[China & SEA]Tariffs have been a "strategic burden", why the US won't lower them
Yao Zhizhong, Researcher, Institute of World Economics and Politics, Chinese Academy of Social Sciences
The current high rate of inflation in the US is likely to be followed by an "excessive boom" leading to a recession, or even a Great Recession. To bring the US economy to a "soft landing", it is necessary to lower the cost of supply and steer inflation downwards at a time when aggregate demand is slowly contracting, the easiest way of which is to fully remove the tariffs imposed on China under Trump. However, the Biden administration still imagines that it can use the tariffs to put pressure on China and thereby gain additional benefits from China, not realising that the tariffs have become a "strategic burden" for the US.
The US economy looks to be at the peak of a new boom: employment continues to expand, unemployment is at an all-time low since the 1970s, wages are rising, incomes continue to rise and the dollar index has appreciated by 6.5% relative to the beginning of the year. President Biden was even eager to announce an unrealised, and indeed unattainable, "growth miracle", namely that this year, for the first time in 46 years, the US will outpace China in terms of GDP growth.
However, warnings of a recession in the US economy are already rife. Recent research by former US Treasury Secretary Lawrence Summers suggests that in US history, when inflation is above 5% and unemployment is below 4% at the same time, the probability of a recession within a year is 100%. In the first quarter of this year, these two "thresholds" were reached at the same time.
The US government and the Federal Reserve believe that the US economy can avoid a recession and achieve a "soft landing". Good macroeconomic policies, especially fine-tuned ones, can indeed help achieve a soft landing. However, a soft landing is not so easy to achieve. In the history of the United States, a true soft landing was only achieved in the mid-1990s.
The current "soft landing" is not easy to achieve for three reasons.
One is that inflation in the US is too high.
Last May, the US CPI rose over 5% year-on-year and has been moving higher ever since, remaining above 8% for two consecutive months in March and April this year. To bring such high inflation down to the target level of 2%, aggregate demand would need to remain below potential output for a longer and more substantial period of time. This makes it more vulnerable to a recession.
Secondly, the current round of inflation has cost-push factors and the effect of aggregate demand policies is not obvious.
Rising commodity prices due to the Russia-Ukraine conflict, supply chain disruptions and adjustments due to the epidemic, and rising tariffs and supply chain disruptions due to adjustments in US policy towards China have all contributed to some degree to inflation in the US. To counter this cost-push inflation, greater aggregate demand deflation is required if cost-cutting measures are not taken. This would accelerate the recession and increase its intensity.
Third, the US financial markets have experienced an "excessive boom" in an environment of low interest rates andmonetaryeasing.
When interest rates rise and money starts to tighten, especially when interest rates rise sharply, financial asset prices may plummet and financial market turmoil will cause a greater and longer recession in the real economy.
A "soft landing" is still possible if the US can effectively reduce supply-side costs. The advantage of lowering costs is that it would lead to a steady downward trend in inflation during a slow contraction in aggregate demand, thus obviating the need for significant interest rate increases and monetary tightening. However, the Biden administration faces many constraints in reducing costs.
A common way to reduce costs is to cut taxes, but unfortunately, the Biden administration's policy options include only tax increases, not tax cuts. The Biden administration has launched a massive spending programme in the areas of epidemic relief, infrastructure promotion and aid to Ukraine. In the midst of rising interest rates and tightening government debt financing, the Biden administration had promised to cover the government deficit by increasing taxes. This 180-degree policy shift from tax increases to tax cuts was a bit too much for Biden.
Another important way to reduce costs is to lower international commodity prices. Can the Biden administration do this? If the US pushes for a quick end to the Russian-Ukrainian conflict and the economic sanctions against Russia, international energy, food and metal ore prices could all fall back significantly. However, the Biden administration's actions in providing military aid to Ukraine, imposing economic sanctions on Russia and preventing a peace agreement between Russia and Ukraine are not ending the Russian-Ukrainian conflict, but delaying the fighting. Even as energy prices are soaring, the Biden administration is pushing the EU to impose sanctions on Russia's oil exports, causing oil prices to rise further. Clearly, for the Biden administration, the policy of prolonging the conflict and imposing sanctions on Russia takes precedence over lowering commodity prices.
The US also has the option of asking oil-producing countries such as OPEC to increase oil production to lower international oil prices. However, high oil prices are in the interest of oil-producing countries and with the decline in US influence over OPEC members, important OPEC members like Saudi Arabia do not have the will to cooperate with the US to increase production and lower oil prices.
Another way to reduce costs is to adjust supply chain policy to obtain an external, efficient and cheap supply chain. But the Biden administration's supply chain policy is security-oriented, not efficiency-oriented. The Biden administration still cites security as a reason for discontinuing supply chain cooperation with China; seeks to rebuild supply chains domestically that have already moved out of the US; and seeks to establish backup supply chains even among allies and trade and economic partners. All of these measures will only raise the cost of supply.
Perhaps the easiest way for the Biden administration to reduce costs would be to fully eliminate the tariffs imposed on China under Trump. This is relatively easy because the tariffs were imposed by the previous administration, the Biden administration is adjusting to the inappropriate trade policies of the Trump era, the removal of the tariffs is not inconsistent with Biden's overall trade policy or his trade policy with China, and the removal of the tariffs would indeed be beneficial to the US.
However, the US is trying to use the tariff increase as a strategic asset in exchange for additional benefits from China. Little did it know that the tariff increases were no longer a strategic asset for the US, but a "strategic burden". While the removal of tariffs may provide benefits in terms of lower import costs and lower inflation for the US itself, if tariffs continue to be used to gain additional benefits from China, or if tariffs continue to be imposed due to certain domestic pressures, the US economy will continue to suffer and it will be difficult to steer inflation downwards.
If the US cannot get rid of this "strategic burden" of tariffs as soon as possible, and cannot reduce the cost of external supply through international cooperation, the pressure of domestic aggregate demand contraction will increase greatly, and a "soft landing" will be very difficult to achieve. Once interest rates rise sharply, aggregate demand contracts too quickly and financial markets become volatile, the US economy will inevitably experience a recession, perhaps even a major recession.