This blog is part of a a 7-part update series on FSG’s 2017 Events to Watch. Additional updates can be found below:
FSG’s report Events to Watch for 2017—released in December 2016—profiles the major disruptors multinationals should monitor to ensure the resiliency of their strategic plans. This series of blogposts seeks to update FSG’s view on the likelihood, impact, and signposts to monitor for each of the seven disruptors profiled in the report. This post will evaluate the downside disruptor “Trump Trade Chaos.”
Events to Watch for 2017: Trump Trade Chaos
Our downside scenario assumed that President Trump would aggressively implement his campaign promises on NAFTA, China, and US trade partners by withdrawing the US from NAFTA, designating China a currency manipulator, curbing Chinese trade with the US, and replacing multilateral deals with bilateral ones. This dramatic reversal in US trade rhetoric would engender tit-for-tat trade wars, stricter localization requirements, volatile operating costs, and foreign exchange volatility; creating a significant downside cost scenario for multinationals.
Event’s Impact on Market Potential and Operating Environment
- Unpredictable trade wars: developed-market protectionism would legitimize the routine use of sanctions and tit-for-tat tariff impositions on a bilateral basis among large and small economies
- Stricter localization requirements: growing requirements for local content and employment would undermine efficiency of multinational operations
- Volatile operating costs: companies could see costs increases rapidly in markets setting up tariff and non-tariff barriers to entry, creating more difficult decisions around portfolio allocations
- Global FX volatility: Tit-for-tat tariff wars could cause currency volatility if the imposition of trade barriers disproportionally impacts one country’s currency over another’s. Currencies that are relatively disadvantaged by trade barriers should depreciate. For example, assumptions that the US would impose unilateral tariffs against Mexican imports contributed to Mexican peso depreciation after the US election
Signposts to Monitor Revisions
NAFTA exit: In May, Robert Lighthizer was confirmed as the United States Trade Representative (USTR). Although Lighthizer could reinforce protectionist voices within the Trump Administration, he is also a seasoned trade official which may temper his approach to existing trade deals. Lighthizer notified Congress of the Administration’s intent to renegotiate NAFTA in a vague letter that promised to modernize the agreement and work closely with legislators throughout the process. The letter left out controversial provisions such as a retributive tariff scheme and adjusted rules of origin which had been included in an earlier draft. Although Lighthizer has said that the Administration will seek to preserve the current structure of NAFTA, he has also said that many issues will be resolved bilaterally. Lighthizer has also voiced interest in including currency rules in a revamped NAFTA, which would set a precedent for future trade deals. Congress is divided on NAFTA, with moderate Republicans and business leaders pushing for tweaks to the deal while Democrats and right-wing Republicans are demanding a complete overhaul. Mexico and Canada have said they are happy to modernize the deal, but that replacing it with bilateral agreements would be unwise. Pressure from NAFTA partners should not be overlooked as it apparently influenced Trump’s decision to remain in NAFTA. Renegotiation of the deal could begin as soon as August 2017.
Tit-for-tat with China: The Administration has adopted a softer tone towards China, in part to gain support in dealing with North Korea. Contrary to campaign promises, the Trump Administration has not designated China a currency manipulator. However, including a clause on currency manipulation in an upgraded NAFTA would set a precedent for successive trade deals and increase protectionist overtones in trade policy. The US recently signed a non-binding agreement with China opening both markets to increased trade in goods, although the agreement does not address steel or aluminum imports, which have been the target of recent investigations by the Commerce Department. The Commerce Department is currently considering whether to impose tariffs on steel and aluminum imports on national security grounds and on washing machines on material harm grounds, two rarely used measures of US trade legislation. A favorable ruling for US companies that resulted in the imposition of tariffs could negatively impact Chinese exports to the US.
Regional deals exclude US: Trade agreements that exclude the US have advanced as the US has withdrawn its support for multilateral deals. Negotiators for the Regional Comprehensive Economic Partnership (RCEP)—who want to finalize talks by year end—highlighted rising protectionism as a motivating factor in accelerating their discussions. Remaining Trans-Pacific Partnership (TPP) countries have also expressed their desire to continue without the US, although they want to leave the option open for the US to rejoin in the future. The progress of these multilateral deals is unlikely to stoke further protectionist measures in the US as the tone of US trade policy is more likely to be dictated by the Administration’s evolving stance on NAFTA renegotiations and Chinese trade.
A Trump Trade Chaos event was originally forecast at a probability of 25%. We are lowering this probability to 20% for several reasons. First, the US has not withdrawn from NAFTA and the Administration’s rhetoric on NAFTA has softened with the appointment of USTR Lighthizer. Second, the US has not designated China a currency manipulator or materially curbed Chinese trade with the US. Although investigations into steel and aluminum imports have the potential to negatively impact Chinese exports, it is likely that the Administration’s desire for cooperation in dealing with North Korea will keep them from escalating a trade conflict with China. Third, although regional deals that exclude the US have advanced, this development is unlikely to increase the protectionism of the US, which is more closely linked to policy stances on NAFTA and China.
Actions to Take
Given Trump’s rash negotiating style, and his appointment of economic nationalists to key trade policy roles, multinationals should still be prepared to cope with a downside scenario arising from increasing protectionism in the US and retributive tariff wars. Specifically, multinationals should develop contingency plans for markets such as China which could implement higher tariffs in response to US tariffs on steel or aluminum. Multinationals should also develop risk mitigation strategies to address supply chain disruption of foreign exchange volatility if trade barriers increase globally. FSG’ s Events to Watch for 2017 report provides in-depth scenarios, expected impact on business performance and operations, as well as recommended frameworks for contingency planning and effective market monitoring.