Tariffs on China and the U.S. Manufacturing Industry: A Crisis in Confidence

Economic growth in the United States has been quite resilient despite turmoil in the global economy. U.S. GDP grew 2.6% in the first half of 2019, the labor market remains tight, and inflation is below the Federal Reserve’s target.

Yet there is clear unease in the air. In recent months both business and consumer confidence have faltered.

Two key themes are apparent from recent reports on business and consumer confidence. First, both businesses and consumers are concerned about the slowdown in the global economy and are worried the U.S. economy could follow suit. Second, there is a clear consensus that the recent tariff actions against China are particularly worrisome. Luckily, the Trump administration announced last week that the president will be returning to the negotiating table with the Chinese government – a move American workers and businesses prefer over increased tariffs.

The slowdown in business confidence is apparent in the latest survey from the Institute of Supply Management. The organization’s manufacturing index dropped to its lowest reading since January 2016 and ended a 35-month expansion period in which the index averaged over 56.5, well above 50, which is the threshold for expansion in the sector. The index dropped below 50 (49.1), which indicates that manufacturing contracted in August.

The primary culprit is the ongoing tension with China and unease about the possibility of recession. As one respondent put it, “While business is strong, there is an undercurrent of fear and alarm regarding the trade wars and a potential recession.”

This is consistent with findings in the MetLife and U.S. Chamber of Commerce’s Q3 Small Business Index released Tuesday. The index found manufacturers are expecting less revenue with 49% of manufacturers (versus last quarter's 59%) expecting their revenue to increase in the coming year. One source of concern in this report is that hiring, a component of the index, contracted. Only 32% of manufacturers plan to increase staffing (compared to 39% in Q2). This may indicate that businesses are not as optimistic about the future as they are about the present situation, and are therefore being cautious about additional expansion. The non-manufacturing index remained in expansion territory and shows that the service sector is growing despite weakness in manufacturing.

Respondents to the Institute of Supply Management’s survey also noted the impact of the tariffs. One participant from the Accommodation and Food Services sector reported that, “Tariffs are affecting the cost of goods on all items imported from China. We are experiencing a 10-percent increase on Chinese ingredients which kicked in on August 1.”

The consumer confidence data are even more concerning because they point in the same direction. Data released by the Conference Board, a business membership and independent research organization, show a modest decline in overall confidence, while the University of Michigan's Consumer Sentiment Index reported an 8.6% decline in August and a decline of almost 7% from a year earlier.

One point from the Conference Board is particularly concerning. While respondents reported being quite comfortable with the current economy, there was a full 70 point gap between current confidence and consumer’s expectations about the future. Such a wide gap is historically rare and may portend a turning point in the economy.

The recent set of confidence surveys indicate that manufacturing is taking an economic hit, the service sector is doing slightly better, and consumers are increasingly anxious about the trajectory of the economic outlook. Importantly, U.S. Chamber CEO Tom Donohue noted in the Washington Post that there are several policy choices that could improve confidence, restore certainty to the market, and set us safely on solid ground. The administration should end the current tariff escalation and negotiate with China for a long-term, sustainable trade deal, Congress should pass USMCA, and there should be a bipartisan push to finally pass an infrastructure bill.