How Does U.S. Protectionism Affect the Global Economy?

From media reports to late-night comedy, trade protectionism has become a hot topic. As trade economics hits the mainstream, the world is watching and wondering how increasingly protectionist policies might impact consumers, manufacturers and global economies in general.

In The Global Investment Outlook, the latest quarterly report from the RBC Global Asset Management (GAM) Strategy Committee, the team studied U.S. trade protectionism and the likelihood that current posturing will lead to a full-fledged trade war. Here is a brief rundown on the team's view.

Trade War?

While trade protectionism is "among the key risks" the team is keeping an eye on, RBC GAM Chief Economist Eric Lascelles says he would "stop short of calling it a big problem at this juncture simply because it's surprising how much protectionism you actually need before you start to do serious economic damage." In short, the level of protectionism we've seen until now may slow growth a little, and push inflation up a touch but, so far, is still more "annoyance" than cause of a trade war.

In the report, the team notes that a number of different scenarios could play out, but their "base case" forecast is for protectionism to cause only a "mild economic drag." To clarify their views, Lascelles and co-authors of the Macro section of the report, Eric Savoie, Senior Analyst, Investment Strategy and Daniel E. Chornous, Chief Investment Officer, measure the likelihood of each potential outcome – from a 20 per cent chance of a full-fledged trade war to a 10 per cent chance that trade barriers will be removed entirely.

Worst-case vs. Best-case Scenario

A full-on trade war is considered the worst-case scenario. This would involve tariffs on a variety of consumer products and raw materials that would affect many countries and potentially result in a significant economic hit for many countries. The level of damage would depend on how markets react and could range from lower growth to potential recession. The Committee puts the likelihood of this occurring at 20 per cent.

If U.S. pressure tactics prevail and other countries stand down by reducing their barriers to trade, this is considered the best-case scenario. This would open up the possibilities for increased trade around the world. The Committee puts the likelihood of this occurring at 10 per cent.

Three Protectionist Themes

The central protectionist issues facing trade negotiators are NAFTA, U.S.-China trade relations and the recent U.S. tariffs placed on steel, aluminum and (threatened) autos.

On NAFTA, the report states: "NAFTA is suddenly looking more complicated as deadlines are missed, the window for political approval narrows due to upcoming elections, progress on the auto file slows, and a proposed sunset clause creates a new schism." The Committee believes that there is a 50 per cent chance of a new NAFTA deal, a 25 per cent chance of NAFTA being terminated and 25 per cent chance of the agreement remaining as it is. This opinion is based in part on the view that China is the greater concern and therefore the U.S. may be satisfied with a "small or symbolic NAFTA victory."

In China's case, posturing continues as the U.S. adds tariffs on imported Chinese goods and China reciprocates.

Looking Ahead

Trade negotiations take time and there is a lot of uncertainty in the meantime. This can certainly be problematic and has, for example, cut as much as half a percentage point from Canadian GDP.

While "additional actions are entirely conceivable," the current view of the Committee is summed up here:

"The trade file clearly merits close monitoring given its importance and the rapid-fire changes occurring. But it is worth emphasizing that it would take quite a significant dust-up — well beyond current threats — to do a large amount of economic harm. As it stands now, U.S. fiscal stimulus is set to generate a considerably bigger tailwind than protectionism will subtract as a headwind in all but the worst-case scenario."