When Can Tariffs be Effective?

Peter Navarro Trump’s trade adviser and a China hawk is now a staunch proponent of fair trade and tariffs. However, in his 1984 book, he warned that ,”as history has painfully taught, once protectionist wars begin, the likely result is a deadly and well-nigh unstoppable downward spiral by the entire world economy.” He went on to say that, “consumers will pay tens of billions of dollars more in higher prices for a much more limited selection of goods.” Thus we can see that economic theories are very political and fungible. Ignoring such inconsistencies, the fact is that tariffs are neither good nor bad by themselves, and the optimal solution will be based on the specifics of a particular situation.

First of all, tariffs need to be permanent or, at least, guaranteed to be long term in order to work. Businesses aren’t going to invest large sums of money in building new factories, if they think that the next Congress or the President is going to revoke the tariffs.

Tariffs can be helpful if a country has infant industries that need to be protected against advanced foreign competition. China has successfully used protective tariffs in the last 40 years to become an economic superpower; and the US did the same during the 19th century to keep out European competitors. However, there are many situations when tariffs simply backfire.

Raw Materials & Essentials

imports

Consider a hypothetical case of a 25% tariff on coffee beans imported into the US. Nobody will benefit from this, since we are almost entirely dependent on imports. Starbucks and other coffee stores will see their profits go down and will simply pass on some or all of the extra cost to the customers.

The same logic applies to all raw materials such as oil, iron, coal, cotton etc. The economy as a whole benefits when businesses have access to cheap raw materials from which profitable products can be made.

Tariffs on essential products such as food also hurt the economy. Look at all the vegetables, fruits and grains in the supermarket with foreign labels, and you can see why tariffs on them will be harmful.

Intermediate Goods

Then there are intermediate goods such as steel and lumber, which are used to manufacture or build value-added products. Raise the price of steel, it will quickly raise the prices of numerous finished goods — cans, appliances, cars, oil pipelines etc. — and will also negatively affect numerous sectors such as construction — from bridges to buildings. As an example, one of the largest nail manufacturers in the US has already laid off people and it’s now on the verge of going out of business.

Similarly, Trump’s tariff on Canadian lumber has raised the price of an average American home by $9000. The number of jobs gained in lumber industry will be dwarfed by the jobs lost in the construction, real estate and housing-related sectors. (A new home also creates demands for appliances, furniture and numerous other goods).

When Finished Goods Create Jobs

Trump wanted to save the solar industry, so he levied a 30% tariff on imported solar panels. While this may help a handful of US companies sell solar panels at a higher price, the overall sales in the industry will go down.

Cheaper solar panels means more Americans saving money on their utilities, less pollution from fossil fuels, and more service jobs through installation. Thus there’s a balancing act here between manufacturing jobs versus service jobs plus other benefits to the society.

In this case, a better solution might be for venture capitalists or the US government to invest in R&D to innovate solar panels that generate more electricity. This will allow US companies to sell relatively expensive products while staying competitive, and consumers will also have more choices.

When it’s Crony Capitalism

Sometimes, corporations simply bribe politicians to raise tariffs on foreign competitors, without justification. For example, take a look at the revenues of washing machine giant Whirlpool:

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Whirlpool is quite profitable, but it faces a stiff competition from South Korean companies such as LG and Samsung. Rather than working hard to make better and cheaper washing machines, Whirlpool simply spends millions of dollars on lobbying politicians:

Whirlpool Lobbying

A few million dollars spent on bribing politicians result in tariffs on Korean products, which has then allowed Whirlpool to raise prices by 20% in the last few months.

This is simply corrupt crony-capitalism, which harms consumers and innovation.

Shooting Ourselves in the Foot

Many imports from China are simply American goods made in China – iPhones, Nike shoes, GM cars etc. Thus tariffs on “Chinese” goods – as defined by the US Commerce Department – can mean taxes on American corporations and consumers.

Many goods from China also include parts from our allies such as Japan, South Korea, Taiwan etc. Thus, it’s no surprise that, as the chart from PIIE shows, tariffs on “Chinese” goods impact multi-national corporations more than Chinese firms:

Tariff - On Chinese Goods Affect MNCs

Even ostensibly all-American products such as Tesla cars depend on imports for half of their parts. Tariffs on those parts means higher costs for end-products.

Finally, many consumer goods – garments, toys etc. – involve low-end manufacturing and extremely cheap labor, and thus will probably never be made in America again. Tariffs on these goods will simply mean higher business costs for retailers and inflation for US consumers.

Can Tariffs Bring Jobs Back?

The most revealing and enlightening aspect of the tariff debate is that corporations and business groups are almost unanimously against Trump’s ideas for bringing jobs back to the US. General Motors has said that the tariffs would raise vehicle prices, reduce sales and would result in lower wages and fewer workers. The discussion of “What’s good for America?” is complex, since what’s good for American workers isn’t necessarily what’s good for corporations. For international financial elites who are major shareholders in American, Japanese and European automakers, what matters is the total number of cars sold, not where they are made; and what matters is net profit, not increase in employment or wages. Thus the big corporations are going to fight the tariffs. If they don’t want to bring the jobs back, tariffs won’t be effective.

Tariffs to Trade Wars

Sudden, punitive tariffs can escalate into trade wars where no country wants to look weak. The repercussions of such trade wars can be enormously damaging for world trade, global stock markets and national economies. Already, retaliatory tariffs from China, Mexico, Canada and the EU are having huge impacts on prices of commodities and on the exports of US businesses. Soybean farmers, cheese producers, lobster fishermen, Bourbon producers are all examples of Americans already suffering from counter-tariffs.

Hundreds of millions of jobs around the world depend on imports and exports. No country is an island in the highly interlinked, globalized economy.

Solution

Tariffs have been around for centuries and will stay despite all the free trade agreements. There will always be some sectors that are politically or strategically too important for countries to sacrifice at the altar of free trade. The most effective tariffs are carefully planned out and narrowly targeted. We should have a non-partisan, neutral committee to analyze specific situations, and make judicious recommendations that can include tariffs, quotas and subsidies. At the same time, we need to get commitments from the beneficiary corporations to increase domestic production, hire Americans, and not engage in price-gouging.

Author: Chris Kanthan

Related blog posts:

Petrodollar Needs Trade Deficit

Trade Deficit is a Misleading Metric

Are Goods From China Really “Chinese”?

Why It’s Not Easy to Win the Trade War Against China

Trump Wants to Sell Cars to EU. Here’s the Problem

 

 

 

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