July 2018 · Number 2 Impacts on Global Trade and Income of Current Trade Disputes The analysis shows that a US-China tariff Caroline Freund, Michael Ferrantino, Maryla escalation could reduce global exports by up to 3% Maliszewska, Michele Ruta ($674 billion) and global income by up to 1.7% ($1.4 trillion) with losses across all regions. Introduction Global trade tensions have worsened and • Impact on developing countries: Third- developing countries stand to see depressing party countries benefit from increased investments as global uncertainty grows. On July 6, preference margins in the US and Chinese the United States implemented a first round of tariffs markets when the two trading partners on $34 billion of imports from China, as part of $50 impose tariff surcharges. But, when billion in announced tariffs; China retaliated with investor confidence is shaken, these gains tariffs on an equivalent amount of imports from the are more than offset for all regions by United States. Both countries have announced the negative income effects. In this scenario, potential for additional tariffs. The new tariffs will income losses range between 0.9% for depress bilateral trade, disrupt global supply chains, South Asia and 1.7% for Europe and and increase demand for substitutes from other Central Asia. countries. Because both countries are large, there will also be terms of trade effects. The biggest effects • Impact on China and US: The biggest of tariff escalation on developing countries are likely declines in incomes are recorded by China to come from depressed investment, as firms delay and the US, up to 3.5% ($426 billion) and investments because of uncertainty over market 1.6% ($313 billion), respectively. The access. sectors most affected include: agriculture, chemicals and transport equipment in the This note assesses the implications of tariffs US; and electronic equipment, machinery between China and the United States on and other manufacturing in China. developing countries, using a Computable General Equilibrium (CGE) Model, under the following three scenarios: In the current uncertain global business • Scenario 1: 25% tariff surcharge on the $50 environment, developing and developed countries billion in bilateral trade by US and China; need to act to retain investor confidence and avoid the disruption of trade flows and global supply • Scenario 2: 25% tariff surcharge on all chains. Developing and developed countries can products traded between the US and improve the credibility of future policies by China; deepening their commitments in multilateral fora • Scenario 3: 25% tariff on all products traded such as the WTO and regional trade agreements. plus a decline in investor confidence, resulting in a 0.5 pp drop in investment to GDP. Background Information computers, transportation equipment, electrical On July 6, the United States imposed new tariff equipment, and fabricated metal products. As the surcharges of 25% on $34 billion (818 tariff lines) of result of public input, USTR removed from the US imports from China. The legal grounds for original list a number of consumer goods, such as proposing these tariffs, under Section 301 of the televisions. In the list announced on July 10, Trade Act of 1974, is as a response to Chinese failure consumer goods such as appliances, computers and to respect US intellectual property, and perceived furniture are more heavily targeted. unfairness of Chinese technology and innovation The composition of the announced Chinese tariffs policy. Tariffs on an additional $16 billion of US on imports from the United States focuses on imports from China are planned for a later date (284 agricultural products, automobiles and seafood (on lines, with the list under review subject to public July 6) and chemicals, energy products and medical comment). equipment (on the second list). On the same day, China imposed new tariff The Three Scenarios surcharges of 25% on $34 billion (545 tariff lines) of Chinese imports from the United States. The The analysis of tariffs between China and the magnitude and timing of these tariffs is designed to United States on developing and developed countries is based on a CGE Model called parallel the US tariffs on Chinese imports. LINKAGE, under the following three scenarios Additional tariffs on $16 billion of Chinese imports (Figure 1):1 from the US, 114 items (presumably subject to change), are scheduled to follow US tariffs. • Scenario 1: Implementation of the 25% tariff surcharge in line with the detailed On June 18, President Trump directed United product lists issued by China and the US on States Trade Representative to prepare a third list, valued at $200 billion in US imports, in retaliation $50 billion in trade; for the Chinese retaliation against the original • Scenario 2: Implementation of the 25% Section 301 tariffs. The composition of this list in tariff surcharge on all trade between the US terms of commodities is unknown. As a point of and China (including ad valorem comparison, total US imports of goods and services equivalent barriers on trade in services of from China in 2017 were valued at $544 billion, and 25%); 2 This scenario demonstrates effects total Chinese imports from the United States in 2017 from full tariff escalation. were valued at $188 billion. Thus, the original $50 • Scenario 3: Implementation of the 25% billion of imports targeted by US tariffs amount to tariff surcharge on all trade between the US less than 10% of all imports from China, while the and China and a decline in investor original $50 billion of imports targeted by China’s confidence, resulting in a 0.5 pp drop in tariffs amount to more than 25% of China’s imports investment to GDP. This assumption is from the United States. consistent with the decline of global investment as a share of GDP in 2001 The composition of the US tariffs on $50 billion of recession and amounts to about a quarter of imports from China focuses on technology- the global investment decline as a share of intensive intermediate goods traded by GDP during financial crises in 2008.3 multinational companies, including machinery, 1 2 This analysis is conducted based on the While services barriers are likely to take other application in Maliszewska, Olekseyuk, Osorio- forms than tariffs, such as investment or travel Rodarte. 2018. Economic and distributional restrictions, a tariff equivalent of 25% is assumed. 3 impacts of comprehensive and progressive It is also slightly less than one standard deviation agreement for trans-pacific partnership: the case (0.64) in the series of investment to GDP since of Vietnam (English, Vietnamese). Washington, 1990. D.C.: World Bank Group. July 2018 · Number 2 · 2 Figure 1. Scenarios under investigation Scenario 1 Scenario 2 Scenario 3 600 NEGATIVE SHOCK TO 500 Billion USD of imports 544 544 INVESTMENT 400 300 200 188 188 100 50 50 0 U.S. AND CHINA IMPOSE 25 PERCENT U.S. AND CHINA IMPOSE 25 SCENARIO 2 PLUS 0.5 PERCENT TARIFFS ON A DESIGNATED LIST OF PERCENT TARIFFS ON ALL IMPORTS DECLINE IN GLOBAL IMPORTS FROM EACH OTHER INVESTMENT/GDP U.S. IMPORTS FROM CHINA CHINESE IMPORTS FROM U.S. Source: Comtrade and staff estimates (2017). 2017 US imports of goods at CIF amount to $526.1 billion (USITC), while imports of services amount to $17.4 billion (census.gov). The analysis focuses on long-term effects and impact on both China and the US, leaves out other policy factors that could alter the but also create distortions for effects of the tariff escalation in developing and developing and developed developed countries, particularly in the short term. countries that are not considered in this analysis. a. The analysis assumes perfect reallocation of exports and c. Tariffs on other products or production in line with medium countries that are being to long term elasticities. Due to implemented or are under short term rigidities and linkages consideration could have through global value chains, as compounding effects, especially well as lower substitutability of on investor confidence. import sources in the short run, the impacts on trade are likely to Effects on Trade and Income be more muted, with bigger losses 1. Global income declines by up to 1.7% for the US and China and smaller ($1.4 trillion) with losses across all gains for the rest of the world. regions. Global decline of income is expected to be relatively small from tariffs b. The policy scenarios are limited to alone. It reaches 0.04% under Scenario 1, tariff changes between the US and and 0.3% under Scenario 2 (Table 1). China China. Both countries could and the US each lose about $30 billion in implement broader forms of Scenario 1, while other regions are only economic or financial retaliation, as well as non-economic retaliation that could affect political stability. Finally, forms of managed trade that could replace tariffs would reduce the negative July 2018 · Number 2 · 3 marginally affected.4 Under Scenario 2, the machinery and equipment (Figure 2). decline of income is projected to be higher Under Scenario 2 imports from China for China -2.5% ($302 billion), but also decline across all sectors and are being significant for the US -0.4% ($85 billion). In replaced by imports from several other this scenario the trade diversion effect countries including in East Asia, such as dominates the income effect and several Japan and Malaysia (electronic equipment), countries benefit from increased preference Vietnam (wearing apparel) and others margins in US and Chinese markets. In the (Figure 3). In Scenario 3, sectoral impacts medium/long term, third partners replace are similar to Scenario 2, but the decline of US exports on the Chinese market and vice imports is larger due to due to stronger versa, benefiting also from improved terms income effects and higher price of capital in of trade. Scenarios 1 and 2 do not the US (Figure 4). incorporate the impacts through investment and financial markets, which 4. Chinese imports from Latin America, are likely to magnify the negative effects of Europe and Central Asia and other high- tariff escalation on trade and income. With income countries partly offset declining increased uncertainty from tariff imports from the US. Under Scenario 1, escalation, global investment is likely to Chinese imports from the US decline decline. Scenario 3 shows that in this case primarily in agricultural goods, chemicals global income declines by 1.7% ($1.4 and other manufacturing products. Exports trillion) with losses across all regions. from Europe, Australia, and Latin America replace US exports of agricultural goods 2. Global exports fall by up to 3% ($674 (Figure 5). Under Scenario 2, the decline of billion), with largest declines in China imports from the US affects all sectors with and the US. Global decline of exports the additional large decline in transport reaches 0.3% under Scenario 1 and 1.2% equipment (Figure 6). Note that imports under Scenario 2 (Table 2). China and the from other East Asian countries are US each lose about $40 billion in exports in negatively affected, particularly for Scenario 1, with global exports declining by electronics and machinery and equipment, $60 billion, as some of the other regions due to regional value chain linkages. Under become more competitive on US and Scenario 3, the impacts across sectors are Chinese markets. Under Scenario 2, the similar to Scenario 2, but magnified (Figure decline of total exports from China and the 7). US reaches $190 billion and $166 billion, respectively, with a significant decline of 5. In the US, output of agriculture, chemicals global exports of $276 billion. Finally, and transport equipment contracts, while under Scenario 3, global exports would output of apparel and electronic decline by 3% (similar in magnitude to the equipment expands. The announced contraction in global exports in the 2001 retaliation by China affects mostly exports financial crisis which followed the burst of of US agricultural products, automobiles, the dot-com bubble) or about $674 billion. seafood (List 1) and chemicals, energy products and medical equipment (List 2). 3. US imports from non-China East Asia, As a result, exports and output of these Mexico and Europe in part replace lower sectors in the US decline with the biggest imports from China. Under Scenario 1, US impact on agriculture (-2.7%), chemicals (- imports from China decline significantly in 0.4%), other manufacturing goods (-0.8%) the sectors targeted by tariff surcharges (Table 3). At the same time output of and are replaced to some extent by imports electronic equipment and machinery and from the EU and Mexico, especially in the equipment (1.2%) and output of metals case of electronic equipment and (0.8%) expands to replace imports. Under 4 Under Scenario 1, despite increases in the volume of exports in SAR and MENA, these regions face a terms of trade loss and negligible income decline. July 2018 · Number 2 · 4 Scenario 2 a larger decline would be expected in agriculture and transport equipment, with gains in electronic equipment, textiles and apparel. Under Policy Implications Scenario 3 most sectors shrink, including several services sectors, with largest losses In this context, developing and developed for agriculture and transport equipment. countries need to act to retain investor confidence and avoid the disruption of trade flows and global 6. In China, output of electronic equipment supply chains. Suggested actions include: and other manufacturing sectors decline, • Use the WTO or the duly constituted while agricultural output expands. The dispute settlement bodies of regional 25% tariff surcharge announced by the US trading arrangements to bring disputes affects mostly Chinese exports of regarding other countries’ trading practices machinery, computers, transportation and to authorize reciprocation. equipment, electrical equipment, and fabricated metal products. The Chinese • Renew economic liberalization programs, output of machinery and equipment and reducing distortions, such as subsidies, and electronic equipment declines by 1.0% and continue ongoing trade liberalization 1.3%, respectively. Agriculture (1.0%) and efforts through multilateral and regional other manufacturing goods (0.6%) benefit fora. from output increases to replace imports. Under Scenario 2, the gains in output of • Continue to uphold the multilateral trading agriculture and natural resources are system and commitments in regional trade magnified, including gains in transport agreements to improve the credibility on equipment. However, several services the course of future policy. sectors would be expected to decline along with some manufacturing sectors, such as, • Avoid resorting to non-transparent forms wearing apparel or machinery and of retaliation outside of the rules-based equipment. Under Scenario 3, declines are system, such as non-tariff measures. magnified, while the expansion of natural resources and agriculture is muted. • Minimize policy uncertainty by the timely and clear communication of future changes in trade policy. About the author(s): Caroline Freund, Director, World Bank’s Macroeconomics, Trade & Investment Global Practice cfreund@worldbank.org Michael Ferrantino, Lead Economist, World Bank’s Macroeconomics, Trade & Investment Global Practice mferrantino@worldbank.org Maryla Maliszewska, Senior Economist, World Bank’s Macroeconomics, Trade & Investment Global Practice mmaliszewska@worldbank.org Michele Ruta, Lead Economist, World Bank’s Macroeconomics, Trade & Investment Global Practice mruta@worldbank.org July 2018 · Number 2 · 5 Appendix 1 – Figures and Tables Table 1. Impact on income (million USD at 2017 prices). Lists 1 and 2 implemented on 25pp increase tariff surcharge 25pp increase tariff surcharge both sides on bilateral US-CHN trade on bilateral US-CHN trade and decline in investor's confidence $million % $million % $million % USA -29,414 -0.2 -84,501 -0.4 -312,789 -1.6 China -33,123 -0.3 -301,919 -2.5 -425,749 -3.5 Mexico 2,766 0.2 16,467 1.4 -9,522 -0.8 Canada 1,731 0.1 10,637 0.6 -18,676 -1.1 EAP excl. China 2,954 0.1 12,769 0.3 -53,957 -1.3 SAR -192 0.0 6,644 0.2 -27,181 -0.9 LAC 2,929 0.1 2,047 0.1 -32,778 -1.1 AFR 95 0.0 196 0.0 -6,409 -1.1 ECA 659 0.0 -6,933 0.0 -342,447 -1.7 MENA -29 0.0 193 0.1 -2,752 -1.2 HICs 3,349 0.1 3,676 0.1 -106,978 -1.7 ROW 2,184 0.0 7,439 0.1 -95,649 -1.1 Global -34,771 0.0 -266,344 -0.3 1,359,471 -1.7 Note: EAP: Brunei, Malaysia, Singapore, Vietnam, Thailand, Korea, Philippines, Indonesia, Cambodia and Laos; SAR: India, Bangladesh, Sri Lanka, Southeast Asia, LAC: Chile, Peru, Brazil, Colombia; AFR: South Africa, rest of SACU, Tanzania, Ethiopia and Kenya; ECA: EU28, Russia, Turkey; MENA: Egypt; HICs: Australia, New Zealand, Japan; ROW: rest of the World. Source: WB staff estimates. July 2018 · Number 2 · 6 Table 2. Impact on total exports (million USD at 2017 prices and % deviations from the baseline). Lists 1 and 2 implemented 25pp increase tariff 25pp increase tariff on both sides surcharge on bilateral US- surcharge on bilateral US- CHN trade CHN trade and decline in investor's confidence $million % $million % $million % USA -38,480 -1.7 -166,622 -7.2 -207,796 -8.9 China -40,495 -1.7 -190,092 -7.9 -238,224 -9.3 Mexico 2,953 0.7 14,197 3.3 332 0.1 Canada 1,858 0.4 8,396 1.6 -2,288 -0.4 EAP excl. China 4,037 0.2 23,649 1.0 -13,851 -0.6 SAR 204 0.0 3,684 0.7 -4,235 -0.8 LAC 1,361 0.3 2,513 0.6 -6,845 -1.6 AFR 123 0.1 454 0.3 -1,731 -1.2 ECA 4,880 0.1 12,751 0.1 -149,636 -1.7 MENA (Egypt) 19 0.0 160 0.4 -334 -0.9 HICs 2,152 0.2 6,993 0.6 -13,075 -1.2 ROW 3,313 0.1 14,548 0.4 -33,713 -1.0 Global -59,486 -0.3 -275,661 -1.2 -673,699 -2.9 Note: EAP: Brunei, Malaysia, Singapore, Vietnam, Thailand, Korea, Philippines, Indonesia, Cambodia and Laos; SAR: India, Bangladesh, Sri Lanka, Southeast Asia, LAC: Chile, Peru, Brazil, Colombia; AFR: South Africa, rest of SACU, Tanzania, Ethiopia and Kenya; ECA: EU28, Russia, Turkey; MENA: Egypt; HICs: Australia, New Zealand, Japan; ROW: rest of the World. Source: WB staff estimates. July 2018 · Number 2 · 7 Table 3. Output changes in the US and China (%age deviations from the baseline) USA China Sc. 1 Sc. 2 Sc. 3 Sc. 1 Sc. 2 Sc. 3 Agriculture -2.7 -4.6 -5.9 1.0 2.2 2.0 Natural resources / mining -0.3 -0.1 -2.7 0.3 2.2 2.0 Food, beverages, tobacco -0.1 0.3 -0.8 0.2 0.5 0.3 Textiles 0.1 4.7 3.6 0.3 -0.4 -0.8 Wearing apparel and leather 0.1 8.0 7.5 0.3 -2.5 -2.8 Chemical, rubber, plastic products -0.4 -0.3 -2.1 0.2 0.6 -0.4 Metals 0.8 -0.1 -1.4 -0.6 0.3 -1.2 Transport equipment 0.2 -1.9 -3.2 0.0 1.6 0.1 Electronic equipment 1.2 5.8 4.0 -1.0 -7.4 -8.8 Machinery and equipment nec 1.2 -0.5 -2.3 -1.3 -0.3 -2.1 Other manufacturing -0.8 1.4 0.1 0.6 -1.9 -3.1 Utilities 0.0 0.0 -1.4 -0.1 0.0 -0.8 Construction -0.1 -0.7 -2.8 -0.1 -1.4 -2.9 Trade and transport 0.0 0.0 -1.1 -0.1 -0.3 -1.0 Finance and other business services 0.0 0.1 -1.6 -0.1 -0.3 -0.8 Communication and business services nec 0.0 0.1 -1.0 -0.1 -0.6 -1.4 Social services 0.0 0.0 -0.4 0.0 -0.1 -0.2 Total 0.0 0.0 -1.2 -0.1 -0.3 -1.3 Source: WB staff estimates. July 2018 · Number 2 · 8 Figure 2. Imports by the United States under Scenario 1 (deviations from the baseline in $billion at 2011 prices). Source: WB staff estimates. Figure 3. Imports by the United States under Scenario 2 (deviations from the baseline in $billion at 2011 prices). Source: WB staff estimates. July 2018 · Number 2 · 9 Figure 4. Imports by the United States under Scenario 3 (deviations from the baseline in $billion at 2011 prices). Source: WB staff estimates. Figure 5. Chinese imports under Scenario 1 (deviations from the baseline in $billion at 2011 prices). Source: WB staff estimates. July 2018 · Number 2 · 10 Figure 6. Chinese imports under Scenario 2 (deviations from the baseline in $billion at 2011 prices). Source: WB staff estimates. Figure 7. Chinese imports under Scenario 3 (deviations from the baseline in $billion at 2011 prices). Source: WB staff estimates. July 2018 · Number 2 · 11