Originally published by Cuffelinks
During the 2016 US presidential campaign, a familiar rhetoric used by Donald Trump was the need for the US to re-evaluate trade deals such as the North American Free Trade Agreement (NAFTA) as well as several bilateral trade agreements with the intention to improve domestic employment and industries.
In line with this protectionist view of international trade, on 1 March 2018, President Trump announced his plan to enforce a 25% tariff on steel imports and a 10% tariff on aluminium imports. Immediately post-announcement, the US and global equity markets pulled back sharply over global trade concerns.
Since this initial statement, several trade negotiations have taken place, and on 22 March, the Trump Administration announced that it would suspend the steel tariffs on select countries until 1 May 2018, including Australia.
However, on the same day, President Trump also issued a memorandum directing his Administration to take action under section 301 of the US Trade Act of 1974, related to China’s acts, policies, and practices related to technology transfer, intellectual property and innovation. The actions include:
- Restrictions on Chinese investment in the United States.
- Imposition of higher customs duties on imports from China.
This announcement sparked global concerns over a potential trade war between the US and China which resulted in another sharp drop in global equity markets. As trade negotiations continue, the outcome of the tariff proposals and the Administration’s broader trade policy remain unclear. Many market participants believe that a ‘watered down’ version of the initial proposals may be implemented.
Impact on infrastructure and flow of trade
Theoretically, the enactment of tariffs changes the trading dynamics between economies, which in turn, changes the flow of trade. For the importing nation, the local consumer must seek domestic alternatives or pay a premium for imported goods. For the exporting economy, on the assumption that the volume of goods produced remains unchanged, these goods can be redirected to other countries. This redirection of trade flow has a net positive impact on infrastructure. Let’s explore why.
From a global perspective, user-pay infrastructure, specifically port, road, and rail operators, move goods throughout the global economy as well as domestically. Given tariffs impact trade flows, these companies are set to be most exposed to the impact of a US tariff on Chinese imports.
We believe that in the event the proposed tariff on Chinese imports is imposed, it will likely change the direction of trade flowing out of China rather than the volume. In other words, it’s likely that the goods will be shipped to other countries instead of the US.
For port operators outside the US, this could mean that shipping volume could remain neutral, or, in fact, could stimulate the need for greater shipping which positively affects the infrastructure needed to support the redirected trade. For instance, the frequency of the China to US route might be replaced by increased China to Europe shipments. As an extension of this, where the goods land will require a recalibration of that economy’s infrastructure to account for the increased goods coming in and then the movement of these goods around that economy. Domestic freight rail operators, and warehousing and storage providers, may have to increase their capacity to account for the increased trade.
From the perspective of the US, fewer goods being imported from China may see long-haul rail companies experience a reduction in freight volumes, however, domestic intermodal operators might see increased activity domestically as US consumers switch to alternative products. This will result in a need to re-calibrate US infrastructure. Trump’s infrastructure proposal, if passed by Congress, will help make capital available for this recalibration.
Caveats on identifying consequences
However, we do see some cautionary elements to consider:
1) The actions of the Trump Administration, including high-level personnel changes, since taking office have heightened US political risk. Some market participants believe that the recent share price movements signal that the equity markets are factoring in this heightened risk, that is, it’s less about trade, and more about general policy uncertainty.
2) Investors like infrastructure assets because they are typically characterised by long useful lives and a stable cash flow profile. Tariffs, in contrast, are often short lived and thus have a limited impact. For instance, in early 2002, the Bush Administration imposed steel tariffs of up to 30% on the import of steel. Similar to Trump’s tariffs, this tariff was highly controversial, with many market pundits fearing a global trade war. In November 2003, the World Trade Organisation (WTO) ruled against the steel tariffs citing that they had not been imposed during a period of import surge and thus the tariff violated the US WTO tariff-rate commitments. Given a looming $2 billion penalty in sanctions coupled with trade retaliation from the European Union, the US withdrew this tariff in December 2003. This tariff was only enforced for an 18-month period.
3) The enactment of a tariff may not completely remove the comparative advantage some economies have in the production of certain goods. For instance, relative to the US, Australia has a comparative advantage in the production and export of steel (predominately in the cost of transportation from the point of origin in East Coast Australia to the final market in the US West Coast). The implementation of a steel tariff, for instance, is highly unlikely to completely erode this and thus may not result in the intended redirection of steel trade flows.
Nick Langley is Chief Investment Officer of RARE Infrastructure, an affiliate of Legg Mason