Consequences of a Trade War

Brandon:

Neil and I started a conversation (Is a Trade Deficit Bad for the United States) in which I asked if it was bad to run a trade deficit and whether tariffs work to correct trace deficits. All of this was in response to President Trump beginning to enact tariffs (as he had promised to do throughout his campaign). At first these tariffs were on steel and aluminum, but there is broad discussion of other products as our trading partners threaten retaliation. As the US threatens or implement tariffs and our trading partners respond with tit-for-tat escalation the press has been talking about "trade wars". So my question to Neil was: Can we win a trade war?

Neil:

When President Trump tweeted: "Trade wars are good and easy to win." I nearly fell out of my chair. While some economists, have begun to reinterpret the trade wars of the 1930s to emphasize the role of monetary policy, general agreement that the resulting economic losses contributed to the depth and length of Great Depression remain. The conclusion about the overall economic effects of a trade war are straightforward, the world as a whole loses, so from a global perspective my short answer to your question is no.

That does not mean that there are not winners and losers and sometimes the winners are in industries seemingly far removed from the original dispute as the NPR story on the "chicken tax" you referenced illustrates. The logic of retaliation in a trade war is to inflict the maximum political pain. When the U.S. imposed a 25% tariff on vans and light trucks in retaliation for the German tariff on frozen chicken it was aimed directly at VW, which was one of the engines of German industrial recovery and a major employer. At that time VW was organized a trust controlled by the West German government and the State of Lower Saxony. Talk about political pain! So it is no wonder that in response to the threat of U.S. tariffs on a broad range of Chinese products, China's response was to retaliate against an agricultural sector that had voted heavily for President Trump.

Writing in Politico, Zachary Karabell points out that the threatened tariffs which "...represent perhaps $25 billion tax on a reciprocal trade relationship that last year amounted to nearly $700 billion." While this is a relatively modest impact on the overall economy it doesn't mean that there won't be acute pain in some sectors, especially agriculture.

The threat of a trade war comes at a bad time for the agricultural sector where prices and farm incomes have been under pressure in recent years. The reaction from commodity groups, farmers and agribusiness has been one of shock and outrage.

While much of the press coverage has been focused on midwestern hog, corn and soybean farmers, China has also threatened retaliation on California crops including fruits, nuts and wine. With control of the House of Representatives at stake in the fall the Administration is scrambling to mitigate the potential impacts of a trade war on farmers. However, as this AgriPulse article points out, this is more simply said than done.

Farmers directly facing the threat of a trade war are upset, but the reaction from those who would like to see a change in the agricultural status quo, including some advocates for small farmers and organic agriculture has been distinctly different. I have included two rather lengthy Facebook threads in response to initial posts by Klaas Martens, a farmer near Penn Yan, New York, which illustrate the emotional reaction and also raise some interesting questions about the impact of a trade war on the structure of American agriculture.

What will these tariffs mean for agriculture if they are fully implemented? I will be the first to acknowledge there is a great deal of uncertainty about the outcome, but here are some initial thoughts.

1. More consolidation. No doubt that a tariff on soybeans imposed by our largest export market will further depress already low prices. As a result some farmers, generally the older, smaller or poorly capitalized, will retire or quit farming. Their acreage will generally be picked up by larger well capitalized farms or by long-term investors. While some comments in the above Facebook threads express hope that the economic pressures of a trade war might force more increased diversification and changes in farming practices, those changes are likely to be marginal. Perhaps a little more diversification, (some farmers in Illinois are talking about planting more pumpkins) but additional economic stress is likely to discourage farmers from making the investments and taking the risks of adopting new farming practices like cover crops to increase soil health and improve environmental outcomes.

The vertical integration of the hog industry is nearly complete and the large integrated producers will not feel the effects of tariffs immediately since their contracts will buffer initial price shocks. It is small independent producers, dependent on the spot market who will be most immediately hurt. Local and organic hog farmers will feel the pinch too since consumers will substitute “industrial" pork for “artisan” pork as prices fall. They will either have to cut their prices too or lose market share. Some more independent hog farmers will exit the business and at the end of the day the large integrated producers will control even more of the market. An interesting twist is that Smithfield Foods, the largest pig and pork producer in the world is now owned by the Chinese and as the largest exporter of pork to China they are likely to be hit hard. Smithfield's Chinese parent, WH Group is a large producer of pork in China and soybean tariffs will raise their domestic production costs as well.

2. Incentives for expansion of the South American soybean industry. Nixon's 1973 soybean embargo, an attempt to hold domestic prices down, was a key factor in the expansion of soybean production in South America. The obvious question arises, will a unilateral tariff on U.S. soybeans imposed by the worlds largest soybean importer elicit supply response from South American exporters, Brazil, Argentina, Paraguay and Uruguay? A recent study, prepared for the U.S. Soybean Export Council by Purdue economists, Farzad Taheripour and Wallace Tyner, Impacts of Possible Chinese Protection on U.S. Soybeans suggests that the answer to that question is yes. Taheripour and Tyner's analysis was completed earlier this year before the Chinese had announced a 25% tariff. They examined both a 10% and 30% tariff under a broad range of assumptions using the Global Trade Analysis Project (GTAP) model. Without going to the details of the of their analysis, here is the bottom line: a 30% tariff on U.S. soybeans would lead to:

a 50-92% decline in China's soybean imports from the U.S.
a 33-48% decline in total U.S. soybean exports
a 22-36% increase in Brazil's total exports
an economic welfare loss for the U.S. of $2.7-3.9 trillion
an economic welfare loss for China of $2.6-5.1 trillion and
a global economic welfare loss of 6.1 trillion.

Remember that these impacts were the result of only one 30% unilateral tariff on soybeans and not the full tit-for-tat package of trade actions that China and the U.S. have been threatening.

Who won this hypothetical round? Brazil and South America with substantial increases in soybean production, exports and economic welfare.

Put that together with a November 2018 soybean price that is 2 1/4 cents above the March 2019 contract and see commercials already willing to pay up for new-crop s

The German tariff on chickens eventually went away but the 25% tariff on light trucks persists with the US auto industry being the unlikely winner of a dispute that started with a German tariff on frozen chicken.

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Consequences of a Trade War

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