• Trade Talks Take A Detour
  • Getting Stuck In The Middle
  • What Is CECL, And Why Does It Matter?

In geometry, we’re taught that the shortest distance from A to B is a straight line. In economics, everything is described by a curve. And in political science, we learn that policymaking can be a long and winding road.

Trade negotiations between China and the United States took a sudden turn last week, when the White House announced new tariffs. China responded early this week with countermeasures. These provocations came as a rude awakening after three months of negotiations that seemed to be on the brink of success.

While abrupt, the reversal of course was not altogether unexpected. As we noted several weeks ago, trade negotiations are difficult, and ratification of agreements can be more so. The issues being discussed are complex, and they are part of a large, complicated economic and strategic relationship between the two countries. Consensus is still possible, but it may take longer to reach. The consequences of delay for the global economy could be substantial.

Last week, the United States increased tariffs on $200 billion of imported goods from China and threatened to extend the tariffs to an additional $325 billion of products. The new measures were prompted by allegations that China had retreated from commitments made during negotiations. China has denied this assertion, and has retaliated by increasing tariffs on $60 billion in goods imported from the U.S.

Weekly Economic Chart 1 - May 17

A review of how tariffs operate is in order. Counter to popular belief, the target country’s government does not pay the tariff: it is paid by domestic importers from that country. In the short-term, this prompts importers to do one (or a combination of) three things:

  • Ask their Chinese supplier for a price concession to offset the tariff
  • Pass the cost along to consumers
  • Absorb the tariff in their profit margins

As a result of these effects, the tariff is a kind of tax largely paid by U.S. consumers and shareholders. But American negotiators feel that the current backdrop of strong economic growth and strong markets mean these costs can be absorbed comfortably.

Over the longer term, tariffs may cause consumers to shift away from Chinese products, and U.S. firms to shift supply chains to reduce reliance on China. Whereas a 10% tariff may not have been enough to prompt this reorientation, a 25% tariff might be. This is why economic projections show that the new measures will hit China much harder than the United States.

“The longer that tariffs last, the more likely that production will shift out of China.”