By Ellen Zentner, Morgan Stanley chief US economist, originally published in the NYT.
A protracted, escalating cycle of trade tensions has begun.
In the latest action, the United States has proposed a 10 percent tariff on $200 billion in Chinese goods. This follows a tariff on $50 billion of imports from China. Together, the value of targeted goods amounts to nearly half of all American imports from China last year, and countermeasures by China are expected.
Even if all the proposed actions don’t go into effect, prolonged uncertainty alone can have a measurable impact on economic growth, and we should not underestimate the risks.
Most of the Federal Reserve’s policymakers agree that uncertainty and risks from trade policy have “intensified,” according to the minutes of the Fed’s Federal Open Market Committee meeting in June. Most private-sector economists share this view. While I don’t expect today’s conflict to be as severe as the Smoot-Hawley Tariff Act of 1930, which was meant to protect American workers but instead prolonged the Great Depression, it is unlikely that the global economy will escape these trade disputes unscathed.
Estimating the magnitude of the impact can be tricky. Consider this: Just the threat of trade actions, even if there is no follow-through, is enough to dent business sentiment and investment. Most business decisions are based on a five-year horizon. That means you need to be able to predict what you can charge for your product, and what it will cost to make it. Trade disputes provide a murky lens at best, which most likely delays investment.
Nevertheless, the United States is on track for G.D.P. growth of more than 4 percent in the second quarter, according to my estimates. This may lead some folks to conclude that concerns over trade are overblown.
I caution strongly against that conclusion.
First of all, this growth is taking place against the backdrop of corporate tax cuts, which are expected to lift business spending on capital and equipment. If not for the lingering uncertainty over trade, investment in the United States might have been even stronger.
Second, roughly half of the growth we are seeing now is a result of a side effect of trade tensions — "doomsday prepping." Global companies are stockpiling raw materials, intermediate goods and finished goods before tariffs take effect and raise the prices of those goods. Once the bite of tariffs hits demand, companies will no longer need to build inventories, and this boost to economic growth could end. Such a reversal is not likely to sit well with investors as they witness a potentially sharp slowdown in the second half of the year, and that could affect both stock and bond markets.
Economists who believe tariffs will have only a small impact on growth need to cast a wider net. While the most direct effects will likely come from retaliatory measures that dent American exports, those impacts are just a fraction of what should be considered. Economists also need to consider the indirect effects of tariffs on consumer demand. Of the first $50 billion of announced tariffs, less than 2 percent apply to consumer goods. So the spillover effect on consumer demand — tariffs passed on as higher prices to consumers — should be quite small. But consumer goods represent more than 30 percent of the latest round of tariffs, which affect $200 billion in Chinese goods and could go into effect as soon as September.
Not all industries can pass on the cost of tariffs to the consumer. There are a few other options. Companies can pursue cost-sharing with their trade partners to preserve business on both sides. Or they could choose to absorb higher costs and live with smaller profit margins. Of course, investors don’t take kindly to companies facing margin squeezes. Finally, firms can absorb the tariffs and cut costs elsewhere, but labor is the largest line item, which means layoffs or slower hiring.
Changes in how financial markets respond will also amplify the effects of tariffs. We’ve already seen a good deal of volatility in markets every time there is news about escalating trade tensions. Since the start of the year, financial markets have become increasingly sensitive to the risks of further tensions. As the actual direct effects of each round of tariffs become clear, we should not assume that financial markets will continue to absorb the news smoothly.
I believe this is perhaps the single biggest risk to the global economy: At some point, investors will start to question whether global supply chains can withstand the escalating pressures from multiple rounds of tariffs, and financial markets may start to react in unpredictable ways.
The Fed chairman, Jerome Powell, has acknowledged that businesses are increasingly concerned, but the Fed has not built any negative effects from trade into its outlook “just yet.” Perhaps a sharp slowdown in growth in the second half of the year will convince them it’s time.