compass now.