10/1/20: U.S. Tariffs on European Wines: Inflicting Self-Harm

Next week, the  Office of the US Trade Representative is expected to make a determination on the potential imposition of an up to 100% tariff on imports of wine from Europe. Which is a bad thing for the overall state of the global trade, bad news for the European producers of wine, bad news for the American consumers and their European counterparts, and bad news for the U.S. wine industry. But 'bad things' do not stop there. There will be costs imposed on restaurants and bars. There will be negative spillover effects - in the long run - to the competitiveness of the U.S. wine making industry competitiveness. In other words, the new tariffs are a perfect exemplification of how poor policies in one sector can hammer the entire complex chain of value added across a much broader economy, both in the long run and the short run.

Let's start from the top.

Causes

The reason for the introduction of the tariffs on wines made in Europe - the first wave of which came in in October - has absolutely nothing to do with the wine makers or wine importers or wine consumers. Back in September this year, the WTO Arbitration Panel has ruled that Boeing (the U.S. civilian aircraft manufacturer - in addition to being also a major military-industrial complex player) and Airbus (Boeing's European counterpart) received tens of billions in illegal state supports and subsidies over the period of 15 years. These supports included tax subsidies and credits and subsidised loans. All of which was well known to anyone even remotely familiar with economics of both the EU and the U.S. well before the WTO rulings.

Given the state of the U.S. trade policy (War First, Trade Later) and the fact that Boeing is in a pile of financial problems stemming from its disgraceful handling of the 737 Max scandal, the U.S. rushed out of the stables to mount its trade offensive against the EU. imposing 25% tariff levy against European wine producers. The measure, of course, was 'designed' (if one call it thus) to hurt European economies. Wine industry is iconic for countries like France (Airbus major domicile), Italy (which hasn't much to do with Airbus and was partially spared from the hit) and Spain (another Airbus HQ domicile). Germany also got hit, especially given its well known white wine production. Now, Airbus has also major presence in Mobile, Alabama, USA (where is works on A319, A320 and A321 models) and Mirabel, Canada (A220 model), although Chateau Mobile and the fabled reds of Mirabel were spared by the U.S. trade authorities.

The new round of tariffs - the 100% ones being currently considered - also come on foot of the finding that France’s new digital services tax discriminates against US tech companies, according to USTR, even though the French tax is a de facto precursor to the OECD's Digital Services Tax initiative (covered here: https://trueeconomics.blogspot.com/2019/08/12819-oecd-tax-plans-some-bad-news.html and, in more detail, here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3406260).

European response to the same triggers was to call for a negotiated resolution of the disputes over Boeing and Airbus. Which, of course, is not how the U.S. does business these days.

First round impact

The first round of sanctions had little impact on the wine makers, hammering instead U.S. supply chain - distributors, warehousing, wholesalers and retail - and U.S. consumers (just in time for the Holidays season). The reason for this is that European producers have a massive latent excess demand for their wines in Asia-Pacific and Eastern and Central Europe, where consumers prefer European wines - by taste, brands and cost points - to the U.S. wines. U.S. distributors and wholesalers took a direct hit: most of the 25% tariff has been absorbed into lower profit margins by the importers.

One of the reasons this worked is that the U.S. demand for wine is growing, which means that for relatively benign tax hikes, suppliers can lower unit margins in hope of compensating with continued growth in demand.

Demand has grown from the recent plateau of 2 gallons pa per person in 1999-2002, to just under 3 gallons in 2018. This margins logic breaks down when tariffs rise above 35-40% mark, making cost pass-through to the consumers virtually unavoidable.

A message from the small wine importing firm, specialising on ESG impact-driven natural wines, makes another case: http://www.jennyandfrancois.com/2019/12/17/wine-tariffs-threaten-our-very-existence/. "These [proposed 100%] tariffs are really without precedent, but to glimpse a window on the possible disastrous consequences, we could examine the 1930 Smoot Hawley Act. History teaches us that this act hastened the arrival of the Great Depression, extended its length, led to a 65% downturn in global trade, and made imported goods a luxury item only affordable to the top 1% of the American population. What’s more, those tariffs were only between 40-48%, not the 100% tariffs currently in discussion. Smoot Hawley is the reason most of the world’s leaders today favor unregulated free trade." And "I spent 20 years of my life building a successful business, and in one signature the Trump administration could make it all crumble."

Killing wine wasn't a great policy back in the 1930s. For everyone involved. Hammering European wine today won't be either.

A wider impact can be seen in the restaurant and catering sector. Here is how disastrous tariffs on wine can be for restaurants business: https://www.postandcourier.com/blog/raskin_around/proposed-wine-tariffs-could-spur-widespread-charleston-restaurant-closures-opponents/article_3a07ee26-2e44-11ea-a9e1-b3eafe8429c4.html. "One downtown Charleston restaurant owner estimates the loss of Prosecco alone would amount to a $57,167 annual revenue loss... Just those drinks hypothetically work out to more than $1,000 a month in server tips, on average. Assuming that loss is equally shared by a 12-person front-of-house crew, each employee would be out approximately $94, or about two-thirds of the average monthly household utility bill in Charleston."

The impact is not lagged: "when the 25 percent tariff was implemented, Root says, “it became part of our working capital immediately. We had to come up with $40,000 unexpectedly” in order to free up wine which had already shipped. But he characterizes a 100 percent tariff as “impossible.”"

Even in the time-sensitive, so less tariff-elastic cases, it is the U.S. businesses that have been absorbing the lion's share of the cost increases, as illustrated by the 2019 vintage of Beaujolais Nouveau release last year that came after the 25% tariff hike of October 2. This is covered well here: https://www.winemag.com/2019/10/29/tariffs-on-european-union-goods-impact-u-s-wine-industry/. In theory, producers should be absorbing more of the tax increase cost in lower elasticity supply cases. But due to supply chain complexity and the fact that producers face global demand, with lots of substitution options, while the U.S. wholesalers, retailer and consumers have inelastic demand (due to timing-sensitive nature of the market for Nouveau releases) this is not the case.

Bad news for the U.S. producers

So higher tariffs on European wines should be a good thing to the American producers of wine, right? After all, as prices of their competitors rise, their products should experience increased demand due to consumer substitution in favor of cheaper alternatives.

This is a fallacious argument, given complexity of the wine business.

Firstly, price-sensitive consumers who have a greater incentive to switch away from European wines toward other alternatives are likely to go for cheaper Chilean and Australian wines instead of the already higher-priced Californian, Oregonian and other U.S. offerings.

Secondly, demand for all wine is likely to decline due to higher prices, but also due to the reduced range of wines that consumers might consider affordable to them. Consumers do not simply buy the wine by the price. Instead, consumers buy, say, California wine because they want something different from the Italian wine, and they buy Italian wine to diversify their consumption (broaden the range of taste options) from French offerings, and they buy French offerings because they have been consuming Spanish ones, and so on, until they reach back to California wines. It is exactly the same with food: making Thai cuisine more expensive does not necessarily mean Italian restaurants will gain more customers. Instead, it might mean that consumers will reduce demand for eating out in all restaurants and switch to fast food instead.

Thirdly, wine business is also complex. U.S. producers innovate and collaborate with European producers. Adversarial trade is not good for technology and intellectual property transfers between them. And U.S. producers are also worried about inevitable EU counter-measures. Worse, if tariffs were to trigger significant drop off in the number of wholesale, retail and restaurant businesses and trading volumes, smaller U.S. producers (who tend to be more innovative and have greater intellectual property investments in the industry) will have fewer channels to sell and market their own offerings. Here is one California wine producer views on the effect of potential decrease in the number of wholesale / distribution partners under the 100% tariffs proposal: https://tablascreek.typepad.com/tablas/2019/12/no-100-tariffs-on-european-wines-wont-be-good-for-california-wineries.html. To quote them on restaurants part of the chain impact alone: "Restaurants are famously low-margin businesses anyway. Increasing the costs of their wine programs will push some out of business, further reducing outlets for our wines."

Lastly, no U.S. producer of wine would want to face a prospect of their brand capital worldwide being associated with state-imposed tariff 'protection'. Majority of the American winemakers compete on their own creativity, experience, and marketing. In a highly product-differentiated world, hammer-all tax measures do little to help indigenous producers to succeed. They dilute quality of signalling that successful brands develop with their sweat and capital.

To quote, again, the excellent Tablas Creek folks (link above): "Why wouldn’t the wine community just switch its sources to other, non-tariff countries? Wine is not a commodity, where a customer can simply swap in a wine, even one made from the same grape, from one part of the world for another and expect them to be comparable. Wines are products inextricably tied to the place in which they are produced. And the disruption of 100% tariffs on wines from the world’s oldest wine regions would have cascading impacts that would reach deep into a whole network of American businesses, investors, and consumers."

15/8/19: Winning Trade Wars: Round 3

A couple of days ago, Germany's info Institute published two scenarios estimating the impacts of the latest President Trump threats to China, the imposition of a 10% tariff on Chinese exports to the U.S.

Per ifo's Scenario 1: "If the US imposed 10 percent tariffs on additional imports worth USD 300 billion, this would mean additional income of EUR 94 million for Germany, EUR 129 million for France, EUR 183 million for Italy, EUR 25 million for Spain, and EUR 86 million for the United Kingdom. It would amount to EUR 1.5 billion for the EU28 and EUR 1.8 billion for the US. China would see losses of EUR 24.8 billion." Note: the U.S. 'gains' do not account for U.S. agricultural subsidies supports increases announced by the Trump Administration, but include estimated consumer impact. Potential depreciation of yuan was also not accounted for in these estimates.

Summarising Scenario 1, ifo noted that "The additional tariffs on US imports from China threatened by US President Donald Trump would negatively impact China, while giving the US, Europe, and the UK moderate advantages."

"However, Chinese retaliatory tariffs could turn the US advantage into a disadvantage, while somewhat reducing China’s losses," ifo notes in relation to the estimates of the impact under Scenario 2 that includes retaliatory tariffs by China. "These retaliatory measures would lead to even greater advantages for the UK and the EU. ...If China imposes a further 10 percent tariff on US imports, it could see its losses fall to EUR 21.6 billion, while turning profits for the US into losses of EUR 1.5 billion. The UK and the EU would have the last laugh and come off best. Germany would see additional income of EUR 323 million, with EUR 168 million for France, EUR 231 million for Italy, EUR 25 million for Spain, and EUR 58 million for the United Kingdom. The EU28 would benefit to the tune of EUR 1.7 billion."

5/7/18: Does the WTO treat the U.S. "very badly"?

Yesterday, President Trump has suggested that the WTO is treating the U.S. "very badly"

In reality, the U.S. leads WTO in terms of dispute resolutions wins and in terms of intransigence to WTO functioning and reforms. Here is a slide from my lecture on international institutions frameworks highlighting this fact:

In the previous post, I also shown that the U.S. contributes disproportionately less than the EU and China to WTO budget: http://trueeconomics.blogspot.com/2018/07/3718-china-eu-and-us-arch-stantons-grave.html.

In fact, back in October 2017, President Trump claimed that: Trump, Oct. 25: "The WTO, World Trade Organization, was set up for the benefit for everybody but us. They have taken advantage of this country like you wouldn’t believe. And I say to my people, you tell them, like as an example, we lose the lawsuits, almost all of the lawsuits in the WTO — within the WTO. Because we have fewer judges than other countries. It’s set up as you can’t win. In other words, the panels are set up so that we don’t have majorities. It was set up for the benefit of taking advantage of the United States."

WTO dispute resolution rules require that none of the panelists on each 3-person panel hearing disputes cases can be from the country involved in a dispute (per Article 8: https://www.wto.org/english/docs_e/legal_e/28-dsu_e.htm). In other words, the number of experts from any particular country that are available to serve on dispute resolution panels is immaterial to the experts service in the U.S. dispute cases.

In reality, thus, the U.S. loses slightly fewer cases brought against it, than it wins cases brought against other nations by it. The high rates of U.S. losses and wins are fully comparable with those of other advanced economies and reflect, in fact, not some WTO bias against any given nation, but rather the simple fact that majority of nations, including the U.S. tend to bring to the WTO arbitration only such cases where concerns raised are well-founded and researched. Which, in effect, means that the WTO dispute resolutions system (slow as it might be) is effective at restricting the number of frivolous cases being brought to resolution, aka, a good thing.

Much of the above evidence does not just come from my own arguments alone. Here is an intelligent and pro-trade set of arguments about why the U.S. claims of unfair treatment under the WTO regime are not only wrong, but actually conceal the much less pleasant protectionist reality of the Washington's policies: https://www.forbes.com/sites/danikenson/2017/03/09/u-s-trade-laws-and-the-sovereignty-canard/2/#657177747edc.

3/7/18: China, EU and U.S.: Arch Stanton's grave

In a recent statement on Fox News, the U.S. President has compared China and the EU in quite stark and unfavourable, to the EU, terms: ""The European Union is possibly as bad as China, just smaller. It’s terrible what they do to us,” Trump said." Contextually, the statement relates to trade, but it prompted a torrent of replies from Mr. Trump critics, pointing to various aspects of the statement as being untrue. One example:

The problem is, as commonly the case with economic statistics, there is a number to suit any point of view, and the choice of metrics matters.

• GDP comparatives 1: in current prices terms, expressed in billions of U.S. dollars, China's GDP in 2017 was USD12.015 trillion, against the EU's USD 17.309 trillion. The EU was 'bigger' if not 'badder' than China. The U.S, was 'bigger' than both at USD 19.391 trillion.
• GDP comparatives 2: in Purchasing Power adjusted terms (expressed as International dollars to take account of exchange rates differentials and price differences), China GDP was IUSD23.159 trillion against smaller EU GDP of IUSD 20.983 trillion and even lower U.S. GDP of IUSD19.391 trillion. Since PPP adjustment, imperfectly, accounts for the simple fact than people in China and the EU do not live in a dollar-priced world, although some of their imports do reflect dollar-priced goods and services, this is one of the salient measures for comparing three economies. And by this measure, Mr. Trump is correct: the EU is 'smaller' than China, although the U.S. is smaller than both.
• Trade measures: EU ranks second in the world in terms of exports and imports of merchandise trade (excluding intra-EU trade), and it ranks first in the world in terms of exports and imports of services; with total extra-EU trade accounting for 16.8 percent of EU GDP. Merchandise exports amounted to USD 1.932 trillion in 2016, with merchandise imports of USD 1.889 trillion, services exports of USD917 billion against services imports of USD771.8 billion. China ranked first in the world in merchandise exports and second in the world in merchandise imports, fifth in commercial services exports and second in services imports. China's trade with the rest of the world amounted to 20 percent of its GDP, with merchandise exports and imports of USD2.098 trillion and USD1.587 trillion, respectively, and services exports and imports of USD207.3 billion and USD449.8 billion respectively. So total EU trade volumes were USD 5.51 trillion in 2016 against China's USD 4.342 trillion. 'Large' Europe, 'small' China. The U.S. total trade volumes with the rest of the world were between the two at USD4.921 trillion, making the U.S. smaller than the EU.

'Badness measures':

• One possible measure of a nation's 'badness' in trade is the number of official disputes involving that nation as a complainant or the respondent in the WTO. Per WTO 2018 Annual Report, over 1995-2017 period, the U.S. were involved in 115 disputes as a complainant and 134 disputes as a respondent. 'Badsky' China numbers were 15 and 39 respectively - both, fractions of the U.S. Aggregating the EU member states' numbers, EU was involved in 107 and 122 disputes, respectively, although omitting states' disputes before they joined as the EU members reduces these numbers to 98 and 111. Which means the EU is 'worse' than China, but 'better' than the U.S. when it comes to following rules-based trade. The comparative, of course, is distorted by shorter duration of China membership. Adjusting for that, China figures rise to around 50 disputes filed and 160-170 disputes responded, making things even more complicated in terms of 'badness'.
• Another possible measure is the current account surplus each country / block runs against its trading partners. IMF delivers some stats. The U.S. is the 'Goldilocks goodie' in that department, using dollar reserve currency status to run massive deficits at USD 466.25 billion in 2017 (similar to 2016 USD451.7 billion deficit, but vastly smaller than the IMF-projected CA deficit of USD614.7 billion for 2018 - all praise Mr. Trump's profligacy). China is clearly a 'baddy' in these terms, with a current account surplus of USD 164.9 billion in 2017, down on USD202.2 billion in 2016. The EU, however, is in the league of its own 'awfulness', with current account surplus of USD417.24 billion in 2017 up on surplus of USD332.5 billion in 2016. So the EU is 'badder' than the already 'bad' China in these terms.
• Third measure of 'badness' as it relates to trade is the physical support for WTO by each country/block, which can be measured by the annual share of each in total WTO budget. Again, per WTO report cited above: the EU share of total WTO budget is 33.6 percent, against the U.S. 11.38 percent and China 9.84 percent. While China's budget contribution should be lower due to the country having s bizarre, 'non-market economy' status in WTO standing, U.S. contribution is small relative to the country's share of global GDP, while EU's share is disproportionately large. Who's the 'baddest' in these terms?
• Fourth measure of 'badness' can be trade-weighted average tariff imposed by the country. WTO latest data on this covers 2015. The EU run 3.0% trade-wighted average tariff across all of its trade, with average agricultural tariff of 7.8% and average non-agricultural tariff of 2.6% with 100% binding coverage. China average trade-weighted tariff was 4.4% (agricultural 9.7% and non-agricultural 4 percent) with 100% binding coverage. Which makes China 'badder' than the EU. U.S. comparable figures were 2.4%, 3.8%, and 2.3% for average trade weighted tariffs, and 99 percent binding coverage. In summary, the EU is marginally 'worse' than the U.S. and vastly 'better' than China when it comes to tariffs protection.
• In bilateral trade protection terms, 58.3 percent of non-agricultural imports from the U.S. were duty-free in the EU, against 19.6 percent of EU imports from China. China imported 56.5 percent of its imports from the U.S. duty-free, and 46.5 percent of imports from the EU were also zero-duty. U.S. imports from the EU were 64.9 percent duty-free and its imports from China were 35.5 percent duty free. When it comes to U.S. exports, the EU was a better destination, in these terms, than China. 'Better' EU than China in these terms.

We can draw many more comparatives in trying to gauge what 'worse' and 'smaller' might mean in the case of China vs EU comparatives when it comes to possible White House-targeting criteria. In reality, economics, trade, trade policies and finance are complex. Far more complex than Spaghetti Western. Yet, even 'The Good, The Bad, and The Ugly' had serious shades of grey when it came to delineating the three villains Mexican standoff at the Arch Stanton's grave.