What Motivates the Tariffs?

The U.S.-China trade war has been changing markets around the world for months. With nearly 100% of U.S.-China trade set to be affected by tariffs this year, all the cards have been played and both countries appear set to fight a protracted trade battle.

Motley Fool analysts Jim Mueller and Nick Sciple break down what goods are covered, the strategies behind the tariffs from the two countries, and the risk and reward of doing business in China, on this segment of Industry Focus: Energy.

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A full transcript follows the video.

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This video was recorded on Sept. 27, 2018.

Nick Sciple: Jim, why don't you talk about a little bit, what's the strategy behind these tariffs? What is the United States trying to accomplish? Conversely, with their tariffs, what is China trying to do? You mentioned a little bit pushing their consumers toward other countries' goods. But what's the strategy here?

Jim Mueller: A country imposes a tariff basically for one or two reasons. In the past, it's been more the first reason than the second. The first reason is protectionism. That is trying to protect domestic industries. For instance, U.S. steelmakers; that's been a big reason touted in the media by the administration. When steel is cheaper to import than it is to buy domestically, the domestic industry gets hurt. So you put a tariff on that imported steel to try to help protect the local industry.

That's part of what's going on here. But I think the bigger part is more punishment here. This is driven by the U.S.'s view that China has been engaging in ... "unfair trade practices" is such a used phrase, but it's pretty much what's happening. The Chinese government is involved in so much of their industry that they can do things like subsidize the manufacturing of stuff like steel, and then China will export steel to the U.S. at a price that's lower than their own costs. That is not good for the U.S. for many reasons. Also, China has a habit of stealing a lot of IP, either directly through spies or indirectly by forcing American businesses who want to operate in China to share their IP as a condition for being allowed to operate there.

Sciple: Yesterday, there was a great article in The Wall Street Journal walking through the way some of those forced technology transfers take place. One of the facts they cited in there is that one in five members of the American Chamber of Commerce in Shanghai, China, have said that they've been pressured to transfer technology. And among those companies, 44% in aerospace and 41% in chemicals have said they face notable pressure. That Wall Street Journal article talked a little bit about something that Dow DuPont had gone through, a little bit of a forced transfer of their product. So this is something that has been a significant negative impact to the United States, this forced technology transfer, that is trying to be remediated a little bit with these tariffs.

Mueller: The danger there is, you want to operate in China because the market is so big there, and there's so much opportunity to sell stuff there. But do you want to give away all your secrets, and then five, 10 years down the line, see a Chinese company come up and make the exact same thing using your own secrets against you at a lower price, and there goes your market. So American companies are kind of in a bind. Do they want to operate in China today and risk such a future? Or should they not even try to make those extra profits in China? It's a real conundrum for American companies.

Sciple: Yeah. It's such an important market, but also, the consequences of operating in that market could be, over the long term, meaningfully negative.

Mueller: Right. So, what the administration is doing is trying to use these tariffs as a way to break that cycle, that pain point for American companies.

Sciple: Exactly. Let's move over to China's strategy. They're in a little bit of the same Catch-22. They've been predominantly reactionary to the United States' tariffs. They have not been the aggressor in these.

China, we talked about, with the second round of tariffs, they're tariffing almost the entirety of their U.S. imports. Their back's against the wall a little bit. They're running out of products to penalize. China runs a risk, as well, that if they start to make other moves, if they start to target American businesses operating in China, and maybe discriminate against them, that's really going to give them an additional problem in that they really need foreign investment in their economy to drive the growth that they've had. If they were to start retaliating against international investors, that really could cause foreign capital to flee and put them in a dangerous situation.

There's a lot of moving parts here for both countries. Like we're talking about with anything in the macroeconomic environment, there's a lot of moving parts.

Mueller: Right. One of the things that China's trying to do to protect themselves against that -- as you say, they need so much foreign investment -- is, they're trying to build more of a domestic investment supply, bring their population to be more consumer-driven than they currently are, and not as much savers but as buyers. That'll help them, but it's going to take a while. With this extra pressure against them, the clock is ticking.

Jim Mueller, CFA has no position in any of the stocks mentioned. Nick Sciple has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.