U.S. Businesses Are Stuck in Trade War Uncertainty

(Bloomberg Opinion) -- The tariff burden from the U.S.-China trade conflict is “falling almost 100 percent on China,” President Donald Trump’s senior economic adviser Larry Kudlow argued last week. But take a look at what’s happening to business investment in the U.S., and it’s obvious Kudlow is wrong.

Some businesses stand to gain from the president’s trade policy — especially those that compete with Chinese imports. Many others stand to lose. And none can be certain how Trump’s conflict with China will play out over the coming months and years. This leads companies to delay investment decisions, in hopes that the outlook will one day clear up.

Their paralyzing uncertainty is driven by the president’s veering from one position to another. Businesses seem increasingly convinced that he doesn’t understand the basics of international economics. Trump bemoans the relative strength of the dollar one day, declaring China a currency manipulator, and the next he praises dollar-strengthening inflows of foreign investment. With such a tenuous grasp on the facts of the situation, how can he make predictable policy? How can businesses anticipate what he’ll do?

At the same time, events are making the post hoc rationalizations about Trump’s trade regime — that he is actually a radical free trader using tariffs to make trade even more free in the future — increasingly unpersuasive. There’s growing acceptance that the president really is a protectionist to his core.

The U.S. had been imposing a 25% levy on $250 billion in Chinese imports. In June, Trump agreed not to impose additional tariffs and to restart trade negotiations with China. Earlier this month, he abruptly changed his mind, instituting a 10% tariff on the remaining $300 billion of U.S. imports from China, effective Sept. 1. But then came Tuesday, when he delayed much of this action until December. “We’re doing this for the Christmas season,” the president explained. “Just in case some of the tariffs would have an impact on U.S. customers.” This is a shocking reversal from his longstanding insistence that his tariffs don’t have a negative effect on the U.S.

Who can tell what he’ll do next? Will something he sees on cable news goad him into reversing the delay? Will he raise the new tariffs to 25%? Or higher? For businesses in this environment, the option value of delaying investment decisions is quite high.

Huseyin Gulen of Purdue University and Mihai Ion of the University of Arizona have attempted to quantify the effect of elevated policy uncertainty on corporate investment. In a 2016 paper, they show that a doubling of the level of political and regulatory uncertainty — after controlling for measures of broader economic uncertainty — is associated with an 8.7% decline in investment.

New research suggests that the trade war follows this pattern. Economists at Goldman Sachs looked at data from 70 industries, and found that the sectors with the highest share of total sales in China had markedly lower capital expenditures in early 2018, when trade tensions began to escalate. Over the previous two decades, those same industries invested relatively heavily.

Of course, if businesses are feeling more pessimistic about the trade war, they may not just delay investments (and hiring) but cut back. Many surveys show that business sentiment has noticeably darkened. Some further suggest an elevated risk of recession.

The trade war’s likely effects help explain what happened to the promised investment boom following the 2017 corporate tax cuts. The Trump administration stimulated business spending with its left hand, but slowed it with its right.

The president is working against more than just his tax cuts. By pumping the brakes on economic growth, he’s hurting his own reelection chances. You would think that would motivate him to reach a face-saving deal with Chinese President Xi Jinping, and quickly. But this protectionist president seems not to have adequate clarity on what is and is not in his — and the U.S. economy’s — best interest.

To contact the editor responsible for this story: Mary Duenwald at mduenwald@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”

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