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Wrecking balls in motion

mckee

About a week ago, and in the dead of night according to the New York Times, Trump started his trade war. With all the other hoopla going on, not much has been done to call attention to this event.

International trade makes up around 25% of our GDP, which is a number that is not to be sneezed at. However, international trade is not the most interesting subject to examine and even simple explanations can take the reader off into the weeds by the end of the lead. There is just no way to inject any real excitement into basic accounting, trade ratios and market shares.

That said, the event noted may have more lasting and direct consequences upon more of our everyday lives than all of the other matters that the old fool is playing around with will have, even combined. It was exactly midnight that a third round of tariffs imposed by Trump on billions of dollars’ worth of foreign trade from China was to take effect. China immediately announced that it was matching the U.S. action with additional tariffs on of its own. Similar dialogues are rippling throughout Europe, Canada and Mexico as these countries prepare retaliations in response to U.S. tariffs imposed upon their exports. Trump has announced the intention of following suit if retaliatory tariffs are imposed against the United States. The result appears to be the beginning of an inevitably escalating series of retaliatory tariffs that could escalate until trade maximums are engulfed.

So, history seems on the brink of heading down a path last followed almost 90 years ago, when the isolationists convinced then President Hoover to go along with a stiff tariff program intended to protect American jobs. The Smoot-Hawley tariffs were enacted in 1930. Economists and historians estimate that these tariffs were the direct cause of U.S. exports falling by over 40% by 1932, crippling international trade. All economists generally agree that the trade war caused by the Smoot Hawley tariffs exacerbated the Great Depression.

Trump has not announced what specifically he intends to accomplish by the imposition of his tariffs. He has no clear policy to promote. He says only that the U.S. is being treated unfairly, and that we have to reign in the current levels of trade deficits. He doesn’t say why the trade is unfair. Surely, there are specific imbalances that need attention, and there are some trade practices that are unfair. Specific tariffs can be a tool in certain cases. But the task here is to find a tool to apply as a Band-Aid to a specific problem, not to attack every situation with sledge hammer or wrecking ball. Too often tariffs become sledge hammers, leaving too much unintended wreckage. Even when carefully applied, the impact of tariffs will eventually hit the consumer.

Trump’s fascination with trade deficits, and his insistence that they need to be brought into balance, is just plain wrong. Trade deficits are not inherently evil. In a healthy economy with markets that are otherwise booming, trade deficits are a perfectly normal if not even a desirable result. In the U.S. for example, with an economy that is burgeoning ahead, the huge beneficiaries of our trade deficits with most of our trading partners are domestic consumers. Eliminating deficits by definition requires either an increase in production or a decrease in consumption. Where artificial measures are applied, in the usual case it is the consumer who will suffer in the end.

Consider what happened in 2009, when the unions and tire manufacturers complained to the Obama administration that China was flooding the market with radial tires. Domestic jobs were being lost because domestic producers could not compete. So, the Obama administration imposed a punitive 35% tariff on specific types of radial tires exported from China. Because of the specifics involved, economists were able to study the market exactly, and measure the results with a degree of precision.

It might have looked like the special tariffs helped in the short run. Domestic tire producers were able to hold their prices and maintain production, and an estimated 1,200 jobs in the tire industry were preserved. But according to a study released by the Peterson Institute of International Economics, when the consumers’ side of the deals were examined, the additional cost of what had been cheaper Chinese exports cost domestic consumers an estimated $1.1 billion in higher prices. Further, when the tariffs hit, the decline in sales of the imported tires cost an estimated 3,731 domestic jobs lost on the retail side. One academic study on this specific tariff concluded that three retail jobs were lost on the consumer side for every manufacturing job saved on the production side.

In the longer run, the special tariffs did not return all radial tire production to the U.S. Instead, production migrated from China to other cheaper countries. Domestic tire production was initially boosted by the tariffs but soon sagged again as competition from foreign sources spread. One manufacturer, for example, held his employment level from 2009 through 2012, with the addition of the tariffs, but by 2017 – five years later – the employment level at this firm was down by over 25%. A study released in July of 2017 concluded that the special tariffs made no difference to production problems in the tire industry long term yet cost the U.S. consumers billions of dollars in higher prices.

The problems are even more complicated when the commerce being hit are products made up of component parts or subassemblies. According to a 2017 analysis presented by CNN, for example, every car manufactured in the United States could actually be considered an import when considering the origination of all the parts and subassemblies that go into the manufacture. To show the incongruities, by this measure the most “American made” vehicle currently on the market is a Honda pickup – a commercial vehicle partially manufactured in Japan with more than 75% of components manufactured in either the U.S. or Canada.

If tariffs are imposed on parts that are exported to the U.S., this can put the domestic parts manufacturer at a significant disadvantage. The domestic producer’s costs are driven up by the tariffs, often resulting in it conceding market shares to foreign competition which acquires the same parts and subassemblies but without tariffs. If the domestic producer can absorb the additional costs of the tariffs without raising prices, it still must reduce margins which might otherwise be available for increases to wages or reinvestment in plant resources.

All major U.S. automakers also have assembly plants in Mexico. Components are manufactured in the U.S. and elsewhere, shipped to Mexico for assembly, with the completed vehicle then returned the U.S. for sale. In a full-scale trade war, we may find tariffs imposed by the U.S. on parts and subassemblies; tariffs imposed by Mexico on the components sent to plants in Mexico for final assembly and tariffs on the finished vehicle as it is returned from Mexico for sale. Multi-levels of tariffs would hit U.S. consumers purchasing U.S. made cars from U.S. manufacturers on vehicle models intended for sale in the U.S.

One investment analysist said long range planning under Trump was difficult because no one could figure out what his policy was, is, or might become, commenting that “Watching all these trade actions is like watching a pinball machine.” Further, what Trump is doing is probably illegal. Imposition of tariffs are supposed to require Congressional action; the President is only authorized to act without Congressional authorization when declared necessary for national security. Most analysists agree that there is no true national security involvement in any of the tariffs Trump has imposed so far, or in any tariffs that he has announced he intends to impose.

What is clear is that the ultimate target of almost all of these tariffs is, or will be, the American consumer. Despite what it looks like, tariffs are not a tax or penalty imposed upon the foreign exporter. While sometimes the cost of a tariff can be absorbed by exporter; much more common in the short run, and always in the long run, is that the additional cost of the tariff will be passed along into the price to be paid by the ultimate consumer. A tariff in reality is nothing but a sales tax imposed upon the poor end consumer.

Anybody want to guess who that is going to be?
 

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