The United States has levied 25% import duties on $50 billion of Chinese goods and 10% duties on another $200 billion of imports. Unless headway is made in trade negotiations, President Trump has threatened to increase all duties to 25%.
These are big and meaningful numbers. Last year, the United States imported just over $500 billion of goods from China, so approximately half of the value of all Chinese imports are now subjected to around $35 billion of import duties—and this could soon increase to over $60 billion.
Given that Chinese imports account for nearly half of all container imports moving over U.S. ports, one would be excused for prematurely jumping to the conclusion that U.S. port volumes are at great risk—as are the logistics and transportation jobs associated with moving Chinese imports from the port of entry to distribution centers and on to final demand markets. But let’s not hit the panic button just yet.
In 2017 U.S. GDP was $19.4 trillion, so in relative terms, the total value of Chinese imports subjected to duties was equal to just 1.3% of GDP. Taking this logic train to the next stop, the current value of the new tariffs amount to around $35 billion, or two-tenths of a percentage point of real GDP. Even if the tariffs bump up to $60 billion, this is still less than one-third of a percentage point.
If tariffs don’t have a meaningful long-term impact on real GDP, they won’t have a meaningful impact on port volumes.
There is a nearly perfect linear relationship between container imports and GDP. This relationship has remained constant for at least three decades, which is remarkable considering all that has happened over this period, including the signing of NAFTA, the accession of China to the WTO, a boom, bust and recovery in commodity prices, the rise of the tech bubble and its implosion in 2000-2001, multiple wars, and two major financial crises—the 1997 Asian Financial Crisis and the 2008-2009 Global Financial Crisis.
Through all these major world events, the number of containers loaded with imports moving over U.S. and Canadian ports generated by each billion dollars of real GDP growth has remained remarkably consistent. In this light, even the worst-case scenario—in which $60 billion of import duties are levied on Chinese goods—pales in comparison to the magnitude of these other events.
This leaves little reason to think that these new tariffs will disrupt the long-term relationship between real GDP and container imports. For further evidence, we can look at how container volumes were affected by disruptions of a similar magnitude that occurred last year.
Rising fuel prices are like import duties and other taxes in that over a very short period, consumers find themselves having to pay more for a price inelastic product with an income that remains unchanged.
The average price for a gallon of gasoline was 27 cents higher in 2017 than 2016, and the price for a gallon of diesel increased by 35 cents. With over 200 billion gallons of these fuels consumed annually, the increase in fuel prices is equivalent to a $60 billion import duty or tax.
Yet, container imports were 6.8% higher in 2017 than they were in the prior year. For perspective, this was more than 50% higher than the average annual growth rate of 4.5% that prevailed over the preceding five years.
The strong growth in container imports in 2017 appears to be even more exceptional when one considers that the trade-weighted value of the dollar fell by 7.4% over this period. The declining value of the U.S. dollar means that the relative cost of imports increased by 7.4% (more than three times higher than the relative tariff value), yet container imports increased at an unusually robust rate. How can this be?
This seemingly incongruent set of facts—container imports rising even as purchasing power is eroded through rising fuel prices and a weakening dollar—is not beyond explanation. The increase in price for one good or set of goods does not necessarily mean that consumption of other goods must fall by an equal amount, even if total income is held constant.
Before outlining the coping mechanisms available to consumers, two additional points of perspective are worthy of discussion. Even in cases where a consumer is purchasing a consumer good that is entirely manufactured in China, the 25% import duty does not translate into a 25% retail price hike.
A pair of running shoes with a retail price of $100 might only cost the importer $30 and a 25% import duty would amount to $7.50. If the full cost of the import duty was passed to the consumer, retail prices would increase by 7.5%, which is a fraction of the tariff rate.
In the example above, it is assumed that the full cost of the tariff is passed on to the retail consumer. But this is unlikely. Instead, the exporters will share some of the burden through an erosion of profits. And this is, of course, the goal of punitive tariffs—to apply economic pressure to Chinese exporters who will then turn this economic pressure into political pressure.
Look no further than the soybean market to see how these forces unfold. China recently levied a 25% retaliatory duty on U.S. soybeans. This has had the effect of pushing U.S. soybean prices down from over $10 per bushel to around $8.50 per bushel, and in response, the soybean growers and processors have been pressuring the federal government to resolve the trade dispute.
But, while there have been price and political impacts, there is no expectation that the volume of U.S. soybean exports will be affected. Instead, the United States will fill the gap that has been left as Brazilian soybean producers have stepped in to serve the Chinese market.
Here we see that import duties have disrupted the global soybean market and caused prices to reset in the United States, China, Brazil and elsewhere. And while the distribution network has been disrupted, the volume of international trade will remain unchanged in any meaningful way because the fundamental geographic mismatch between supply and demand remains unaffected.
Turning back to the container market, we see that there are four primary coping mechanisms that should allow container imports to remain unaffected by a sudden jump in import duties of the magnitude being discussed.
Aggregate savings cushion. Consumers can choose to maintain consumption by curtailing savings. Since 2000, on a year-over-year basis, the change in quarterly seasonally adjusted gross savings has been positive approximately two-thirds of the time, and on the 22 occasions when savings declined, the average decline was just shy of $30 billion. It is certainly not beyond reason to think that goods consumption, and therefore container imports, could be supported—at least in part—by a savings rate adjustment.
Substitution of goods consumption for services consumption. Similarly, goods consumption could be maintained at the expense of the consumption of services. Consumers could, for instance, forego dinner and a movie and instead choose to buy a new jacket. Indeed, a look at quarterly personal consumption data reveals that the year-over-year growth rates in food services, accommodations, and recreation services declined in 2017, whereas the year-over-year growth rates of both durable and nondurable goods increased.
Model switching/downgrading. Consumers could also switch/downgrade models. To the extent that a tariff increases the final price of a good, consumers could simply choose to buy what would without the tariff have been a slightly less expensive model. A consumer may still spend $100 on a new pair of shoes, but they will be purchasing what otherwise would have been a slightly less expensive pair, and the volume of imports remains unchanged.
The geographic fix. In addition to model shifting and/or curtailing savings and expenditures on services, there is a geographic fix to the import duty problem. Rather than continuing to source goods from China, some importers will use this as an opportunity to shift to alternative sources, most likely other low-cost countries in Asia. This option will be easiest for importers that already mitigate risk through geographic diversification.
Approximately 80% of the $250 billion of the import duties target intermediate goods (~50%) and capital goods (~30%), while only around 20% are being levied on consumer goods. Consumer goods (aka final goods) are sold directly to the consumer. Intermediate goods are consumed in the production of other goods, and capital goods (tools, machinery, equipment, etc.) are used to produce consumer goods, intermediate goods and capital goods alike.
Relative to the final price of a good, import duties on consumer goods will have a much bigger impact than import duties on intermediate goods and capital goods because the foreign content is much higher for consumer goods. National statistics provide some insight into the magnitude of the difference.
Intermediate goods comprise around $125 billion of the $505 billion of Chinese imports. This is equivalent to only around 2.5% of U.S. manufacturing output. If it is assumed that a 25% import duty will be applied to all intermediate goods (many are only subject to a 10% import duty now), these duties will only amount to around $30 billion, which is only around one-half of one percent of total manufacturing output. If the full value of the import duty is passed on to the consumer, we would expect to see prices increase by this small amount.
The case for capital goods, equipment and machinery that is not consumed in the production of final goods is even weaker, as the cost of these duties will be spread across the depreciation period, which might range from 5 years to 25 years.
Not only are consumer goods not the primary target, a meaningful share of the goods that are now subject to import duties are not imported over U.S. seaports. Of the $505 billion of Chinese imports, $154 billion (30%) arrive as air cargo, and 18% of the total value of goods targeted for import duties arrives by air, and of the seaborne trade, around 5% is comprised of transportation equipment that is not containerized. Only around three-quarters of the goods targeted by tariffs are shipped by container.
The sudden imposition of import tariffs has also threatened to elicit unintended consequences. Asheville, N.C.-based Moog Music, a manufacturer of keyboard synthesizers, said that import duties threaten the company’s profitability to such a degree that they may be forced to relocate manufacturing overseas.
Similarly, Tenn.-based A-1 Signs fears that the steel tariffs will render their products uncompetitive, and if this company goes out of business, some portion of the company’s sales will be lost to foreign competition. Ironically, in these and other cases, the net effect of new tariffs on import volumes would be positive, rather than neutral or negative.
While it’s highly unlikely that the import duties will affect the long-standing linear relationship between real GDP and container imports, it is possible that the tit-for-tat trade war will continue to escalate and fail to be resolved. Indeed, JP Morgan now views this outcome as the most likely of possibilities, and their new base case assumes a full-blown trade war. Under this scenario, a variety of forces will pull down the real GDP growth rate by a full percentage point in 2019.
Modeling how this impact to real GDP will affect container imports requires an important assumption be made. Specifically: Will such an impact be sufficiently large to cause a decline in potential GDP (the measure of how much total economic output would exist if all resources were fully deployed)? If there is no impact on potential GDP, any slowdown in 2019 will be countered by accelerated growth the following year as real output races to catch back up with potential output.
On its own, a 1% decline in the growth rate is not enough to affect potential GDP; therefore, any impact on volumes will most likely be very short lived. That said, there is an outside possibility that a full-blown trade war could unleash the “animal spirits” that last spooked markets in late 2007.
Under a worst-case scenario, a contraction in consumer sentiment would cause consumers to curtail spending in favor of savings. Along with a reduction in the velocity of sales, retailers would likely postpone restocking inventories.
A reduction in economic activity could, in turn, cause the unemployment rate to rise, thus causing a further contraction in consumer sentiment, and another round of increased savings and economic contraction. A process such as this would cause a recession and contraction of imports, and if the recession is large enough, it would also cause potential GDP to contract thereby having a lasting impact on container volumes. But, this remains an outside chance at this point.
The tariff war will not be without casualties, but container imports should not be among the wounded.
While hindsight may be 20/20, foresight is closer to 50/50, and it is impossible to know how the tit-for-tat trade war will develop. It wasn’t that long ago that many feared that the Trump administration would be incapable of renegotiating NAFTA, but we now have a new agreement that appears to be a slight improvement on the old one. It’s certainly possible that the trade war will prove to be a successful strategy that leads to improved relations and an acceleration in real GDP growth.
As they stand now, import duties of 25% on $250 billion of Chinese imports are not likely to have a meaningful impact on U.S. port volumes or the logistics and transportation jobs that are associated with Chinese container imports. But as the Moog Music example demonstrates, casualties are already mounting.