Photo by IMF

JAKARTA (TheInsiderStories) – The tit-for-tat tariff increases between the United States and China run the risk of escalating into a broader trade war, which could derail global growth. For the moment, the probability of such an outcome appears low.

The magnitude of the tariffs being considered, so far, will have a limited effect on overall growth (a few tenths of a percentage point), but the impact on global supply chains and specific industries could be significant.

More insidiously, the trade conflict could weigh heavily on financial markets and business investment plans. Recent evidence suggests business sentiment is beginning to erode—in part because of trade disputes.

The good news is with growth momentum strong, the situation would need to become a lot worse before it would seriously threaten the global recovery.

United States: Strengthening momentum, despite rising trade tensions.

Although the economy had solid momentum heading into 2018, the incoming data point to a temporary slowdown in the first quarter. Following an estimated 1.7% annualized gain in the first quarter, we forecast real GDP growth of 3.0% or better over the balance of 2018, followed by 2.9% next year and 2.1% in 2020. Recently legislated tax cuts and new federal spending aid near-term growth. The announced tariffs on the purchases of steel and aluminum abroad and on a long list of Chinese imports—and Chinese counter-tariffs—will have a negative, but probably small, impact on growth.

Europe: Growth is still solid, but softening.

The Eurozone economic expansion is still on firm ground, but evidence is building that the high-water mark for growth was reached in the second half of 2017. Recent data on inflation, output, and retail sales have been disappointing. The European Central Bank (ECB) removed its easing bias in early March, sounding more confident that medium-term core inflation will pick up. Eurozone real GDP growth is projected to ease to 2.3% this year, 2.0% in 2019 and 1.8% in 2020, returning to a pace closer to medium-term potential.

China: If the spiraling trade tensions are brought under control, the damage will be limited; if not…

If announced tariffs are the prelude to an all-out trade war, then the damage to US, Chinese, and global growth could be substantial. This scenario looks unlikely, given the massive mutual (and tangled) interests in US-China relations. Moreover, a US-China trade war would have major spillover effects, as foreign-invested firms in China account for more than 40% of China’s exports. China’s first-quarter real GDP growth held steady at 6.8% year on year, sustained by a stronger industrial sector, robust retail sales, and rising overseas demand. IHS Markit expects growth will ease to 6.7% this year, 6.4% in 2019, and 6.1% in 2020.

Other large emerging markets: Ripple effects—positive and negative.

If the tariffs announced by the United States and China take effect, there could be sizeable impacts on global supply chains, hurting many Asian economies. The shares of exports going to China from some of these economies (e.g., Australia, South Korea, Japan, and Indonesia) are substantial. Similarly, value added by some countries (e.g., Taiwan, Malaysia, and Singapore) to Chinese exports going to the United States is also large. Not all the impacts would be negative, however. For example, Chinese tariffs on US agricultural products could benefit Brazil, Indonesia, and Malaysia.

Bottom line: The threats to global growth have risen in the past month, but do not look especially dangerous—yet.