Trade Wars, Pain and the "Pass-Through Rate"

You don’t need to be a PhD in political science or economics to know that the US relations with China have hit new lows during both the Trump and Biden administrations. Economically, the essence of our trade policy was a tariff war. Politically, two presidents were facing China’s President Xi Jinping reconfiguring his nation into one where he would blow away traditional term limits, effectively becoming the first PRC leader in decades to become “President for Life.” A dictator. In the annual Communist Congress this fall, Xi purged the Standing Committee of the Politburo of moderates and any who even slightly opposed Xi and his policies. Ruthless Xi.

This new hardline vector was in part predicated on the assumption that the United States was fading fast from its own self-inflicted internal polarization. Even as Xi embraced Vladimir Putin prior to the Ukraine debacle, the Chinese leader clearly treated Russia as a junior partner. Internally, Xi focused on pulling China back from a de facto capitalist powerhouse run by a phalanx of corporate billionaires, more committed to their personal wealth than to China’s path to global political and military leadership. Putin’s failure in Ukraine further moved China upward and marginalized Russia’s relevance to Xi.

Xi expanded a manmade expanded island air and sea base in the South China Sea (in the Spratly chain), poured money into upgrading his military to create the largest navy on earth… and began a steady and elevating game of rhetoric and military brinkmanship asserting the PRC’s claims to over Taiwan as a traditionally Chinese territory. Even as President Biden met with Xi, face-to-face and unmasked, at the mid-November Group of 20 summit in Bali, Indonesia, it was clear that progress was little more than “baby steps” to resume a routinized dialog between the nations.

For Americans facing escalating prices at every turn, the heart of the Sino-American diplomatic freeze was the trade war. Biden did little but continue his predecessor’s tariff and trade restrictions, even expanding some critical technical trade restrictions. The question, therefore, must be who fared better or worse in this economic conflict, China or the United States?

A November 22nd Report from the Yale Economic Growth Center, written by Renée Sanacora, focused on the empirical analysis by Yale Economics Professor, Amit Khandelwal, and his fellow researchers. Tariffs and trade restrictions make stuff cost more. Whoever pays those higher costs is generally the absorber of the most pain. If critical parts go missing, the stuff that needs those parts to be built doesn’t get built. Supply is reduced, and as we all know, low supply means… er… higher prices, only now the manufacturer, wholesaler and retailers don’t have enough product – and what product it has is more expensive which does not endear that company to buyers – so they make less money… and may even be forced to layoff some of their workers. More pain.

But when prices go up, sometimes that higher cost is split between the seller and the buyer… sometimes it all goes to the consumer to bear. The above report tells us: “According to Khandelwal’s analysis, the mutual tariff escalations that progressively rolled out marked a rupture in US trade policy history on scale with the Smoot-Hawley Tariff Act of 1930 – a protectionist policy that many economists believe exacerbated the effects of the Great Depression. However, it is difficult to pinpoint how these tariffs affected economies in the short and long term is a hard question to answer. This is because tariffs change the prices of goods at the border, and this affects the behavior of both consumers and producers. Since the beginning of the conflict in 2018, relations between China and the US have deteriorated under two American presidencies from opposing parties.

“‘Khandelwal and Pablo D. Fajgelbaum review[ed] what economists have learned to date about the trade war and its effects. ‘One thing that was surprising in this trade war is that the cost was fully passed on to the consumers,’ Khandelwal said. When tariffs increase, firms face a choice of how much of the cost to absorb, and how much to pass on to consumers. This ‘pass-through rate’ is tool to economists use understand the effects of trade policies. For example, tariffs that are passed fully to consumers makes them worse off, but the flip side of the coin is that it provides a shield for domestic producers. In previous tariff incidences, only about half of tariff changes were passed through to consumers. But, for reasons that still remain unclear, in the US-China trade war, all of it was.

“In aggregate, the trade war lowered US and China GDP, although not by large magnitudes. But, because of the high pass-through rate, the trade war hurt consumers but made US producers better off. Moreover, since different parts of the US specialize in different sectors, the impact of the US tariffs and Chinese retaliations had different impacts across regions. For example, the Midwest, an agriculture-intensive region, was particularly hard hit by China’s retaliations on US agriculture.

“Khandelwal argued in an op-ed in the Financial Times on June 8, 2022, that ‘tariffs can only help manufacturing jobs if they raise prices’ and that the Biden administration should roll them back in order to fight inflation…

“The team [also] utilized product-level global trade flows to track reallocation patterns of the US, China, and the ‘rest of the world,’ finding that while the two economic superpowers reduced trade with each other, global trade overall actually increased by 3 percent. Bystander countries redirected exports from China to the US and increased exports to the rest of the world, resulting in what Khandelwal believes is not just a shuffling of goods, but rather a transition toward new international trade routes. In the past decade, support grew for the Trans-Pacific Partnership and the African Continental Free Trade Area, and Khandelwal believes new networks among lower-income countries will continue to grow in coming years…

“Khandelwal predicted that the trade war will be marked as ‘one of the early, large events among what I think will be many that will lead to a deterioration between US and China relationships.’ He hopes to use surveys to understand effects of recent events on supply chains. ‘Companies were looking to move their operations out of China, and the trade war accelerated that and then the pandemic accelerated it even more.’” In short, Chinese and American consumers got slammed the most – but Xi has no concern about his nation’s consumers and has only recently had to face his citizens’ wrath only over his lockdown zero-COVID policies.

Lacking back-up resources, poorer nations bore the largest brunt of these economic displacements, even as developing countries may have picked up some of the slack to restore parts of the supply chain on a more level basis. American citizens got a reduced but more expensive standard of living, one that has hardly been covered by the pay increases that rippled through our economy. Add interest rate hikes from the Federal Reserve, and US policies are taking us all down a big economic notch.

I’m Peter Dekom, and what often seems like a justifiable punitive response against another nation’s unfair trade practices often boomerangs back to hurt the ordinary citizens of the retaliator… like us!