Macro Weekly – Putting protectionism into perspective

by: Han de Jong

  • US implements tariffs on steel and aluminium…
  • …but grants exemptions to some countries
  • Kim and Trump will meet
  • Draghi has found his mojo again
  • US labour market back to Goldilocks
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US president Trump has implemented tariffs on steel and aluminium imports as he had indicated a week earlier. Contrary to previous communication, he did allow for exemptions: for Canada and Mexico (members of Nafta) and Australia due to the special relationship between the two countries. Other countries can, apparently, also apply for exemptions. Several trade partners, including the EU and China, have warned that they will retaliate should the tariffs actually apply in two weeks’ time. Talk of a trade war has started.

A generally accepted quantifiable definition of a trade war does not exist. We therefore would speak of a trade war if a country takes protectionist measures, other countries retaliate and the first country retaliates back again, setting off a chain reaction. In addition, the number of goods covered by the tariffs should make up a significant percentage of the trade flows.

Most economists warn against a trade war as conventional economic theory says that protectionism reduces the international division of labour and in doing so, reduces total economic output and pushes up prices. There are several points I would like to make about this.

Smoot-Hawley a different proposition altogether

A key question is whether the unilateral US actions will lead to a trade war and what the effects will be. Commentators regularly refer to the Smoot-Hawley legislation of 1930 which raised US import tariffs. While few economists would argue that protectionism caused the depression, most would agree that it did not help and that it either deepened or lengthened (or both) the depression.

There are, however, huge differences between the 1930s and now. First, the Smoot-Hawley legislation applied to over 20,000 goods while US tariffs are now planned for a considerably smaller sample of goods. The result is that the average tariff of all traded goods barely changes. In 1930 the average tariff on goods which were subject to tariffs increased from ca 40% to some 60%. As many goods were exempted, the average tariff of all imports rose from 13.5% in 1929 to 19.8%. The average tariff on all imported goods has fallen significantly since and, apparently, now stands at 2-3%. Tariffs on washing machines, solar panels, steel and aluminium are not going to push that number up by much.

Another big difference between then and now is that the economy was already in decline when the Smoot-Hawley legislation was enacted while the economy is currently growing robustly.

My conclusion is that unless the tit-for-tat of trade measures escalates strongly, this will not quickly develop into a situation where we are required to make significant changes to our global growth forecasts.

My hero, Alexander Hamilton

Perhaps I can make one more point about trade policies. Protectionism’s reputation is probably worse than is deserved. Let’s not forget that the US economy was built on a platform of protectionism in the late 18th and early 19th century. The first US Finance minister, Alexander Hamilton, created the political basis for it in the Federalist Papers. In the 20th century, several Asian economies developed spectacularly, working from a protectionist base. There can be no doubt that protectionism can be helpful to a country and there are circumstances under which protectionism is helpful and justifiable. I doubt, however, that these circumstances currently apply.

Kim and Trump

President Trump is a busy man. Apart from implementing tariffs on imports, he has also ordered a meeting to be setup for himself and North Korean leader Kim Jong-un. It would seem that this is what Kim wanted: to be taken seriously. Now that he has nuclear weapons and he can most likely reach American soil with them, he finally is. A meeting between the two leaders must be considered a plus to all sides.

Draghi succeeds

ECB president Draghi succeeded last Thursday in delivering a message that surprised on the hawkish side without upsetting financial markets. The ECB decided (unanimously) to drop a sentence they had used since 2016, asserting they could increase their asset purchases if conditions would warrant that. This is a tiny step in the direction of policy normalisation. And even though the sentence has been dropped, everybody understands that it could come back, should circumstances deteriorate.

Mr Draghi has a somewhat mixed record when it comes to delivering messages. Earlier this year we had expected him to try and talk down the euro, but following his press conference the euro strengthened.

More important is that while we were surprised by the ECB dropping their easing bias at this point in time, we understand the thinking. The economy is doing well and deflation risks appear to be remote. It does not change our view that rate hikes are still quite far away.

US macro data: Goldilocks on the labour market in February

The US February labour market report provided encouraging news. Payrolls increased by 313,000, the highest monthly increase since July 2016. Revisions to previous months added another 54,000 jobs. The unemployment rate nevertheless stayed at 4.1% as labour force participation increased from 62.7% to 63.0%. Inflation fears eased somewhat. The increase in average hourly earnings had spooked markets a month ago when the pace of increase was reported to have accelerated from the originally reported 2.5% in December (revised to 2.7%) to 2.9% in January. The February data showed that the rise of average hourly fell back last month to 2.6%.

China’s exports explode in February; that is odd

Recent trading days were quite light on economic data. China’s trade data for February was, undoubtedly the most spectacular. Import growth (in USD) decelerated sharply in February (6.3% yoy), down from 36.8% in January. The data is distorted due to the timing of Chinese New Year and the deceleration in February surprised nobody. Much to everybody’s surprise, Chinese export growth accelerated sharply in February, contrary to what one would expect: +44.5% yoy, versus 11.2% in January.

This looks odd as the timing of Chinese New Year reduced the number of working days in February. Some people argue that the spectacular surge in exports may be caused by exporters shipping their products before they can be hit by tariffs, such as in the US. I doubt that. First, the exact same thing happened in 2015 when the number of working days in February was also smaller than in the previous year but export growth spiked all the same. In addition, not only the exports to the US have grown rapidly, it is a broader phenomenon. For now, I think we must conclude it is a statistical oddity, which is hard to interpret. In any event, the numbers do not suggest that world trade is cooling aggressively.

Germany: soft mom, strong yoy

Industrial production and orders data in Germany was softer than expected in January. Orders fell 3.9% mom, after rising 3.0% in December. Industrial production fell 0.1% mom after December’s drop of 0.5%. However, the year-on-year rates were strong: 8.2% for orders and 5.5% for industrial output. These numbers are still significantly above overall economic growth. Ultimately, that cannot last. It is therefore reasonable to assume that momentum in the industrial sector will come down in the months ahead, a development that may already be signalled in various industrial confidence indicators.