Trade shocks, employment and the coming recession

The recession will start on the docks of Los Angeles.

It will be a product of a rational response by producers, wholesalers and retailers to the uncertainty created by policy makers.

The cost of those policy decisions is a misapplied consumption tax on households and businesses that will soon cause a premature and unnecessary end to the economic expansion. Rising inflation, declining real incomes and increasing unemployment will follow.

The price of those policies will be first paid at the ports and then spread to the rest of the economy.

Eugene Seroka, executive director of the Port of Los Angeles, anticipates a 35% drop in inbound shipping containers in the first week of May, with similar drops in the coming weeks.

The average cost of that inbound merchandise will roughly double, which will soon translate to rising prices.

This has all the markings of yet another trade shock, resulting in a loss of employment and household income that will push the U.S. economy into recession.

We can start with the fact that 7% of U.S. employment is involved with transportation and the moving of materials, while roughly 15% more are involved in occupations from warehousing to the wholesale and retail trades.

Read more of RSM’s insights on the economy and the middle market.

For this reason, the number of import containers processed at the seaports of Los Angeles and Long Beach has become a leading indicator of U.S. economic activity and growth.

The ports of Los Angeles and Long Beach are the predominant destinations for goods from South Asia. Seroka states that 45% of import containers processed at the Port of Los Angeles originate in China.

So that draws a straight line from the imposition of the 145% tariffs on China’s goods through the cancellation of 17 of the 80 ships that had been scheduled to arrive in Los Angeles this week.

That line continues to the immediate drop in the earnings of dockworkers, truckers and warehouse employees, all with negative ripple effects on local businesses serving Los Angeles.

Beyond Los Angeles, the drop in imports will increase prices for the remaining inventory, while tariffs put a tax on incoming supplies of essential items from food to iPhones.

During the past six years, there have been three major disruptions to global supply chains. These give us a clue on what we might expect, starting with the southern California seaports.

• The 2018 trade war: The brief U;S. trade war with China, Canada and Mexico in 2018 led to a 35% plunge in container shipments at Los Angeles and Long Beach. The drop in imports was followed by a drop in agricultural exports and the permanent loss of market share for American farmers.
• The 2020 pandemic: The immediate effect of the shutdown in economic activity was a 37% drop in containers processed at Los Angeles and Long Beach.
• China’s 2022 zero-COVID policy: The lingering effects of China’s zero-COVID policy closed down the port in Shanghai throughout 2022. That was followed by the war in Ukraine and the inflation shock, all leading to a 45% drop in import containers at the Southern California ports.

Now comes today’s tariff shock, which is happening soon after the previous episodes. It will be the second time in recent years that government intervention will upset the market-driven, global free-trade system that the U.S. and its allies had developed over the past 75 years.

In 2018, the trade war led to a global manufacturing recession that permanently damaged suppliers along the supply chain.

Germany and Italy, both industrial powerhouses, lost their export market share, leaving China as the last nation standing. And now, Japan, once the leader of manufacturing innovation and just getting back on its feet, has cut its growth forecast because of U.S. tariffs.

Tariffs and the damage done

One immediate cost of the trade policy has been the loss of confidence in the American economy as evidenced in the flight of capital away from traditional safe havens like the U.S. dollar and Treasury notes as American equities came under pressure.

Now, some of the United States’ most important trading partners are seeking alternatives. The governments of Japan and South Korea, for example, have opened trade talks with China.

Closer to home, the U.S. government has attacked an important source of its prosperity: the North American free trade zone.

Then there is the question of whether low-skill, low value-added manufacturing would return to the U.S.

The U.S. economy no longer has a labor force that will accept low-wage occupations. The workers who are the most willing to perform those jobs—immigrants—are being restricted.

In the short run, we anticipate an increase in unemployment first among occupations along the U.S. supply chain. That will be closely followed by an increase in prices caused by a shortage of goods after inventories are exhausted.

Demand will then drop, leading to a return of stagflation, not seen in more than 40 years.

Here’s how a nation gets dragged into recession during a trade shock.

No. 1: Dock workers take the first hit…

In the past, trade disruptions and a drop in import containers processed at the Southern California seaports have sparked declining employment in occupations of transportation and material moving. This is according to data collected by the monthly survey of households conducted by the Bureau of Labor Statistics.

According to Seroka, the Port of Los Angeles executive director, the first to be hit are the paychecks of dock workers, who will suffer from the loss of overtime and then diminished regular hours.

That will be shortly followed by reductions in the number of truckloads of containers leaving the seaport.

No. 2: Then it spreads to the broader trucking sector…

The Truckstop Demand Index is the ratio of bookings to available equipment. The ratio would be expected to rise during periods of excess demand and decrease during slow periods.

There was a substantial increase in the index in March followed by a decline in April, which corresponds to the increase and then flattening in inventory accumulation in the run-up to the tariffs.

The growth rate of employees with occupations in U.S. truck transportation shows an acceleration during periods of growth of import containers and a deceleration in the aftermath of trade dislocations.

Truckers rely on a circuit of everything from big to small businesses. After a surge in demand for trucking in the first months of the year, the number of bookings dropped in April. That implies a loss of revenue for truckers and for the businesses that service trucking.

No. 3: Followed by the railroads…

Containers destined for hubs across the country are likely to leave the West Coast by rail. After each trade shock, rail carloads of containers, known as intermodal transportation, have dropped in absolute numbers and in percentage terms compared to last year.

In this latest episode, intermodal carloads have been in decline since the start of the year, which can be attributed to the rational response of wholesalers and retailers to an economy heading into recession.

No. 4: And then the warehouses …

Whether by truck or rail, the next stop along the supply chain is most likely a warehouse. Once again, we can see a drop in demand for employees at warehouses after each of the trade shacks since 2019.

This is using monthly data collected from BLS surveys of establishments, rather than surveys of households. The number of employees has been flat since last year’s election, which reflects perhaps another rational decision in the face of the uncertainty of policy.

Through it all, prices are distorted…

One should expect a trade disruption to cause price distortions. While increases in top-line inflation will be partially mitigated by falling oil prices, rising prices will first be observed along the dense and complex supply chains in the U.S. and around the world.

Shipping: For shippers, the cost of shipping a standard container from Shanghai to Los Angeles has fallen to $2,590 as of the first week in May. That is a 46% lower than in January and 52% lower than a year ago. We attribute the price reduction to the drop in demand by wholesalers and retailers reluctant to be stuck with inventories if U.S. consumer demand were to grind lower as prices increase and if the economy were to slip into recession.

Prices paid: There is already evidence to expect retail prices to increase as the trade war continues. The latest survey of purchasing managers indicates a sharp increase in prices paid for intermediate goods, which will evolve in higher prices for consumers even if wholesalers and retailers maintain current margins.

The takeaway

Cutting off the U.S. economy from the rest of the world without a plan to replace goods will result in shortages, higher prices and higher unemployment.

Businesses have responded rationally by first pulling forward activity into the first quarter and now pulling back on purchases.

The damage has been done and this week all will observe a large decline in shipping volume into the Port of Los Angeles.

Another disruption to U.S. supply chains through trade policy will mark the end of the current business cycle as the economy slips into recession.