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.

 

 

how do tariffs affect selling prices?

The purpose of tariffs on imported goods is to discourage their use and to encourage the development of domestic substitutes.  It sounds good in theory but may not work in practice.

A recent example of the latter is the imposition of tariffs by the Obama administration on truck tires imported from China.  The tariffs made the Chinese tires affected noncompetitive in the US.  But US tire makers regarded this market as not lucrative enough for them to enter.  So trucking companies began to import more expensive tires made in Thailand.  Economists estimated at the time that because the tariffs raised the cost of doing business for truckers it lowered their profits and overall cost the country about 3,000 jobs.  And then, of course, China retaliated by placing an import duty on poultry source in the US, hurting that industry as well.

The key points:

–tariffs raise the cost of doing business for the industries affected.  That extra cost must either be absorbed by the buyer of imported materials or passed on to the customer.  Theory says that if the end product is unique, the burden will be mostly borne by the end user;  if it’s a commodity, the importing company will have to absorb most of the extra expense.  An interesting case in this regard is toys.  Most of the toys bought in the US are made in China.  A tariff on run-of-the-mill imported toys (which probably means 90% of them) would mostly raise the price to consumers, in my view.

–tariffs may not promote domestic industry, and may do significant net damage, as the truck tire example shows.

–in addition, decades of protection against foreign competition did little to protect US carmakers from the long-term threat of imports.  On the contrary, Washington’s protective umbrella shielded shoddy manufacturing and lack of innovation that ultimately ended with two of Detroit’s Big Three declaring bankruptcy.  To be sure, government action forced foreign carmakers to establish manufacturing operations in the US.  However, the sad case of General Motors, which controlled 40% of the US cara market at one time, makes it hard to argue, I think, that government protection of domestic industry against foreign competition is the best thing to do.