Will Trump tariffs threaten my wealth?

With the arrival of President Trump for a second term we should expect more headlines about a possible trade war.

We introduced a theme of movement away from free trade and globalisation in world economies and markets into our assessments during President Trump’s first term. He turned his tariff firepower onto China and altered US policy towards trade with the world’s second largest economy.

In office, the Democrats continued with much the same stance, increasing the bans on technology trade and adding a 100% tariff against Chinese battery cars. On his return to office, Mr Trump is proposing general tariffs against the rest of the world – with even higher tariffs against China.

Meanwhile, the European Union (EU) and the UK are working on a so-called carbon border adjustment mechanism, a levy or tariff on imported goods that depend on substantial fossil-fuel inputs. Wars in the Middle East and Eastern Europe have also led to various trade bans and restrictions.

The move to freer trade

Tariffs and other limitations on trade were more widely used in the inter-war years of the last century. They got a bad press attracting some of the blame for the Great Depression following the Wall Street crash of 1929. In 1948, countries came together to establish rounds of talks to reduce tariffs on trade. Successive rounds succeeded in getting many countries to agree to reduce tariffs, though agriculture was always difficult.

In 1995, the system was further formalised through the establishment of the World Trade Organisation (WTO), where many countries agreed to accept rules limiting tariffs and restrictions on trade. Members offered each other “most-favoured nation” (MFN) terms with low tariffs. If they lowered a tariff for one member, they usually needed to lower it for all.

China’s accession to the WTO in 2001 was allowed on asymmetric terms, leaving China as a developing economy free to keep some restrictions on trade whilst benefitting from freer access to advanced country markets. It was when the US decided China was exploiting this membership that both US political parties adopted more tariffs and bans on Chinese products.

What is a tariff?

A tariff is a levy imposed on traded goods. It may be an ad valorem levy on imports where the exporter must pay a stated percentage of the value of the goods as an extra tax. It may be a fixed fee per unit of traded product. There can be export tariffs where a country wishes to restrict export of home production they think is needed at home, but this is now rare amongst advanced countries.

Some countries wish to impose tariffs to raise revenue for the government. President-elect Trump is keen on the idea of collecting revenue from tariffs to help him cut taxes on income and profits. In 2019, his additional tariffs helped lift customs revenue to $72bn from this source, compared to $42bn in the prior year. Under President Biden it has risen further to almost $100bn this year. Mr Trump speculates on how much scope extra tariff revenue would give him to cut taxes.

Some wish to protect domestic industry. Quite often, advanced countries produce more expensive goods owing to higher labour costs and more regulation. They may wish to offset this by requiring a tariff levy on possible imports. The EU’s planned carbon adjustment is designed to compensate for dearer energy in the EU, with higher taxes on imports. Some tariffs or other trade restrictions seek to address poor labour practices and low wages in some exporting countries.

Some tariffs are designed to shock the exporting country with a view to forcing policy change by them. Tariffs and sanctions may be applied to countries that disrupt world peace, steal intellectual property, disrupt lawful trade and behave badly towards their own populations.

Other free trade distortions

Countries have a wide range of policy options if they wish to influence what is produced, how it is produced and how much it costs – both at home and abroad.

If domestic production is uncompetitive with foreign exports, the state can subsidise home output. It can offer favourable tax incentives, grants, soft loans and preferential buying to support home output. It can make it more difficult for foreign exporters by designing product and sales regulations that require more cost or expensive changes to overcome. It can impose safety or labour condition requirements that effectively ban some foreign products.

A country can nationalise a business area giving it more privileged access to state purchasing, and access to cheap capital and underwriting for any losses incurred. Nationalisation does sometimes also include confiscating or buying on favourable terms foreign company investments in the country concerned. Countries that do this may then find retaliatory actions limiting their access to international banking and to some transactions as well as many pulling out of future investment in that country.

How high are current tariffs?

The WTO publishes its assessment of average tariff levels as well as setting out by category what tariffs are permitted. Their assessment says the trade-weighted average MFN tariff by country:

These average tariffs are low by historical standards and reflect the long drive from 1948 to 2016 to get tariffs down and invite more countries into the WTO system. There are, within these averages, penal tariffs as recently imposed on Chinese battery cars by the US and EU.

What impact will higher tariffs have?

When a country imposes a tariff on another’s exports it hopes the exporter will put their prices up and will pay the tariff bill on the imports that survive the price shock. It usually hopes people will buy more domestic product. There will be an increase in the price level, an increase in government revenues, and some stimulus to domestic production.

The exporting country may decide it does not wish to lose so much volume, so it may absorb some, or all, of the tariff payment by depressing its profit margins or cutting costs whilst keeping its prices down. This changes the impact. The price pressure is eliminated or abated, there is less or no stimulus to domestic production, but the tariff imposer still gets the boost to revenue

The relative balance of these outturns depends on how much excess capacity there is worldwide for the items being hit by tariffs and on the politics surrounding the sector in each affected country.

What will President Trump do?

Some of his tariff threats, as with Mexico and Canada, are designed to get a change in their policies towards border security. He may do a deal. His specific high tariff threats to China are likely to result in some higher tariffs and other trade friction, but again he might abate the initial proposal. He may wish to impose a lower general tariff to collect some more revenue but will face arguments that there is no easy basis to justify this under WTO rules. There could be resistance in Congress to his use of powers under US trade and emergencies legislation if he stretches it too far.

As a result, it is likely there will be some tariff rises but less than some of his statements imply. They will hit some exporting country margins and volumes, add to US price pressures and provide some further stimulus to domestic production. Onshoring more manufacture will continue to be more strongly driven by subsidy, US purchasing rules and the relative health of the US economy. Although the ultimate impact is uncertain, the impact of tariffs on market valuations should not be significant in the West.