trade, tariffs and Harley Davidson (HOG)

Modern economics has been founded in study of what caused the Great Depression of the 1930s, with an eye to preventing a recurrence of this devastating period.  We know very clearly that tariffs and quotas are, generally speaking, bad things.  They reduce overall economic activity in the countries that apply them.  Yes, politically favored industries do often get a benefit, but the cost to everybody else is many times larger.  We also know that the use of tariffs and quotas can snowball into a storm of retaliation and counter-retaliation that can do widespread damage for a long time.

My point is that it’s inconceivable that high-ranking public officials in Washington don’t know this.

 

HOG motorcycles are Baby Boomer counterculture icon.  The company’s traditional domestic male customer base is aging, however, and losing the strength and sense of balance required to operate these heavy machines.  At the same time, HOG has had difficulty in attracting younger customers, or women or minority groups to its offerings.  So it’s an economically more fragile firm, I think, than the consensus realizes.

HOG has been damaged to some degree by the Trump tariffs on aluminum and steel, which are important raw materials.  (As I understand them, the tariffs are ostensibly to address Chinese theft of US intellectual property, although they are being levied principally against Japan and the EU.  ???)

Completely predictably, the EU is retaliating against the tariffs.  In particular, it is levying its own 25% tariff on HOG motorcycles imported from the US.  This affects about 20% of Harley’s output.  HOG says the levy will cost it $100 million a year in lost income, implying that all of the EU-bound Harleys are now made in the US.  HOGs response is to shift production targeted for the EU to its overseas plants.  My guess is that this will take 1000+ jobs out of the US.

In contrast to the job loss from this one company, public reports indicate the total job gain from the steel/aluminum tariffs to be about 800 workers being recalled to previously idle steel/aluminum plants.

 

Mr. Trump’s response to the HOG announcement was to threaten punitive tariffs on any imports of foreign-made Harleys–a move that could threaten the viability of HOG’s network of around 700 independent dealerships.  7000 jobs at risk?

The stock market declined sharply on the day of the HOG announcement.  I think that’s because the HOG story is a shorthand illustration of how tariffs, and quotas, cause net losses to the country as a whole, although they may bring benefits to a politically favored few.

 

A second negative effect of trade protection is a long-term one.  My experience is that most often the protected industry, relieved of immediate competitive pressure, ceases to evolve.  After a few years, consumers become willing to pay the increased price to get a (better) imported product.  In my mind, General Motors is the poster child for this.

 

Stock market implications?  …avoid Industrials.  The obvious beneficiary of Washington’s ill-thought out trade policy is IT.  For the moment, however, I think that this group is expensive enough that Consumer Discretionary and Energy are better areas to pick through.

 

 

trade wars

Recently President Trump announced plans to impose tariffs of 25% on imported steel and 10% on imported aluminum, citing national security reasons.  He followed this up with a Twitter comment that, for the US, trade wars are good–and easy to win.

My take:

–much of modern economics stems from study of the causes of the Great Depression of the 1930s.  The key factors:  the wrong fiscal and monetary response, world wide; and the imposition of tariffs to “protect” local industry.  These did substantial economic damage, deepening and prolonging the global slump instead.  The idea that Mr. Trump may not be aware of this is the really worrisome aspect of the current situation.

 

–the first-order effects of the proposed tariffs will, in themselves, likely be miniscule.  Domestic prices for both metals will rise.  As a result of that, and of possible tariff payments to the government, income will shift from the users of the two metals to Washington and to domestic producers of steel/aluminum.  Because of this, at least some metal fabrication will shift away from the US to other countries.  One EU-based maker of appliances has already suspended plans to increase its manufacturing capacity in the US.

–second-order effects will likely be larger.  The EU, for example, is indicating it will retaliate by placing large tariffs on several billion dollars worth of goods that it imports from the US.   Presumably, other affected countries will do so as well.

 

–there was a similar incident during the Obama administration involving Chinese-made truck tires.  Economists estimate that it resulted in the loss of 3,000 American jobs.  If there was anything good about that situation, it was that it was isolated–Washington understood this was a one-off payment to a domestic union for its political support.  Today’s concern is that, despite overwhelming economic evidence to the contrary, Mr. Trump actually believes that trade wars are good–and will continue to act on that belief.

 

 

protecting domestic industry

If his inaugural speech is any indication, a principal tool President Trump expects to use to enhance US economic performance is to help expand sunset manufacturing industries by protecting them against imports.   More useful action would be to emphasize improving the skill level of the workforce and to encourage innovation.  There may be a place for preventing foreigners from selling at below production cost (dumping) designed to stamp out competitors.  But by itself, and as a principal strategy, protection usually ends up making the economic situation worse, not better.

That’s because:

it stifles innovation, as we can see from the current parlous state of the Japanese economy, which embarked on a strategy of protection in the early 1990s.  That country still has domestic industry that’s state of the art circa 1980, but little that’s more recent.  The US auto industry, which Washington protected from foreign competition beginning in the late 1970s from the 1970s onward, is another example.

other countries retaliate when the borders are close to their products.  President Obama placed import duties on Chinese truck tires, effectively barring them from the US market.  China responded by taxing agricultural products sold there by US firms.

protection typically raises costs to local consumers, lowering their standard of living.  Mr. Obama’s headscratching move simply redirected the source of imported tires from China to Thailand–at much higher cost.  Economists estimate that this unintended (I hope) effect alone cost several thousand US jobs.

 

Let’s hope the president sticks to corporate tax reform and infrastructure spending.