What does a small-scale farm-holding, two presidents, some tech companies and their respective local currencies all have in common? Well, the answer might be obvious if you have been paying attention to the so-called trade war between China and the US in the news lately. But why is it of concern and what are the far-reaching implications for the rest of the world?
Well, active involvement in international trade is a vital sign of a country’s financial health and a significant input to its Gross Domestic Product (GDP), which measures the value of all goods and services produced in a country from raw materials (input costs), to value added (assembly and skilled labour costs) to come up with final goods or services. And though “domestic” implies that this refers to a country’s internal economy as a whole, the contributions can be extended in especially from a services perspective when the country places emphasis on or relies on income from Foreign Direct Investment (FDI) to help boost its economy via its GNP – similar measurement but slightly different from GDP.
Fact is, all goods and services – and the input costs associated – derive from and are determined by the price or costs starting with that of the initial extraction/acquiring of raw materials. These then undergo the production and assembling process leading to the product or service of intrinsic value for both local and international (via exports) consumption.
An ideal situation for a country is to export more then it imports to maintain a positive balance of trade – so basically more money flowing in than out. The extra surplus can be ploughed into the economy via the fiscal budget and can supplement a shortage of funds raised from domestic taxes. The opposite, which isn’t always a bad thing, (called a trade deficit) would have to be managed and nursed like any other loan – but kept low compared to GDP.
The US has often criticized Germany for exporting a lot (of its cars, trains and machinery) and not importing much and thus not being ‘fair’ in trade practice. But trade itself, arises from market forces, priorities and consumer demand – everyone loves a BMW, Audi and Mercedes Benz so these German-made products will always be in demand compared to US car makes. Who you chose to trade with will often give rise to favourable balance of trade if you are engaged in a trade agreement or part of a trading bloc.
Why this is also a big deal is because the demand for a country’s goods and service will directly impact the strength of its local currency – more trade means more of your currency is required to pay for goods and thus the value of the Dollar, Euro, Yen or Naira etc., goes up. A strong local currency leads to stronger purchasing power for its citizens and residents when they want to plan things like holidays, purchase goods online, invest or just send cash abroad as gifts. So, you can see why a strong Dollar or Euro is always favoured and why sometimes drastic measures are taken to keep it that way.
“A higher demand for a country’s goods and services has a direct positive impact on its currency and exchange rate”
A quick glimpse of the world in terms of the input costs for goods and services that gives countries a competitive edge when it comes to trade, sees the US with intellectual property, services, weaponry; Germany with its steel and engineering machinery giving rise to high performing automobiles; many African countries with their mineral and resources such as oil, tobacco cocoa; Israel with military intelligence, South America with agricultural produce; India with IT and customer services; China with agriculture, building/(manual) labour and of late technology.
The said technology that China (no.2 on the list) offers the rest of the world is the subject of hot debate: The alleged theft of US intellectual property for tech gadgets and software by China, is one of several unfair trade practises and motives for why the US (no.1 on the list) recently decided to start imposing heavier (punitive) tax-like increases on multiple goods imported by China. These extra costs, referred to in trade terms as import tariffs, have a spill-over effect on the costs of production. China then reciprocated by hitting the US with tariffs (mainly on agriculture produce) causing the trade war that drives each country to protect its own economy or just show its economic muscle as we can see as the top two trading nations head for a showdown on the trade sphere.
The higher input costs naturally, lead to the price of the product going up and reducing its competitive advantage and demand. Higher input costs can also affect the local labour force for the worse too. Factories, multinational corporations and industries such as farms (both commercial and subsistence) – like the small-holding farm mentioned – will have to cut the cost of labour and in worse cases which we have seen, lay-off workers if they are to keep making a profit or let alone, break even.
These factors would have hopefully been taken into consideration before pulling the tariff triggers and acting with emotions rather than looking at the far-reaching implications not only locally, but to other recipients of the goods and services.
Have the talks of the trade war impacted productivity and the global trade economy? So far its just the stock markets (securities and commodities) reacting. Only time will tell.
The ramifications will also depend on the price elasticity of demand of the commodities under the tariffs: that is, how markets and respective industries affected react to the sentiment versus the actual economic activity they engage in.