Trade wars and political risk forecasting

The US-driven trade wars demonstrate the difficulty – but not impossibility – of forecasting political risk

On July 25, European Commission President Jean-Claude Juncker stood beside President Donald Trump in the White House Rose Garden and announced, to general surprise, that an agreement had been reached to de-escalate a trade war between the United States and the European Union.

The Trump administration has proven notably erratic in policy-making. Announcements on tariffs are often made with little to no warning. Trump has tweeted that “trade wars are good and easy to win” and that “tariffs are the greatest”. His twitter feed has seen a dramatic rise in mentions of trade and tariffs since March of this year. Yet, as seen in Juncker’s visit, trade wars can wind down in a similarly dramatic fashion.

 

For corporations attempting to mitigate risk, the current level of unpredictability in Washington can be daunting.  But, as we have found at OA, it is certainly possible to lay out some useful indicators that can help guide those who have to develop corporate strategies.

Less is more

In just the last 12 months on his Twitter feed, Trump has called NAFTA “the worst trade deal ever made” (Aug 27, 2017), “a bad joke” (Jan 18, 2018), “a bad deal for U.S.A” (Mar 5, 2018), and Mexico’s “cash cow” (Apr 1 & 3, 2018). This has been a continuation of his long-held suspicions of the trade deal with Mexico and Canada.

 

The worst trade deal ever made

Donald Trump, August 27, 2017

Yet NAFTA still remains in existence. This agreement is one of the foundational pieces of economic governance in the United States, and the US government’s bureaucracy has, either deliberately or through following procedure, managed to prevent its repeal. 

This stands in contrast with targeted tariffs on steel and aluminum, which were imposed by the White House under a national security claim. Even though this claim has been challenged and retaliatory sanctions imposed, it provided a quick path to implementation. For a president pushing on all fronts to exert power, the actions that face fewer procedural checks will continue to be more appealing.

Lesson: The probability of an action decreases as the number of veto points or actors necessary for approval goes up.

The 1950s redux

Trump repeatedly made claims about trade deficits that exclude trade in services. He has said that the global US trade deficit is around $800 billion dollars and that the has a US trade deficit with Canada. When including services, the US global deficit drops to $566 billion deficit and trade with Canada goes from a $23 billion deficit in goods to a $3 billion surplus.

While this omission has often been chalked up to Trump’s habitual inaccuracy, this attitude is more likely the result of a 1950s-like mindset with regards to the economy. Goods are prioritized far more than their actual importance to the economy (79% of Americans work in services). Indeed, in one of the more revealing statements Trump has made, he said that he was elected by the citizens of “Pittsburgh, not Paris” when he withdrew the United States from the Paris Agreement.

Pittsburgh does not seem to have been chosen for being of particular significance to the election. Indeed, it is a heavily Democratic city and its mayor immediately responded with support of the Paris Agreement. But Pittsburgh has a historic status as an industrial center. It was the capital of the US steel industry until the 1970s, and it was often portrayed in popular culture as blue collar manufacturing town.

Today, Pittsburgh is a rising high-tech hub, with an economy driven by healthcare and robotics. However, it is a telling symbolic choice that betrays a nostalgia for an economy long since evolved. Along with Trump’s references to coal, it is clear that Trump’s trade agenda is more well-suited to a US economy of decades ago that no longer exists. This approach fits with the basic premise of “Make America Great Again,” a ‘Golden Age’ approach to US policy.

Lesson: Rhetoric matters and can often both drive and reveal direction in policy.

Political vulnerability to retaliation

When the EU launched retaliatory tariffs on the United States in March, they chose, among the goods hit, Harley-Davidson motorcycles (built in Wisconsin, the state of Speaker of the House Paul Ryan) and bourbon whiskey (from Senate Majority Leader Mitch McConnell’s Kentucky). When China retaliated with tariffs on soybeans, it hit districts that have mostly Republican representation in Congress.

The political calculations are clear. Targets of Trump’s tariffs can read US political news and are retaliating against industries located in places represented by those who might have greatest sway over Trump. While this has not yet led to clear returns – the White House has provided 12 billion dollars in emergency aid to farmers and agribusiness rather than drop the tariffs – it is likely to remain as a political strategy. 

It may become more useful in January 2019 if Democrats win the House of Representatives; Republican senators and representatives who would be needed to override a presidential veto constraining the Executive Branch’s trade authority may find themselves under even greater pressure then.

Lesson: Trade wars involve multiple countries with many actors. Looking at the next moves out of Washington will show you only one part of the story.

Giving Trump a win

Assuming that Congress will not tie the White House’s hands – which it almost certainly will not before November – the only way for a trade dispute to de-escalate is for the White House to decide to back down.

The only way for a trade dispute to de-escalate is for the White House to back down

One reason why Juncker gained an agreement was that Trump appears to believe that it was Washington’s tariffs that forced the EU to the table. This was in part because Juncker was able to “give” Trump the appearance of a win. Unlike many national leaders, Juncker did not have to appeal to an anti-Trump electorate for re-election. He also had not previously clashed with Trump at the G-7 or NATO summits, like Trudeau, Macron, or Merkel.

In assessing whether a trade war will see a rapid de-escalation, it will be important to note whether the non-US side of the dispute has the domestic ability or willingness to grant Trump a “win”. This is more likely to be the case among non-democracies whose leaders do not have to face voters; China may be an exception because of the belief in Beijing that the economy can sustain a trade dispute for longer. 

Lesson: Trade wars are not simply economic affairs. Each national leader has his or her own set of domestic constraints that will shape the likelihood of an agreement all sides can tolerate.

Assessing risk exposure

The above is not an exhaustive list of what matters for this new era of unpredictable trade disputes. But it does help to illustrate questions to ask when determining a company’s risk exposure. 

  • Is a critical piece of the supply chain not covered by a broader trade agreement, but could be targeted by simple White House action?
  • Is it connected in some way to a high-profile sector in Trump’s view of an industry-led economy?
  • Is it located in the district of a senator, governor or representative who a non-US country would consider a possible effective voice against protectionism?
  • Is the target of US tariffs led by someone who could “end” the trade war through a photo op or quick agreement? 

By creating a process to follow, and developing resources to identify the factors that matter and stress-testing plans and operations, political risk can become – if not fully predictable – more manageable for corporations.