The recently announced tariffs and potential “trade war” with China have dominated news headlines over the past few weeks. This is an extremely complicated and layered topic; one of which I don’t think most of us fully understand. The rationale (and impacts) come from many different directions. Even at a high level, it can be quite confusing. Therefore, I’d like to give a little insight into tariffs and why the media is highlighting it so much these days.
Essentially, a tariff is a tax levied on products imported from a country (or multiple countries). Several reasons exist to impose tariffs (such as raising revenue to protect domestic industries from foreign competition). Let’s say Chinese steel is $500 per unit to import to the U.S. Now, the U.S. can issue a tariff of 25% on that import. Effectively, this tariff makes the cost for the consumer (the U.S. business) $625 per unit vs. $500 to purchase Chinese steel. I’d like to point out while the U.S. levies the tariff on a Chinese product, the U.S. importer/business is responsible for the increased cost.
The natural question is, “Why in the world would anyone want to pay more for goods?” As I alluded to earlier, there can be numerous reasons for imposing tariffs. These reason could ultimately be economic or political (or both) in nature. For the focus of this article, however, I’ll focus on the two main reasons the U.S. is aggressive on issuing such tariffs against China.
Reason 1: The powers that be feel that the trade deficit with China is too large right now. Per the government census in 2017, we exported roughly $130 billion to China while importing a whopping $505 billion. (That’s a trade deficit of $375 billion!) China is not acquiring our goods for their 1.4 billion people at the same rate we are consuming their goods for our 325 million people.
The belief is it takes jobs away from Americans at a disproportionate rate, while rewarding a country who isn’t holding their weight in trade equality. If we impose tariffs on a product to level the playing field (with regards to price), domestic producers would be more competitive and ideally create more jobs. Additionally, if we impose tariffs to make Chinese steel the same price (or even more) as Japan’s steel, we would shift more of our steel purchases to Japan. (An interesting aside: we export $204 billion to Japan, while importing $262 billion. That creates a $57 billion deficit for a country of only 127 million people.)
To help illustrate, below is a graphic from the Congressional Research Service about the products America Exports to China.
Reason 2: The current administration targeted China because many in the U.S feel China is utilizing unfair trade practices on numerous industries. One of the biggest exports of the U.S. is technological innovation and intellectual capital. Through the use of things such as forced technology, many feel these valuable propriety components are being “stolen.”
The Chinese government has requirements for foreign companies, which expose those companies to the risk of losing their technology or proprietary secrets. A good example is automobile manufacturers. They must partner with a Chinese firm in order to manufacture and sell those cars in China. This forces a company like GM or Ford to open up their proprietary technology to another China-based company.
Another example is technological companies (such as Facebook and Amazon) are required to have their cloud-based data locally handled in China. The rationale is the requirements are driven by security, but it still exposes sensitive data for U.S. consumers.
For the simple fact that it gives them access to a 1.4 billion-dollar market, many companies willingly comply with these stringent rules.
Through these hard line negotiations, hopefully we can get a more favorable trade tactic and a more equal trade balance with the second largest economy on the planet. The presumably net effect would be more sales to a large trade partner and thus more revenue to U.S. based companies.
At the end of the day, this process will undoubtedly be a long and drawn out negotiation between two very powerful countries. With that in mind, I wouldn’t let the current market volatility and headlines drive you to make any rash investment decisions. The reality is this is a very important relationship for both countries’ economies. Thus, an amicable outcome is likely at some point, and if I had to guess a more favorable one for U.S. based companies than today.