Talks between the U.S. and China have made significant progress over the last several weeks, and the two sides appear to be closer to a deal than at any time over the past several months. However, while the restoration of positive trade relations will help the trade outlook, other factors are likely to keep trade growth subdued going forward.
Trade talks between the U.S. and China appear to have progressed in the months since President Trump and President Xi Jinping committed to a moratorium on escalating protectionism, and the two sides appear to be close to a deal that could remove most of the tariffs on imports from China that the U.S. imposed last year. In exchange, China would pledge to have tighter protections of U.S. intellectual property and commit to purchase more U.S.-made goods. The timing of removal of tariffs remains an issue, however, as China would like for the tariffs to be removed immediately while the U.S. would prefer to phase them out over time to make sure that China fulfills its commitments.
In essence, this kind of deal could bring trade relations between the U.S. and China back to where they were in the middle of 2018, before the U.S. instituted 10 percent tariffs on $200 billion in Chinese imports. The removal of these tariffs would provide some boost to both economies, particularly in China where the export sector is more critical to overall manufacturing performance.
The U.S. economy is still slowing
However, it is unlikely that the removal of tariffs alone will bring back the robust trade growth that the global economy experienced throughout the second half of 2017 and first half of 2018. For one, the U.S. economy is clearly on a decelerating path, with the pace of growth slowing steadily since the second quarter of 2018 and likely to continue to weaken once first quarter results are released next month.
The slowdown in the U.S. economy removes one of the main engines for import demand in the global economy. The U.S. economy is the largest in the world and runs an ever-widening trade deficit each year, which spurs demand for exports from its major trading partners such as Canada, Mexico and China. This U.S. slowdown is likely to affect goods trade more than service trade because: 1) the U.S. actually runs a surplus in service trade with the rest of the world; and 2) the sectors that are slowing in the economy are primarily the goods-consuming areas of the economy such as retail spending and business investment.
Now, some of this slowdown is likely being caused by the trade conflict with China itself. For example, business investment is moderating in part because firms are concerned about what trade policy is going to be. A satisfactory resolution to the trade war with China should, as a result, provide a boost to investment spending.
However, trade policy uncertainty is not the only thing making economic growth decelerate after strong growth in the middle of 2018. The effects of the 2018 Tax Cuts and Jobs Act are already beginning to fade, and will not provide the same boost to growth in 2019 as they did in 2018. In addition, the economy will begin feeling the effects of higher interest rates after the Federal Reserve raised rates four times in 2018.
As a result, any trade deal that emerges will likely only have a small overall effect on growth throughout 2019. Expectations were for 2.5 percent growth for the year before any trade deal, and the removal of tariffs would only boost the outlook by approximately 0.1 percent. Again, the deceleration in the economy is still expected to be focused in the goods-centric areas, which will have an outsized effect on import demand for other economies.
China has structural issues
Similarly, the Chinese economy looks set to slow down even further in 2019, even if a trade deal is reached. China’s GDP slowed to 6.6 percent for all of 2018, marking the slowest pace of growth for the world’s second-largest economy since 1990. Manufacturing in China has been hit particularly hard over the past several quarters, with purchasing manager’s index data falling into contractionary territory in each of the last three months.
Like the U.S. economy, some of the weakness in China can be attributed to the trade conflict itself. Manufacturing activity in China is still heavily influenced by export demand, and the U.S. economy is the single largest destination for China’s exports, so a trade war with the U.S. is particularly harmful to the Chinese economy.
However, the trade war is not the only reason that China’s economy is slowing. In fact, China has been on a decelerating path consistently in the years following the Great Recession as it continues to grapple with structural issues that plague the economy.
China’s economy has experienced surging debt levels over the past several years, with total debt in the Chinese economy now over 2.5 times the size of the entire economy. Some of this debt went into funding infrastructure in China, but a large portion has been dumped into building up the industrial sector. As a result, China now finds itself with too much industrial capacity in an economy that is trying to transition towards a consumer-based economy. Fiscal and monetary stimulus briefly propped up economic growth in 2017, but the Chinese government began taking steps to rein in debt levels towards the end of 2017.
Because of the structural challenges facing the economy, China is likely to continue to decelerate throughout 2019, whether a trade deal is reached or not. This has important implications for trade within the Asia-Pacific region, since a significant amount of intra-regional trade flows in an out of China. It also has important implications for European exports, as China is one of the top export destinations for trade outside of the European Union.
Brexit complicates European trade
Conditions in Europe are arguably worse, as concerns over the impending Brexit deadline are compounding troubles caused by slowing growth in many of the major economies in the region. The European Union (EU) grew at a 0.8 percent annualized pace in the fourth quarter of 2018 as year-over-year growth fell to 1.4 percent. This marks the slowest pace of yearly growth in the region in five years and, like China and the U.S., much of the weakness is tied to goods-intensive sectors of the region’s economy.
The global trade picture has certainly not helped matters in Europe, particularly among countries that depend heavily on exports to the rest of the world. Germany, which typically outperforms the rest of the region, actually declined in the second half of 2018, in part hampered by weakening growth in the U.S. and Asia.
The impending exit of the United Kingdom (UK) from the EU has only made matters worse, as investment and trade has slumped because businesses are unsure of the trade policies that will emerge once the UK exits. The deadline for leaving the EU is March 29th, and UK leaders have yet to reach a resolution on exactly how the country will leave, and what the terms of trade will be once the exit occurs. This has clearly disrupted growth in the UK, and has ripple effects in trade throughout the region. It is worth noting that two-thirds of all trade in the EU is intra-regional, so the slowing of European economies has an outsized effect on trade.
The combination of slowing growth in the U.S., structural challenges in China and Brexit disruptions in Europe have darkened the trade outlook for 2019. While a resolution between the U.S. and China will likely help the outlook some and may stave off a full-fledged trade recession, it is not a panacea for all of the global trade ills. Global trade growth is likely to be considerably slower in 2019, whether the U.S. and China call off their trade war or not.
Ibrahiim Bayaan is FreightWaves’ Chief Economist. He writes regularly on all aspects of the economy and provides context with original research and analytics on freight market trends. Never miss his commentary by subscribing.
