Weekly economic briefing: Where is the world heading on trade?

The Weekly Economic Briefing is written by two senior Deloitte Economists, David Rumbens from Deloitte Access Economics in Australia and Ian Stewart Deloitte’s Chief Economist in the UK. They provide a personal view on topical financial and economic issues. Subscribe to receive the Weekly Economic Briefing in your inbox!

In this week’s blog:

Australian economic briefing
UK economic briefing
International economic briefing

Australian economic briefing by David Rumbens

This section of the briefing provides a snapshot of key economic data and issues of relevance to Australia.

Politics versus economics: Where is the world heading on trade?

One lesson from history is that when the two are in conflict, politics trumps economics. That was the lesson of Brexit. And it appears to be true in the current trajectory of world trade policy.

We may not be in the throes of a full-blown trade war just yet, but trade skirmishes are escalating. China’s decision on Monday to add tariffs of 15% to 25% on US$3 billion of US imports marks another step on the road of tit-for-tat trade retaliations against the US, even while the US itself may enact yet more tariffs. This has investors worried about how far this escalation will continue, and equity markets took another big hit.

While the US was central to establishing the current ground rules of global trade, the Trump Administration’s recent actions pose the biggest challenge to those rules since they were first established. Let’s recap what’s happened so far:

On 1 March, the US announced a blanket 25% tariff on steel imports and a 10% tariff on aluminium imports, citing national security considerations (and thereby avoiding breaking WTO rules). No country would be exempted, the Administration said. Global share markets fell.

On 7 March, the European Union, which would be among the most affected by the tariffs (despite China being the US Administration’s apparent main focus), retaliated by suggesting it could apply tariffs on US imports.

On 9 March, President Trump tied the potential for Canada and Mexico to be exempted from the tariffs to renegotiating NAFTA – the 24-year-old free-trade agreement between the US and those two countries.

The EU followed up its initial threat on 16 March by proposing tariffs on 100 products exported by the US – putting itself at risk of violating WTO rules. Investors and others’ concerns about a tit-for-tat rise in tariffs were given some initial validation. And the post-WWII gentlemen’s agreement on the global trading system faced another threat.

On Friday 23 March, President Trump ordered his government to compile a list of Chinese exports on which new tariffs would be applied, with reports that US$60 billion in tariffs would be imposed. China promised retaliatory measures. Global equity markets took another tumble. Meanwhile, the US said that US allies would be exempted from steel and aluminium tariffs until 1 May, when the terms of permanent exemptions could be negotiated.

The next day, the US Administration clarified that tariffs would apply to US$60 billion-worth of Chinese imports (not US$60 billion in tariffs), with an average tariff of 25%. China retaliated with tariffs on a much more modest US$3 billion of US export goods, and notably didn’t announce tariffs on the high-volume imports of maize and soybeans.

This was followed up with Monday’s announcement, while the door seems to be left open for more Chinese retaliatory responses.

China’s initial response has been one of relative restraint. (Even with this Monday’s additional tariffs, China has added tariffs on about US$6 billion-worth of imports, versus the US’s US$60 billion.) China and the US are also reportedly in behind-the-scenes negotiations to try to iron out their trade differences, suggesting that China is not keen to allow trade barriers to surge.

European leaders have reacted strongly. Regarding negotiations over permanent tariff exemptions, French President Macron asserted that the EU will not be blackmailed, saying “we will discuss anything, as a matter of principle, with a country that is a friend and that respects WTO rules.  We will discuss nothing, as a matter of principle, with a gun pointed at our head.”  EU Trade Commissioner Malmstrom said, “we are always ready to talk, but not under threat.” Such public rift among Western allies is highly unusual, perhaps unprecedented.

So where to from here? President Trump has said that the recent tariffs were the “first of many”. The EU and China have retaliated, and a full-blown trade war cannot be ruled out – especially with both President Trump and US Treasury Secretary Mnuchin saying they’re willing to go down that path.

But if the US Administration is not willing to heed the calls of world leaders and US trade associations, perhaps it is willing to listen to the equity market. President Trump has tied his fortunes to the equity market, claiming that the strength of the equity market reflected the strength of his policies. In making the equity market a barometer of his success, he may have somewhat tied his hands on policy. Hence, when equities plunged on his tariff announcement, the US Administration quickly backtracked (see chart). If the Administration wants to keep the equity market happy, that may curtail how aggressively it pursues policies that hurt international trade.

Chart 1:US equity prices

Source: Thomson Reuters Datastream

 

For Australia, the impacts of a full-blown trade war between the US and China would be nasty, but not dire. The prices of Australian exports such as coal and iron ore would fall, hurting Australian incomes. But this would be partly offset by a lower Aussie dollar. In the scenario that we have previously modelled, there would be more than 20,000 fewer jobs in Australia by late 2019. Some sectors would be hit harder than others: mining and construction would feel the most pain.

For more information on the Australian brief, please contact co-authors David Rumbens and Craig Michaels.

 

UK economic briefing by Ian Stewart

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to and view previous Monday Briefings at: http://blogs.deloitte.co.uk/mondaybriefing/

Can labour scarcity drive productivity?

  • To the bafflement of economists Britain’s economic recovery has been accompanied by growing demand for labour and falling wages. Since 2007 the number of people in work in the UK has risen by 2.7 million, an increase of 9%. Over the same time earnings, after allowing for inflation, have fallen by about 2.5%.
  • The so-called Phillips Curve, which assumes a relationship between unemployment, wages and inflation, seems to have broken down. The US has also seen the relationship between labour demand and wages weaken.
  • Economic uncertainty and different forms of work, including the growth of self-employment and part-time work, have dampened wage and inflation pressures. The relationship between labour supply and demand may have changed, but recent data suggest it has not been destroyed.
  • In the wake of the financial crisis the number of people moving from one job to another fell sharply as employees reacted to uncertainty by staying put. Today low unemployment and plentiful job vacancies have increased the incentives to change jobs in search of pay rises and seniority. In a powerful sign of growing wage pressures so called job-to-job flows are running at the highest level in 17-years in the UK. It is much the same story in the US.
  • Last week the Bank of England reported that employers were facing widespread recruitment difficulties, with skills shortages broadening from construction, engineering, software development and professional services and logistics to hospitality, warehousing, agriculture and food. The Bank noted that growing skills shortages reflected a diminishing availability of EU migrant labour.
  • This represents a big change. For the last two decades employers have been able to count on a strong supply of workers coming to the UK from overseas, and increasingly from the EU.
  • 2.7 million more people are in employment in the UK today than in 2007 of whom 45% are EU-born, mainly from the Central European nations, 32% are from outside Europe and 23% are UK-born. Immigration has played a major role in meeting increased labour demand in the last decade.
  • But a weaker pound and Brexit-related uncertainties seem to have dimmed the appeal of the UK to EU workers. The annual rate of growth of the UK’s EU-born workforce slowed to just under 4% at the end of last year after a decade and a half of growth averaging around 12%.
  • A historically low unemployment rate, coupled with new barriers to EU migration, represent a step change in labour supply. Wage pressures seem likely to mount. The Bank of England reports that UK employers expect pay rises to average 3.1% this year, up from 2.6% in 2017. This will be good news for consumers, but a challenge for employers.
  • The question is whether rising labour costs will be financed by productivity growth or whether margins will be squeezed, and jobs lost. The theory that sluggish wage growth has contributed to an inefficient use of labour, and low productivity, is about to be tested.

PS: Last week we hosted a Brexit webinar for Deloitte clients and asked them how confident they were that the EU withdrawal terms would be ratified before March 2019 and that the transition would actually happen. 38% were not confident; 41% were somewhat confident and 8% were very confident. The rest were unsure. At least for this business audience there was a fairly high degree of scepticism that Brexit will go according to plan.

 

OUR REVIEW OF LAST WEEK’S NEWS

Facebook, Amazon, Google and other ‘FAANG’ stocks suffered their worst one-day decline last week as fears of increased regulations and setbacks for technology companies impacted the sector which has powered the S&P to record highs.

The FTSE 100 ended last week up 1.9% at 7,056.

 

International economic briefing by Ian Stewart

Economics and business

  • The Bank of England (BoE) said that a shortage of labour is holding back economic growth in the UK
  • The UK manufacturers are planning to increase investment as factories operate near capacity, according to the BoE Agents’ survey for Q1
  • UK car production fell by 17% in February on an annualised basis, the seventh consecutive month of decline
  • GNK shareholders accepted an £8bn hostile takeover bid from Melrose industries, who made commitments to invest in “R&D, skills and people”
  • China announced duties on US food imports of up to 25% in response to the Trump administration’s tariffs on steel and aluminium products
  • France’s current budget deficit has fallen below 3% of GDP for the first time in ten years, reflecting increased revenue from a growing economy
  • The BoE warned that mortgage lending in the high loan-to-value or loan-to-income brackets has risen significantly since the financial crisis
  • Autonomous vehicle maker Waymo to purchase tens of thousands of vehicles from Jaguar Land Rover
  • Saudi Arabia signed a $200bn deal with Japanese investment giant SoftBank, potentially establishing the world’s largest solar power generation project
  • The US yield curve is at its flattest point since 2007. An inverted yield curve tends to be a reliable predictor of recessions
  • Harvard economist Jeffrey Frankel suggested that technological innovation has had a negative effect on productivity in recent years, citing cyber-attacks and the rise in distractions
  • UK courier firm DPD is to offer its 6,000 drivers the right to be classified as workers with rights to sick and holiday pay
  • Investment in the UK rose by 4% in 2017, the highest of any G7 country. Most of the investment growth was due to increased spending on buildings including private housing, offices and infrastructure

Brexit and European politics

  • British companies could be frozen out of ‘Galileo’, a huge European space project after Brexit due to security concerns, according to the European Commission
  • European aeronautics giant, Airbus, has said the UK’s participation in such projects is crucial for partnership on defence and security
  • Only 12% of unemployed Europeans aged 20-34 would move to another EU country for work, whilst 19% said they’d move outside of the EU, according to Eurostat
  • The European Commission is considering using €56bn of profits made by the bloc’s central banks to help fill the long-term budget hole left by Brexit
  • British car production could fall by 8% over five years if carmakers do not commit to making key models in the UK, according to AutoAnalysis
  • The average fertility rate in the EU is 1.6, well below the generally accepted level of 2.1 needed to sustain a population without immigration
  • The BOE said banks can use their existing regulatory licenses until the end of the Brexit transition period, the FT reports
  • British businesses want unrestricted access to European workers to continue after Brexit, according to a report by the Migration Advisory Committee
  • Bloomberg reports tensions between Germany and France over how to respond to proposed US tariffs on European steel and aluminium, with Germany apparently preferring a more conciliatory approach that would help German exporters
  • Estimates of the number of finance jobs set to move from the UK due to Brexit has fallen by half compared to six months ago, according to a Reuters survey of City firms
  • The European Investment Bank has approved a £120m fund aimed at businesses in the North East of England, the region with the highest unemployment nationally

And finally…

Euguene Ng, known as Dr Ark by his clients in Singapore, provides eyelifts for some of the world’s most expensive fishes which can sell for thousands of dollars. The doctor loosens the tissue behind the fish’s eye and pushes the eyeball further into the socket – cosmetic sturgeon


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