Oekonommenstimme: US-Chinese Trade War
MNEs are good bargainers
Who pays for it?
26 September 2018
US consumers and input suppliers will bear a significant share of the tariff costs. A rough estimate indicates that on average 30% of the tariff costs have to be paid by US consumers and input suppliers.
At the beginning of the week US imposed tariffs on Chinese exports. In total about 200 billion USD of Chinese exports will be covered. That is quite substantial. Tariffs will gradually increase to 25% until the end of the year, and one might believe that this leads to significant tariff revenues (around 40 billion USD). Two problems arise. First, we are likely see some behavioral response. Consumer and US (intermediate) input buyers will substitute Chinese goods for relatively cheaper non-Chinese goods. The US administrations hopes mainly US goods creating US manufacturing jobs. I discussed this substitution effect earlier this week. Thus, while in 2017 the effected goods amount to 200 billion, they will not in 2018 and 2019. Second, who is actually paying the duties? If the producer just adds the tariff to the price of the good, the price increase exactly by the tariff. In this case, the consumer would pay the tariff, while the profit margin of the producer is not effected. The producer could as well reduce its (retail) price by the tariff, and the consumer will face the same after-tariff price. In this case, the producer will pay for the tariff by reducing its profit margins. In the real world, we are likely to observe something in-between. The producers reduces its profit margin and the consumer faces higher (retail) prices. If a country imposes a tariff, it ideally wants the foreign producer to reduce its profit margin and hence pay for the tariff and not its domestic consumers. So who is paying the tariff recently introduced? We can use economic theory to estimate the incidence of the tariffs. It all depends on the relative elasticities of supply and demand. Whoever is more price sensitive will pay less of the tariff costs. Using the Borda and Weinstein Import and Export elasticities estimates I compute the incidence for the products. On average about 30% of the tariff is paid by local consumers and input buyers. Meaning that once the 25% duties become effective prices of these goods in the US will increase on average by 7.5%.
The graph shows the incidence in percent on domestic consumers and input buyers for 122 HS 3-digit product categories. Clearly, the costs are widely dispersed, with some categories consumers almost bearing the entire tariff incidence.
The costs on US consumers and input buyers will be significant, but mainly depend on the importance of intermediate inputs in the production process.
End note: The incidence is computed using the standard formular: E_S/(E_D + E_S), where E_S and E_D are the supply and demand elasticities respectively.
It is a matter of substitution
24. September 2018
Today US tariffs on Chinese goods take effect. Will these tariffs really accomplishing what they are supposed to do? President Trump wants to bring back manufacturing jobs to the rust belt, while retaliation tariffs try to hurt US producers and minimizing impact on domestic (EU, Nafta, Chinese) consumers. Looking at the elasticities of substitutions of goods indicates that goods imposed with duties are well chosen.
As Chad P. Bown of the Peterson Institute of International Economics pointed out immediately after Trump’s tariff list was published, a great share of the products on the list are intermediated inputs. This should make US input suppliers more competitive and US production of inputs should increase. On the other hand, David Dollar and Ahi Wang of the Brookings Institute say that these tariffs will hurt the most competitive (exporting) industries in the US. When their inputs get more expensive, either their profit margins decline or firms are not able to sell as much due to higher prices.
In contrast, retaliation tariffs focus much more on final (consumer) goods, which seems like a bad idea as EU, Nafta and Chinese consumers are directly affected by higher prices.
Still Trump’s and retaliation tariffs rely on the same economic idea: higher prices lead to substitution effects towards (local) inputs or (local) final goods. Using the Broda and Weinstein (2006) estimates I find that the elasticity of substitution of products on the section 301 list (June 2018) have an average elasticity of substitution of 3.1. The products on the Chinese retaliation list have an average elasticity of substitution of 5.4. Thus, final goods are much easier to substitute than intermediate inputs. Clearly, Austrian marmalade can be a good substitute for US peanut butter, but aluminum or specific machinery is much harder to substitute. Hence, tariffs make US input suppliers more competitive relative to Chinese suppliers. Keeping this in mind Trump’s tariffs will bring back input supplying industries while higher costs are born by US input users, US and foreign consumers. Retaliation tariffs are focused on very specific producers and regions, while consumers can easily substitute towards alternative products. Thus, more of the economic costs of the retaliation tariffs is born by the US producers.
Both tariffs are set in a way to accomplish their political goals. Still US tariffs have considerable side effects and it is not clear that the job gains in the input supplying industries can compensate job losses in the input using industries.
Eurozone Economic Outlook: Trade tension
20. September 2018
Will global trade tension drag down economic growth in Europe? The joint Eurozone Economic Outlook of KOF, IFO and ISTAT discusses the possibility. Although the trade tension are mainly focused on China and Nafta, Eurozone trade slowed down as well leading to a lower economic growth. Two explanation come into my mind. (i) Is it uncertainty as Handely (2014) would suggest. Already the threat of higher tariffs decreases trade. (ii) Are value chains effected, as Richard Baldwin most likely would suggests. In 2014 World Input Output Tables state that Germany provided over 500 Million USD of manufacturing machinery and equipment as inputs for the Chinese basic metal sector.