Global Trends by Martin Khor

Monday 24 September 2018

Escalating trade war threatening the world trading system

Both the United States and China will today raise tariffs against more of each other’s imports, in an escalating trade war that dims global economic prospects and threatens the world trading system.                                                                                                                                               


Today marks another milestone in the escalating global trade war that threatens to shake the foundations of the world trading system and cause economic uncertainty at a time of financial fragility.  It’s an altogether bad development that adds more gloom to global economic prospects.

Last week, the United States announced it was going ahead with slapping an additional 10 percent tariff on US$200 bil worth of imports from China. Hours later, China said it would put 5 to 10 per cent extra tariffs on US$60 bil of imports from the US in retaliation.

Both sets of tariff increases will come into effect on 24 September.  But that’s not all.  The US also said it would raise the extra tariffs on the US$200 bil of imports from 10 per cent now to 25 per cent at the end of the year.  And if China retaliates (which it now has), the US might slap higher tariffs on yet another US$267 bil of Chinese imports.  

This comes on top of tariffs on an initial US$50 bil worth of imports that the US had placed on Chinese imports a few months ago, and equivalent tariffs on US$50 bil on US imports that China imposed as retaliation.

And even before that the US had put extra tariffs on steel and aluminium imports from all countries, except a few that were exempted for the time being.  The US is also threatening to put tariffs on imported auto vehicles and parts including from Europe.  That is on hold because of a bilateral deal reached, but could be re-ignited if President Trump is not satisfied with European behaviour.

The US itself is experiencing negative effects of this trade war. The prices of the initial US$50 bil of imported Chinese products have started to go up in the US, raising costs for both consumers and producers.   The Chinese are similarly affected.   Exports of both countries are also bound to decline, and this will eventually affect their overall economic growth.

There will be collateral effects on other countries.  In Asia, those that are integrated in the global supply chain will find less demand for their exports of components to China. The effect on Malaysia is projected by analysts to be around 0.4 to 0.7 percentage point of GNP in 2019.

This could be offset by positive effects.  Some companies producing in China are considering relocating to other countries, including Malaysia, to escape the US’ punitive tariffs.  And some Malaysian products may become cheaper than Chinese products which will now have extra duties.    But it is likely that the bad effects will outweigh any such good effects, at least in the short run.

It is clear that the US is to blame for the trade war.  Its unilateral actions are against the spirit and rules of the trading system, and have in fact undermined its legitimacy and viability.

The steel and aluminium tariffs were imposed under the US security clause of its domestic trade law, while the other tariff increases are under Section 301 of the trade law.   The US actions are against various WTO rules.    

Challenges to the US unilateral measures have been taken by China and other countries at the WTO.   If the US is found in violation, which is quite likely, it has to stop its actions or face retaliation:  the countries that win the cases heard by WTO panels of experts are allowed to impose equivalent tariffs on US products.

However, the US has engineered a crisis in the WTO’s dispute settlement system so that soon the outcome of successful cases against it cannot be implemented.

This is because the US is now paralysing the WTO’s Appellate Body by refusing to allow new appellate body members to be appointed to replace those retiring.  Soon there will be only three members left, out of a full body of seven, and two more will be retiring in January 2019.  A minimum of three members is needed to sit on a case.

Thus if a lower-level panel rules against the US’ unilateral actions, and the US lodges an appeal which cannot be heard because there are insufficient appellate body members, the panel decision cannot be enforced.

This would make the WTO a quite toothless organisation.  There would be no legal remedy to enforce penalties for breaking the WTO laws.  Countries that impose unilateral tariff increases can get away with it.  In turn, other countries would also do the same. 

The rules-based trade system is already starting to break down. We are now seeing blatant protectionism by the US and retaliation by affected countries.  Within months the trade war could spread, with the law of the jungle becoming more prominent.

There are some rules over which tears will not be shed in the developing countries if they cannot be upheld anymore, such as the WTO’s TRIPS agreement on intellectual property.  The free trade economist Jagdish Bhagwati has said the TRIPS treaty does not belong to the WTO.

But what all members like about the WTO is its role in ensuring the predictability that their exports can sell in the markets of its members, with tariffs at rates agreed to at the WTO.

If that predictability is lost, then there can be a lot of uncertainty, as one country after another can unilaterally impose extra tariffs on other countries, which may then trigger retaliation.

This breakdown of the trading system may be the more serious effect of what started as a US-initiated trade war.   US President Donald Trump may not care what happens to the system, as he has said many times that the WTO is a terrible organisation which the US should leave.  And his recent actions in fact seem calculated to undermine, if not destroy it.

It is a new world we are looking at, in a scenario that would not have appeared possible a year or even months ago.

Policy makers, companies, analysts and the public should ponder about this, even as they follow the details of the tit-for-tat trade war between the US versus China and other countries.