Trade tensions – unintended consequences

It is common rhetoric to describe U.S. President Donald Trump as a non-conformist. President Trump came out of the gate swinging, dismantling long-standing trade agreements and partnerships with neighbours, allies and the world’s second largest economy.

In July, the U.S. threw the first punch against China imposing $34 billion of tariffs on Chinese steel and aluminum products. Further tariffs were imposed on Aug. 22 targeting another $16 billion worth of goods, affecting approximately 279 Chinese products. On both occasions, China immediately reciprocated resulting in both nations imposing tariffs on $50 billion worth of products. The current state of affairs, by no means suggests that the trade spat is close to being resolved as all signs point to further intensification.

According to President Trump, the large U.S. Trade deficit with China is solely attributable to unfair trade practices. While there is no denying that as it relates to intellectual property, China and the U.S. are not playing by the same rules, trade disparities tend to be the result of relative growth rates and relative real exchange rates. Highlighting the net imports versus China seems to be partially motivated by making good on president’s Trump campaign promise to bring back American jobs and partially by the “Made in China 2025” initiative.

This initiative is aimed at re-engineering China from a manufacturing economy to one focused on high-tech industries. The ultimate objective being to increase the standard of living in the world’s most populated country. To achieve this goal, foreign companies accessing the Chinese marketplace are required to do so through joint ventures with domestic firms.

It is this implied transfer of intellectual property to Chinese firms that the U.S. is understandably dismayed with.

The tit-for-tat public so-called negotiations taking place at the moment, make a lot of sense from a political standpoint as they resonate with the U.S. president’s voter base. To assess the potential economic consequences of this conflict however, a deeper dive into the subject is required.

The global value chain

It is a fact that China exports more than $130 billion of goods to the U.S. per year, but that statistic does not reveal the many components imported by China to assemble products destined for U.S. ports. Countries such as Japan, South Korea, Taiwan as well as other Asian economies are major suppliers of components and raw materials for use in the manufacturing of goods for export to the U.S. The trade figures also do not reflect sales to Chinese consumers by U.S. subsidiaries overseas. Case in point, Apple generated $45 billion in revenues from China in 2017, yet as per trade data it is estimated that China only imports $1 million of mobile phones.

The Trump administration’s stance on trade is based on the belief that U.S. manufacturing jobs are being outsourced to China. While this trend of outsourcing was prevalent in the eighties, the economic landscape is vastly different today. In the last few decades foreign companies, especially in the auto industry, have gradually built plants in the U.S., contributing directly to the U.S. labor market.

Conversely, U.S. automaker General Motors, sells more cars in China than in the U.S. and the rest of the world combined. Ironically, if you wanted to purchase an American made car, the Japanese branded Toyota Camry would fit the bill. Taking into account materials or labor, the Camry is nearly 90 percent American made.

Consequently, today’s extensive global supply chains, accentuate the difficulty in assessing the ultimate fall-out of a campaign targeting China in this manner.

Which equity sectors are vulnerable?

It is therefore meaningful to gauge how distinct industries will be impacted. U.S. manufacturers facing higher imported input costs would undoubtedly be hurt by an ongoing trade conflict. U.S. sectors which source a significant share of revenues overseas are most vulnerable. Independent Investment Research firm, BCA Research, opines that the semiconductor and technology equipment space top the list.

On the other hand, industries which can expel competitors and pass on tariffs through higher prices to consumers may benefit. U.S. defense manufacturers are a prime example of this. A lack of competition, coupled with rising military tension should lead to a boon for the sector. Likewise, service sectors such as financial services and healthcare services are less vulnerable to anti-trade policies and could help to provide a potential safe haven, should trade tensions rise even further.​