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Whack-a-mole: Comparative advantage is being redefined by Trump’s trade war

After this week, we might need to rethink the concept of comparative advantage in trading relationships with the US.

The winners in trade with the US won’t necessarily be those who can produce goods more efficiently than others, but those countries with lower tariff rates on those goods than their competitors.

Over the next few days, Donald Trump will send out letters to about a dozen countries informing them of the tariff rate the US has set on their exports to the US, with those rates to come into effect on August 1.

Treasury Secretary Scott Bessent said some countries might be given a three-week extension to negotiate.

Treasury Secretary Scott Bessent said some countries might be given a three-week extension to negotiate.Credit: Bloomberg

On Wednesday, the 90-day pause on the imposition of Trump’s “reciprocal” tariffs ends. Those tariffs ranged from 10 per cent to 49 per cent when they were first announced on April 2. The pause was designed to give countries time to negotiate individual trade deals.

So far, Trump has gained only a framework agreement with the UK, the outline of a deal with Vietnam and a fragile truce with China from the pause, a far cry from the “90 deals in 90 days” his administration promised.

Trump has consequently opted to unilaterally dictate the tariff rates, although his Treasury Secretary, Scott Bessent, said at the weekend that some countries might be given a three-week extension to negotiate.

“There’s a lot of congestion in the home stretch,” Bessent said on Fox News Sunday.

“So, by telling our trading partners that they could boomerang back to the April 2 date (and the reciprocal tariff rates), I think it’s really going to move things along the next couple of days and weeks,” he said.

Trump said on Sunday that he had already signed some letters.

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“So, we’re going to start sending letters out to various countries starting tomorrow. They’ll range in value from maybe 60 or 70 per cent tariffs to 10 and 20 per cent tariffs,” he said.

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“It’s a lot of money for our country, but we’re giving them a bargain,” he said, continuing to demonstrate his ignorance of the way tariffs work.

Tariffs are paid when goods are landed in the US by the importer – they’re paid for by US companies, which may absorb some of the cost or pass some or all of it onto consumers. They are a tax on domestic consumption.

If the tariff rates are going to range from 10 per cent to 70 per cent they will create massive arbitrage opportunities.

Countries that were uncompetitive in a regime where the average US tariff was about 2.5 per cent are suddenly going to be very competitive if their rate is 10 per cent and their competitors are being hit with tariffs that are multiples of that level.

The hotchpotch of tariffs that the Trump administration envisages will create chaos within the global trading system and the supply chains that support it, along with opportunities and threats for individual economies. It will also be an administrative nightmare for US customs.

The US is aware that its differential tariffs could lead to attempts to game the regime and is particularly concerned that China might do what it did during the 2018-19 trade war, during Trump’s first term as president, when many Chinese exports to the US were re-routed through other Asian countries and Mexico.

In the deal the administration announced with Vietnam, where it reduced the reciprocal tariff rate from 46 per cent to 20 per cent, it added a caveat. The rate will become 40 per cent on any goods or components that have been transhipped from another country.

It’s seeking to impose similar, China-targeting, clauses in deals with its other major trading partners, along with other restrictions on their ability to trade with China. Given that China is also a major trading partner for most other economies, the US’ attempt to isolate China is likely to experience significant pushback.

China has already been re-directing its exports. In May, its exports to the US were 43 per cent lower than for the same month last year, but its total exports were up nearly 5 per cent. Exports to South East Asian countries were up 15 per cent and those to the European Union 12 per cent.

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While it is unlikely that those exports flowing into Europe will be transhipped, the US will be playing “whack-a-mole” in Asia and Latin America as Chinese companies, and others, seek to exploit the new tariff regime.

July 9, or whenever the new US tariff regime is in place, won’t be the end of the changes to the global trade settings.

A source of considerable trade friction, and an impediment to deals with Japan, South Korea and the European Union, are Trump’s sectoral tariffs. The US has imposed 50 per cent tariffs on imports of steel and aluminium and 25 per cent on autos and auto parts.

Trump has foreshadowed – the administration is compiling the necessary documentation – further sectoral tariffs on pharmaceutical products, semiconductors, timber and copper.

Any deal or, more likely, tentative outlines for deals, announced this week will be vulnerable to any future new sectoral tariffs. The EU, for instance, is a major exporter of pharmaceuticals to the US.

The EU accounts for about 14 per cent of all US goods imports and is America’s second-largest trade partner, behind China.

While Bessent said there had been “very good progress” in discussions with the EU, and the EU itself has said it is hopeful that an agreement in principle can be signed, US demands that US companies be exempt from EU regulations and that the EU accept a 17 per cent tariff on its agricultural exports, along with the sectoral tariffs on steel, aluminium, autos and perhaps pharmaceuticals, are massive hurdles to any final deal.

The EU has drawn up its own list of potential retaliatory tariffs on imports from the US, covering about €116 billion ($A209 billion) of US goods, that it could deploy if its negotiations break down.

The potential for a full-scale trade war between the US and EU is high, adding to the threat to global trade and the global economy posed by the existing trade hostilities between the US and China. Tensions between Europe and China are also mounting as China’s export volumes to the US decline but those to Europe climb.

Vehicles waiting for shipment at a shipping terminal in Shanghai, China.

Vehicles waiting for shipment at a shipping terminal in Shanghai, China.Credit: Bloomberg

Even before whatever Wednesday’s deadline for deals – or Trump’s unilaterally imposed tariffs – produces, the 10 per cent baseline tariffs and the 55 per cent rate on imports from China are having material effects.

While the shifting flows of global trade are just starting to show up, an insight into their early impact on the US can be seen in US customs data, with tariff revenues hitting a record $US23 billion in May.

That is a 270 per cent increase on the same month last year, a 25 per cent increase on the April number and a revenue stream that will obviously swell significantly once Trump’s post-July 9 tariff regime is in place.

That’s a big new tax source, although it hardly put a dent in America’s fiscal deficit of $US316 billion in May.

While Trump’s tariffs could raise nearly $US2 trillion from US companies and/or consumers if they remain in place over the next decade, that wouldn’t cover the existing annual deficit, let alone cumulative deficits over the next decade.

Then there are, of course, the $3.4 trillion to $US4 trillion of increases in those deficits from Trump’s One Big Beautiful Bill, which are yet to come.

What a tangled, chaotic, destructive, web Trump is weaving to address an issue – America’s $US1.2 trillion trade deficit – that has more to do with macro influences than the unfair trade practices that are Trump’s justification for America’s trade war on the rest of the world.

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Original URL: https://www.watoday.com.au/link/follow-20170101-p5mczh