Global Economic Update

Trade war intensifies 

LAST weekend, President Trump threatened to raise tariffs on China by the end of last week, and the tariffs did indeed go up by then. The US administration said that China had backtracked on promises made during negotiations.1 Consequently, the United States increased existing tariffs on Friday because a deal had not been reached. Specifically, the 10 percent tariff on US$200 billion in imports from China went up to 25 percent. The US trade negotiator Robert Lighthizer said, “Over the course of the last week or so we have seen an erosion in commitments by China. Really, I would use the word reneging on prior commitments.” Lighthizer was asked why he thought the Chinese had backtracked. He noted, “My own view is that these were serious, real commitments that were enforceable and that some people in China found that difficult and objected to it. For whatever reason, it is where it is.” In addition, US Treasury Secretary Steve Mnuchin said, “It did become particularly clear over the weekend, with some new information, that they were trying to go back on language that had been previously negotiated, very clear language that had the potential of changing the deal dramatically. It’s unfortunate if we can’t conclude an agreement because I think this agreement would have opened up China.” Thus, the two US officials appeared to suggest that hardliners in the Chinese regime resisted some of the commitments made by China’s negotiators. 

Because the threatened higher tariffs were previously scheduled to take effect earlier this year, and were then postponed, the normal review process has already taken place. Thus, it was feasible to increase the tariffs quickly. At the same time, the president’s additional threat to impose new tariffs on all remaining US$325 billion in imports from China cannot happen quickly and must go through a review period.2 The US administration indicated that it will move to boost tariffs on all remaining Chinese imports if an agreement is not reached within 30 days. If this happens, all Chinese goods sent to the United States will be subject to a 25 percent tariff. That would directly cost the American economy roughly 0.5 percent of GDP. Chinese, American, and European equity prices fell throughout last week on worries about a worsening trade war. The hit to equities was especially sharp for industrial companies that export capital goods to China, and for technology companies that rely on Asian supply chains. 

Why are investors worried? The reason is that a 25 percent tariff is a lot more onerous, and likely to be far more impactful, than a 10 percent tariff. In the past year, the value of the renminbi has fallen about 10 percent against the US dollar, thus effectively offsetting the impact of the 10 percent tariff on almost half of Chinese exports to the United States. But once those goods are subjected to a 25 percent tariff, it is likely that businesses will either raise their prices or take a major hit to their profit margins. Some US importers will probably attempt to import goods from other countries, but this will not be feasible for many products. The end result will be significantly higher prices for US consumers and businesses, effectively reducing their purchasing power. This will be harmful to the global competitiveness of the US companies that import components used in manufacturing. 

Another reason to worry is that China has declared retaliation against US tariffs, thus reducing the competitiveness of US exports to China. In addition, European companies are said to be worried that the trade war between the United States and China will hurt them.3 Some European leaders have urged that the two sides return to a focus on multilateral trade liberalization, which seems unlikely at the moment. 

While many analysts worry that the higher tariffs will derail the economic recovery, President Trump offered a different viewpoint. He said, “I’m different than a lot of people. I happen to think the tariffs for our country are very powerful. Tariffs will make our country much stronger, not weaker. Just sit back and watch.” Meanwhile, China announced that it will boost tariffs—from between 5 and 10 percent to as high as 25 percent—on US$60 billion of imports from the United States.4 Consequently, the US administration has announced that it will provide US farmers with financial support to offset the impact of higher Chinese tariffs on US agricultural goods. President Trump said that the money collected from tariffs will be used to “buy agricultural products from our great farmers, in larger amounts than China ever did, and ship it to poor and starving countries in the form of humanitarian assistance.”5 Yet it is reported that US farmers, as well as other exporters to China, are worried that the retaliatory measures implemented by China will lead Chinese businesses to permanently develop better trading relationships with others,6thereby damaging the long-term prospect for US exports to China. 

What is left for China to do in retaliation given that it has already imposed tariffs on most imports from the United States? China can restrict trade with the United States or punish the United States economically in many ways, such as increasing the existing tariffs; slow walking imports through customs; compelling state-run companies to stop purchasing American goods; harassing US companies operating in China; and discouraging Chinese consumers from purchasing American goods and from purchasing services from US-based companies, such as retailers or restaurants. 

Meanwhile, it is reported that many US companies are now planning to shift assembly of goods from China to other countries including Mexico, Cambodia, and India.7 Moreover, even if the tariffs come down, the lingering uncertainty about the economic relationship between the United States and China may compel these companies to permanently avoid being exposed to China. In addition, some US companies are concerned that fraught relations between the two countries might cause Chinese consumers to become averse to American brands. This could be highly problematic for those US companies that have become highly exposed to the Chinese consumer market. 

It has been speculated that China could respond to the US tariffs would be to sell US Treasury securities on a large scale.8 Theoretically, this could lead to a sharp increase in US bond yields and, consequently, an increase in borrowing costs for US businesses and households. That could damage the US economic recovery. Nonetheless, a large sale of Treasuries might not lead to an increase in yields if there is sufficient global demand for an asset that is perceived as the ultimate safe asset. The trade war itself creates the kind of uncertainty that often leads investors to favor safe assets such as US Treasuries. Indeed, when China did sell a fairly large volume of Treasuries a few years ago, US bond yields barely budged.9 Moreover, if yields were to increase, China would suffer a capital loss on its remaining holdings of US Treasuries. Thus, it is not clear that selling Treasuries would necessarily be in China’s interest. Meanwhile, China’s central bank currently holds roughly US$1.2 trillion in US Treasuries. 

Why were the United States and China unable to reach a deal? It is reported that, in recent weeks, Chinese officials had become convinced that the United States was eager to make a deal and that, as a result, China did not need to accept US demands to provide details about the laws it intended to change.10The Chinese perception that the United States was eager for a deal came, in part, from the fact that the US administration was putting pressure on the Federal Reserve about monetary policy. The Chinese interpreted this as evidence that the administration was worried about the fragility of the US economy and, consequently, would be reluctant to boost tariffs. After all, trade restrictions would likely have negative economic consequences and would also likely result in a drop in equity prices. Yet now the Chinese side is surprised to find that the US side recoiled against China’s perceived intransigence. In addition, it might also be the case that the US administration was worried about potential backlash from hardline supporters in the United States if it agreed to a deal with China that might be seen as inadequate or cosmetic. President Trump’s former chief strategy advisor Steve Bannon wrote an article this week in which he lauded Trump’s decision to threaten higher tariffs.11 He said that China is “the greatest existential threat ever faced by the United States.” 

Although US business leaders have been nearly unanimous in their condemnation of the threat of higher tariffs on China, the US policy has been well received by Congressional leaders of both political parties.12Notably, several leading Democrats have lauded Trump’s decision and urged the administration to take a hard line on China.

One exception is former Vice President Biden, a candidate for president. He said that China is “not competition” for the United States. His comment “China is going to eat our lunch? Come on, man!” elicited criticism from within his own party. 

Finally, there is a concern across Asia about the economic ramifications of the intensifying trade war between the United States and China.13 The worry is that it could disrupt existing supply chains. Consequently, several regional central banks cut their benchmark interest rates this week. The central banks of the Philippines, Malaysia, and New Zealand all cut rates. The central bank of Australia is expected to do so as well. In the case of the Philippines, the rate cut was partly due to concerns about slowing economic growth unrelated to the trade war. Meanwhile, regional currencies are under pressure as many investors worry about the potential impact on growth. Already there has been economic weakness in the region. The burgeoning trade war could exacerbate the situation. 

Global trade volume declines

The volume of international trade declined 1.7 percent from January to February and was down 1.1 percent from a year earlier, according to a study conducted by the Dutch government.14 This is the sharpest drop in trade volume since 2009 during the global recession. The volume of trade has been stagnant or declining since 2018 when the trade war between the United States and China intensified. The result is that the volume of international trade in early 2019 was no higher than it was in 2018. 

This is an unusual situation. In modern times, trade has played a key role in generating global economic growth. Generally, trade grows faster than GDP and tends to stimulate industrial production and investment. The fact that trade is now in decline bodes poorly for the health of the global economy in the months to come. Of course, it is important to note that there are other factors aside from tariffs that have had a negative impact on trade volume. These include a weakening of global demand, trade diversion as a result of Brexit, and a consolidation of Asian supply chains within China. Still, tariffs and the threat of tariffs have played the principal role in diminishing trade. With the US decision to boost tariffs on China, and the retaliation, it is likely that the global volume of trade will decline further. 

Rising risk of corporate debt in the United States

The US Federal Reserve has warned about the risks to the financial system from the sharp increase in corporate debt.15 In the Fed’s periodic report on financial stability, it noted that “borrowing by businesses is historically high relative to [GDP], with the most rapid increases in debt concentrated among the riskiest firms amid signs of deteriorating credit standards.” It drew attention to the fact that, although the volume of corporate debt increased 4.9 percent in 2018, leveraged loans increased by 20.1 percent, thereby boosting the risk profile of the corporate sector. It also said that asset values are relatively elevated and that investors continue to exhibit a high appetite for risk. It noted that, in the housing market, prices have risen faster than rents for several years. This is often a sign of a bubble. Indeed, a separate analysis by Nobel Laureate Robert Shiller found that, in real (inflation-adjusted) terms, house prices have rebounded substantially and are now almost as high as the level reached prior to the last recession.16 This is a much higher level than seen during the last century. At the same time, the Fed’s financial stability report noted that “household borrowing remains at a modest level relative to incomes.” It also said that banks are well capitalized and that leverage is modest for financial institutions compared to pre-crisis levels. Thus, a mixed picture emerges. The Fed said that, although default rates remain relatively low, the financial system is vulnerable to shocks such as a worsening trade war, a messy Brexit, or a global economic slowdown. It said a downturn could hurt the financial system because of “the rapid growth of less-regulated private credit and a weakening of underwriting standards for leveraged loans.”

Meanwhile, there has been a big jump in the volume of interest-only commercial property loans in the United States, which are significant components in commercial mortgage backed securities.17 Interest-only and partial interest-only loans accounted for 89 percent of the loans backing new commercial mortgage-backed securities in the first quarter of 2019. This was the highest share since 2009 and consistent with levels seen just before the last recession that began in 2007. While default rates remain low, the concern is that defaults will increase should there be a downturn. In addition, a drop in property values could mean a sharp loss in the values of mortgage backed securities. That, in turn, could mean trouble for the financial institutions that hold many such securities. Interest-only loans are structured so that the borrower only pays back principal at the end of the loan period. A partial interest-only loan is structured so that only interest is paid for a particular period of time during the term of the loan. Usage of both types of loans typically jumps at the tail end of the economic cycle. Thus, the sharp recent increase could be a signal of trouble to come. 

Inversion of the yield curve in the United States

The yield curve has inverted.18 The yield on the three-month Treasury bill today exceeded the yield on the 10-year Treasury bond. This had briefly happened in March as well. In the post-war era, every recession has been preceded by a sustained inversion of the yield curve, and almost every time the yield curve inverted a recession soon followed.

Why is this? Consider that banks are in the business of taking short-term deposits and giving long-term loans. This provides their profit margin. When the yield curve inverts, banks have less incentive to create credit. An inversion generally leads to a decline in credit market activity and a consequent drop in economic activity. The yield curve inverts because the Federal Reserve tightens monetary policy by raising short-term interest rates. This suppresses expectations of inflation, thereby reducing long-term rates. After the yield curve briefly inverted in March, the Federal Reserve announced its decision to hold off on further rate hikes. This pleased many investors, boosted their expectations for growth, and led the yield curve to rise. Yet the latest inversion likely reflects investor concern about the negative potential impact of the burgeoning trade war. Indeed, the so-called “breakeven rate,” which is an excellent measure of market expectations of inflation, has fallen sharply in the last week. The result was a decline in the yield on the 10-year bond. 

Meanwhile, another popular measure of the yield curve, which is the gap between the yields on the 10-year and two-year bonds, remains positive for now. If the Federal Reserve actually cuts short-term rates in the coming year, as some observers now expect, it is likely that the yield curve will not remain inverted. 

US-China trade talks: What’s going on?

US President Donald Trump threatened to boost US tariffs on China by the end of this week if a trade deal is not completed. Equity prices plummeted as investors feared that the trade war is suddenly worsening.

In recent weeks, there have been many news reports indicating that the US and China were getting closer to a trade deal, that a meeting between the two countries’ presidents was imminent, and that such a meeting could be an occasion to sign the much-anticipated deal.19 Indeed, as recently as Friday (May 3), US President Donald Trump said that the talks were going well. However, over the weekend, Trump tweeted that he is inclined to increase the existing tariffs coming Friday (May 10), stating that the negotiations are taking too long.20

He likely either wants to speed up the negotiations or convince the Chinese that failure to arrive at a deal soon will have serious consequences. Or, this could be a political move—the US administration could be trying to create the impression that an impending deal came about because of its toughness with China. As trade expert Chad Bown of the Peterson Institute said, “If they announce a deal later this week, it will make it appear as if he acted as tough as possible to get the deal.”21

Meanwhile, US and Chinese officials are scheduled to meet in Washington this week to work on the deal. Whether the latest tariff threat will boost the likelihood of a deal or cause the Chinese to stay away from the talks is not yet clear. China may take offense at the threat, and not wanting to appear to buckle under US pressure, it may decide to walk away from the talks. Thus, undertaking the threat may turn out to be a somewhat risky strategy for Trump. In any case, the latest word is that a Chinese delegation still intends to travel to Washington, but not necessarily this week, and not necessarily including 100 people as previously planned.22 Chinese media hasn’t reported Trump’s threat, which allows China’s government the flexibility to act on the matter.

It is worth noting that in 2018, the US had imposed a tariff of 25 percent on US$50 billion of imports from China, and a 10 percent tariff on US$200 billion imports. In his tweet over the weekend, Trump threatened to boost the 10 percent tariff to 25 percent. In addition, he threatened to apply a 25 percent tariff to all remaining Chinese imports that are north of US$300 billion per year. However, the strength of the US economy comes despite tariffs. Moreover, the tariffs and the threat of more tariffs have already had a negative impact on trade flows and business investment, thereby accounting for the slowdown in economic growth in the second half of 2018. Trump also said that the tariffs had “little impact on product cost.” However, imports on which the 25 percent tariff was imposed have dropped sharply, whereas those on which a 10 percent tariff was imposed have grown slower than previously. Evidently, the higher prices have influenced demand.23 In addition, trade has partly been diverted from China to other countries in East Asia. China has retaliated against the existing tariffs, thereby contributing to a negative impact on US exports to China. If Trump follows through on the latest threat, it is likely that China may retaliate in kind, thereby potentially creating further problems for US exporters.

Reports on the trade negotiations have indicated that the two sides have reached agreement on a number of issues, including ending forced technology transfers, protection of intellectual property, and increases in Chinese imports of US goods.24 The reports added that the remaining issues to be agreed on are: Whether China will reduce subsidies for state-owned enterprises (SOEs) and the mechanism for enforcement of the trade agreement. On subsidies, China is reluctant to agree to the US demand. Reducing subsidies for SOEs could be tantamount to changing the economic model on which China has depended for decades. On enforcement, the United States wants to delay reduction of existing tariffs until China demonstrates compliance. The United States also wants to retain the right to boost tariffs should China fail to comply and to restrict the latter’s right to retaliate against any new US tariffs. China is said to be reluctant to agree to the US terms regarding enforcement.25

Markets fall on US trade tariff threat to China

Market reaction to the US threat was strong. Equity prices in the US, Europe, and Asia fell sharply while the offshore renminbi fell as well. The yield on US Treasuries fell, and the US dollar and Japanese yen rose against most major currencies. In the US, various business groups urged the administration not to follow through on the tariff threat, saying that such tariffs could boost prices, reduce consumer purchasing power, and lead to significant job losses.26 Also, the price of oil fell sharply, likely indicating that investors see a worsening trade war as potentially having a negative impact on the demand for commodities.27 Notably, shares in European automotive companies fell sharply as investors are likely worried that the US administration might follow through on previous threats to impose tariffs on automotive imports. Another industry that took a big hit was technology, which is heavily dependent on trans-Pacific supply chains.

What can we expect next? First, not all threats made by this US administration have been implemented. Thus, there is uncertainty over how the latest threat will play out. Second, it is not clear that President Trump has the authority to boost tariffs so quickly. There are processes that must be followed, including seeking comments from the public. Thus, a more likely scenario is that the process will be commenced this week, but that new tariffs might take a bit longer to be implemented.

Still, in anticipation of the tariffs, business behavior is likely to adjust. This could mean accelerating imports to avoid tariffs and shifting supply chains away from China. If the tariffs do go into effect, prices will rise and demand in the United States will likely be affected. We must keep in mind that about 40 percent of US imports from China are components used in producing final goods.28 As component costs rise, businesses will likely have to either raise prices or take a hit to profit margins.

US export competitiveness may also suffer. Some US companies are likely to attempt to source components from other countries. Retaliation by China would also hurt US export competitiveness. China’s government wants a deal but wouldn’t want to be seen as being bullied. China’s economy has already been hurt by the existing trade war and the government wants to avoid a new round of tariffs. However, the uncertainty surrounding the relationship with the United States could lead China to seek other sources of growth in the long term. This could include a greater focus on boosting domestic demand as well as engaging in trade liberalization with countries other than the US.

Finally, the US tariffs would likely be temporary—until China makes concessions. Thus, there remains uncertainty about future trading relations between the United States and China. Besides, the fact that the US administration continues to make sudden and unexpected threats, and might take unexpected actions, means that the general trading environment remains uncertain. This has already had an effect on investment, especially on investment in global supply chains. Even if the US administration doesn’t follow through on the threat, the fact that it is making the threat can have an impact on the global economy. Most businesses prefer a road map over uncertainty, even if that map involves higher costs.

Is the dominant role of the US dollar at risk?

The dominant role of the US dollar in the global economy has given the US government a potent weapon in its foreign policy toolkit. That is, it can use sanctions to punish countries and businesses that use the dollar for transactions. On the flip side, the use of such sanctions has lately encouraged other countries to promote the use of other currencies, thereby potentially undermining the dominant role of the dollar. This dynamic is now at work when it comes to US relations with Iran. Specifically, the US government withdrew last year from the nuclear deal that had been agreed upon by the previous US administration with Iran, Russia, China, the UK, Germany, and France. At the time of withdrawal, the United States unilaterally reimposed sanctions on Iran, but initially exempted many countries from penalties for purchasing oil from Iran using US dollars. Now, the United States has announced that it is eliminating these exemptions.29 This means that, going forward, if a country purchases oil from Iran using US dollars, its businesses and banks would face US government penalties because such transactions necessarily flow through US financial institutions. The United States is in a position to do this because most commodities are priced in US dollars, and most commodity transactions in the world take place in US dollars.

US Secretary of State Mike Pompeo said that the United States’ goal is to halt all Iranian oil exports. While the US policy might be successful in the short term, it could backfire in the longer term if other countries are successful in their efforts to encourage the use of other currencies. China’s government, for instance, has taken steps to encourage the use of the renminbi, and will likely encourage commodity exporters to accept payment in renminbi. To this end, it has explicitly pledged to maintain a stable value of the renminbi. It has also established forward contracts for commodities based in renminbi. And it has established the China International Payments System (CIPS) as an alternative to the US dollar-based SWIFT system meant to facilitate international transactions. Members of the European Union are likewise interested in boosting the role of the euro. Meanwhile, Russia is trying to reduce dependence on the US dollar, especially as the US government has sanctioned Russian businesses and people. Russia has shifted a large part of its stockpile of reserves from dollars to renminbi and especially to gold.30

What is different about the current round of sanctions imposed by the US on Iran is that they have been enforced unilaterally and on an unusually large scale. Past sanctions on Iran—prior to the nuclear deal—were imposed in conjunction with other countries. By acting unilaterally, the United States has encouraged resistance to the dominance of the dollar on the part of China, Europe, and Russia. If these countries are successful in significantly reducing their dependence on the dollar, it could presage an eventual end to the era of dollar dominance.

What would de-dollarization mean? It could mean that the United States could no longer borrow externally in its own currency on such a large scale at such a low cost. It could mean that US businesses could face greater currency exposure, especially those that import commodities. And it could mean that US borrowing costs would likely rise as the dollar would no longer be viewed as the safest asset. The British pound was once the world’s dominant currency, something that changed quickly early in the 20thcentury.

Economic growth rebounds in the eurozone

Economic growth in Europe rebounded in the first quarter of 2019.31 The European Union (EU) reports that, in the 19-member Eurozone, real GDP was up 0.4 percent from the previous quarter and 1.2 percent higher than a year earlier. In the larger 28-member EU, real GDP was up 0.5 percent for the quarter and 1.5 percent higher than a year earlier. Quarterly growth in the eurozone was 0.1 percent in the third quarter and 0.2 percent in the fourth quarter of 2018. Moreover, Italy experienced two consecutive quarters of declining real GDP, typically the definition of a recession. Yet, in the first quarter, Italy’s real GDP rebounded, rising 0.2 percent. France’s GDP was up 0.3 percent and Spain’s GDP was up a strong 0.7 percent. Although the figures for Germany have not yet been released, it can be inferred from the European data that Germany did well in the first quarter of 2019. This is good news given that Germany’s real GDP contracted in the third quarter and was flat in the fourth quarter of 2018. If the eurozone economy continues to do well, this could enable the European Central Bank (ECB) to avoid a controversial easing of monetary policy, which has been under discussion.

For the last few months, there has been general pessimism about the global economy given weak data from Europe, China, and the United States. Now, with the release of European first quarter growth figures, it appears that the three largest economies in the world are on the mend. Europe and the United States rebounded in the first quarter and China’s GDP growth stabilized. However, the US figures were distorted by temporary trends in inventory accumulation and trade. Besides, China continues to exhibit challenges. So, it is likely too early to say that the global economy has turned the corner.

US job growth strong, but workforce participation declining

The latest employment report from the US government indicates continued strength in the job market, with strong growth in payroll employment and a big decline in the unemployment rate. However, a survey of households indicated a sharp decline in labor force participation. Wages accelerated, but only modestly. The government releases two reports: One based on a survey of establishments and the other based on a survey of households. Here are the highlights of the reports:

• The establishment survey found that 263,000 new jobs were created in April, the fastest increase since January.32 Three key industries accounted for the lion’s share of the increase. These were professional and business services, where jobs were up by 76,000; healthcare, which was up 53,000; and leisure and hospitality, which was up 34,000. There was almost no growth in manufacturing employment, which was up only 4,000. In addition, retail employment fell by 12,000 as the onslaught of online retail continued to take a toll on store-based employment. Interestingly, construction employment was up 33,000, a very strong number. The establishment survey also indicated that average hourly earnings were up 3.2 percent from a year earlier—an acceleration from the past, but a modest number nonetheless.

• The survey of households found that the number of people participating in the job market (either employed or actively seeking work) fell by almost 500,000 in April.33 The result was that the participation rate declined from 63.0 in March to 62.8 in April. The survey found that the number of people working declined, but even faster than the number deemed unemployed. The result was that the unemployment rate fell from 3.8 percent in March to 3.6 percent in April—a 50-year low. How is it possible that the household survey showed a decline in employment while the establishment survey showed the opposite? One reason is that the household survey includes self-employment while the establishment survey only shows employment by business or government establishments. Another reason is that both surveys are, well, surveys. They are based on a small sample and are subject to sampling errors. In any event, the household survey results ought to restrain optimistic inferences gleaned from the establishment survey.

Overall, the report offered conflicting signals. On one hand, strong payroll job growth suggests that wage inflation ought to be accelerating rapidly. But this is not the case.

From the perspective of the Federal Reserve, the job market provides reason to tighten monetary policy while actual wage behavior suggests otherwise. Meanwhile, the household survey appears to contradict the positive results of the establishment survey. From the Fed’s perspective, this would appear to provide a good rationale for its relatively neutral policy of “patience.”

Is United States’ slow productivity growth due to an aging workforce?

In recent years, the US economy has grown more slowly than in the past. In the long term, economic growth comes about when there’s a rise in the number of workers as well as an increase in the productivity of those workers. In recent years, there has been a decline in the growth of the US labor force, and there have been only modest increases in productivity. As for the latter, there is new evidence that the weakness in productivity gains might be related to the aging of the workforce.34

A new study conducted by the Federal Reserve Bank of Minneapolis found a correlation between aging and weak growth. Specifically, it noted that, in the last 40 years, there has been a decline in the number of new businesses being created and a decline in the rate at which older businesses are folding up. This fall in business dynamism came at the same time as the share of the workforce over the age of 45 increased dramatically. In addition, the study noted that the degree of labor market mobility has also declined, a fact likely associated with an aging labor force. Younger workers tend to be more amenable to changing jobs and locations. The study indicated that the fall in business dynamism may partly explain the decline in labor market mobility. That is, creation of fewer new businesses means fewer opportunities for workers to jump ship. At the same time, the relative dearth of young workers might discourage entrepreneurs from creating new businesses as they face difficulties in hiring the workers they need. The conclusion is that declining business dynamism and labor market mobility are partly the result of an aging workforce; these factors have directly and negatively influenced productivity growth and, therefore, economic growth. Finally, the authors of the study wondered if boosting immigration might help offset these trends.

Is the United States-Mexico-Canada Agreement in trouble?

The United States-Mexico-Canada Agreement (USMCA), the proposed successor to the North American Free Trade Agreement (NAFTA), appears to be in trouble. For the USMCA to come into effect, it must be approved by the legislative bodies of all the three countries, but none of them have approved it so far. The US administration had hoped to get it done this year given that 2020 is an election year.

In the United States, there are obstacles to passage of the agreement in both the houses of Congress. In the Republican-controlled Senate, there appears to be resistance to the deal until the administration refuses to drop the tariffs on steel and aluminum. The head of the Senate committee that handles trade, Chuck Grassley of Iowa, said, “If these tariffs aren’t lifted, USMCA is dead.”35 And John Cornyn of Texas, the No. 2 Republican in the Senate, said, “I don't think there are going to be 51 votes to pass it with the tariffs still outstanding.”

Senators from farm states are especially concerned because the steel and aluminum tariffs were met by retaliatory tariffs on US agricultural exports. Yet the US administration has been reluctant to cut the tariffs and to link them to the USMCA. Commerce Secretary Wilbur Ross said, “The President is not going to take tariffs off unless there are other things that protect national security.” The administration has sought the Mexican and Canadian agreement to replace the tariffs with quotas. But neither Mexico nor Canada are amenable to this idea. US trade negotiator Robert Lighthizer said that the US policy with respect to steel and aluminum is meant to “avoid import surges and prevent transshipment; the need to reduce excess production and capacity in overseas markets; and possible mechanisms for contributing to increased capacity utilization in the United States.”

Meanwhile, the US House of Representatives, controlled by the Democrats, has been reluctant to pass the USMCA unless Mexico implements labor reform legislation. Mexico’s Congress has, indeed, passed such legislation, but Democrats in the House want assurance that the new law will be enforced. Mexican trade negotiator Jesus Seade said that Mexico is firmly committed to the new legislation and that it is consistent with the government’s ideology.36 He said, “We are soulmates, bringing their ambition to fruition. What’s frustrating and certainly very puzzling is the lack of appreciation for the scale of changes on labor. It is very difficult to imagine what else could have been done. Nothing is missing from the best practice book of the International Labor Organization.”

As for Mexico, the government’s trade negotiator said that the Mexican Senate is not likely to ratify the USMCA deal until the US eliminates the tariffs on steel and aluminum. Canada, too, strongly favors the United States cutting these tariffs before it ratifies the agreement. As a result, implementation of the USMCA is likely not imminent.

Foreign direct investment in China is accelerating

Despite a weakening economy and uncertainty due to the trade war with the United States, foreign direct investment (FDI) in China is rising, especially investment coming from the United States and Germany.37Specifically, overall FDI into China in the first quarter of 2019 was up 6.5 percent from a year earlier, including a 12.3 percent increase in investment in the manufacturing sector, which accounted for about a third of inbound FDI. Notably, FDI from the United States into China was up 65.6 percent from a year earlier. In addition, investment from Germany was up 80.6 percent while that from South Korea was up 73.6 percent.

Why the sudden confidence of foreign investors in China? There are a number of possible explanations.

First, the Chinese government has implemented a new law making it illegal for local governments or companies to compel the transfer of technology.

Second, it might be that investors are relatively confident that the US and China will reach an accord in the near future, and that the result will be a stabilization of economic relations. Moreover, investors might be confident that such a deal would involve liberalization of Chinese markets and better protection of intellectual property.

Third, investors are likely pleased that the Chinese government has implemented stimulus measures, including tax cuts, which are likely to cause an acceleration in growth.

Finally, despite the slowdown, China continues to grow at a relatively strong pace. As such, it remains an attractive market at a time when many other markets appear troubled. Its size, and its embracing of new technologies, also make it attractive.