Trade Wars: Are They Good or Bad and Why
AMERICA - CHINA
AMERICA - CANADA
AMERICA - MEXICO
AMERICA - EU
$ 50 Billion
$ 13 Billion
$ 3 Billion
$ 2.8 Billion
Short History of Tariffs
Prior to 1776, tariffs were used as a form of bloodless war between nations, literally. It was the indiscriminate destructive nature of trade wars (retaliatory tariffs). It was this fact that led Adam Smith to publish Wealth of Nations in 1776 in an attempt to persuade parliament to choose free-trade over trade war. He was only partially successful then but ended up revolutionizing economics as history moved on.
After 1776, tariffs were quite popular, especially in America, but normally for a different reason. Tariffs then were used to protect certain industries within the border of a nation (as opposed to attack the economy of another country as Trump is doing.) This was important to a fledgling American industry as England was quite aggressive in trying to stop America from building an industrial base.
In American history, tariffs were used for three main reasons: 1) to help American businesses gain a foothold in a world market, 2) to raise revenue before there was an income tax, and 3) protectionism as with the Smoot-Hawley Tariff Act of 1930. Rarely has America used tariffs as a form of warfare (the Cuban trade embargo might be an example here).
Save for the first reason, tariffs have always backed-fired and made things worse for America. Smoot-Hawley is a prime example of the damage tariffs can do by taking a serious economic downturn in American and turning it into a world-wide depression.
Today tariffs are very low, about 3% on average worldwide and what America faces. Agriculture is an exception as nations try to protect their farmers. For example, America imposes a 350% on the import of tobacco. Other countries have large tariffs on agriculture as well such as Canada's 298% tariff on butter that Trump complains about.
While Donald Trump frames it differently, what he is doing to our allies is clearly a one-sided trade war against what he wrongly perceives as so-called "unfair" tariffs. In other words, he is retaliating. He justifies it by falsely claiming a national security interest. By doing so, he sidelines Congress.
On Jun 8-9, he attended the annual G-7 (now G-6 as he effectively dropped America out of the group) summit and blew relations with our allies up calling Canada's Prime Minister Justin Trudeau "very dishonest and weak". In response, the G-6 members said they will certainly retaliate against Trump.
Instant Trade War!
Do You Think Donald Trump is on the Verge of Starting a Trade War?
Do You Think Donald Trump UNDERSTANDS He is Starting a Trade War With Our Allies?
How Do Tariffs Work?
Tariffs are very simple in concept. For normal, protectionist type tariffs, the country imposing them wants to make specific imported goods more expensive to the American consumer so that they will buy American-made alternatives. In today's world, except for fungible goods like meats, vegetables, and grain that will mean Americans will pay more for those products. Why? Because the reason American's are importing foreign goods is that they are cheaper and, in some cases like cars, a better quality. It is as simple as that.
Who pays and gets the tariff? The seller pays the tariff and the country imposing the tariff keeps the money, This was a famous way the U.S. financed itself in the 1800s, especially before there was an income tax. This is important to remember.
Donald Trump, although he won't admit this, is imposing retaliatory tariffs. He thinks, wrongly, that 1) a trade deficit is bad and 2) they are in part caused by unfair tariffs or restrictions by the other country. That is not actually true, but he thinks it is. For example, he is has made the price of imported steel 20% more costly to American manufacturers who use it and therefore must raise the prices to Americans of things they make with it. There are three different set of events that happen depending on the item to which a tariff is applied.
These are goods use identity is more or less lost when it goes to market. For example, Mexico is imposing a retaliatory tariff on pork. Once the pig is slaughtered and sent to market, then you can't really tell where it came from; it is all mixed together from a consumer's point of view, i.e, fungible. It is also sold in large quantities. In free trade for pork, a Mexican consumer is no different than an American consumer and supply and demand sets the amount supplied and the price paid. The thing about fungible goods is that in America, American consumers have a wide variety of choices and substitutions, so that their demand is what is called "inelastic", i.e. demand doesn't change much with price; most agricultural products are inelastic relative to demand. You'll see why that is important in a minute.
So here is a simple view of what happens when Mexico slaps a retaliatory tariff on a fungible product (right now, some of those are pork shoulder and legs (20%), some bourbons, apples, and cheeses (20 - 25%) (all total, about $3 billion worth). Let's pick on pork. Here is what is going to happen:
- Demand for pork in Mexico will fall because, even though it is somewhat inelastic to price, a 20% increase in price overwhelms that inelasticity.
- Pork is a major export item for American farmers, so demand will dwindle increasing inventories.
- Assuming pork producers (they) view this as a moderate to long-term situation, they will cut back production.
- In cutting back production, they will lay-off America workers.1
- They will also cut prices to get rid of excess inventory
- Because demand for pork is inelastic, decreased prices won't lead to a comparable increase in demand (as one pork producer said it might in an article I read).
- They will also see a noticeable decrease in profits.
- Mexican sellers will find other sources for pork (probably through a free-trade pact with several South American countries that has been in the works 2)
So, who wins in this scenario? Nobody.
How loses? The American pork producer, the American worker, and probably the Mexican consumer to a small degree.
1 In addition to lost jobs, it also means an increase in means-tested public assistance and lower demand for many other products.
2 If that comes to pass, then America pork farmers will suffer a permanent loss in demand.
Retaliatory 10% Aluminum Tariff
Trump's aluminum tariff will act differently that Mexico's pork tariff. On reason is Mexico has other sources of pork while, at least in the short to medium-term, America will not have other sources of aluminum. In 2017, America produces domestically or recycles 42% of America's aluminum needs. Imports account for only 68%. This represents a significant increase in imports from 2015. The Environmental Information Agency attributes this decrease in domestic production mainly to the cost of production in the United States. What that means is America has plenty of capacity to produce [expensive] aluminum. Further, aluminum products are somewhat inelastic to price while the supply is elastic to cost - so long as foreign sources of supply are available.
So, given this situation, what happens with Trump's 10% tariff? Fortunately (I hope) nothing much more than things made with aluminum get more expensive (inflation). That is because there is an old saying that if you increase the price of an item by 10%, no one will notice (unless the item is highly elastic like a Porsche Sports car).
- Aluminum producers will pay 10% more for much of the products they use aluminum for
- Since imports are so high, that means most items made with aluminum will get more expensive, maybe 1 - 3% (a can of beer might increase about 1.5% for example)
- Since most items (save aluminum wire, automobile, or planes) are inelastic to price, demand won't drop if manufactures raise their prices.
- If manufacturers do not raise their prices, then their profits will decrease
- There is plenty of capacity to produce more domestic aluminum so that is not the problem. Cost of production is, however
- If the cost to produce domestic aluminum is more than 10% then America will probably keep importing
- If it is less than 10% (unlikely, I think) then domestic producers will ramp up production and hire more workers (the outcome Trump is hoping for)
- In all scenarios, I don't see why there would be a significant drop in demand as seen by the foreign producers especially if the cost of new production exceeds the 10% tariff.
25% Steel Tariffs
US steel manufacturers are running at about 80% capacity right now. That is where it leveled out after the disastrous 2018 recession. Prior to that it ran at 90%, basically full capacity. The reason is hasn't grown back to 90% is not all of the manufacturers that shuttered during the recession have, or can reopen.
Further, unlike aluminum, steel products are price elastic, meaning small changes in price CAN result in large changes in demand. (Do you think Trump as a clue about ANY of this stuff?) The U.S. produces only 22% of the steel it needs with imports supplying the rest. That is important given that, in the short to medium-term, steel production is at or near capacity. That means for the US to produce more steel, it will have to re-open closed factories - an expensive and time consuming proposition.
It is Trump's steel tariffs that are the most problematic. Why? Because, as stated above, 1) low capacity to produce more, 2) elastic pricing, 3) high cost and long lead-time to produce more, and 4) high demand. So let's see how This one works:
- The 25% tariff is probably large enough, despite high demand, to reduce imports of steel, meaning loss of profits to the foreign suppliers
- The tariff will induce a noticeable increase in the price of production for anything made of steel in America. Since imports constitute such a large percentage of steel, that means a huge amount of products and services might be affected.
- This puts steel manufactures in a conundrum. With steel price-elastic, they can't pass the increased cost of production (the tariff) on to consumers without decreasing demand (unlike pork, where you can). But they can't increase domestic production either in the short-term because of lack of capacity. That means they must eat most of the tariff themselves.
- If they have to assume lower profits, then they will most likely try to cut other costs to compensate, like labor where you get the most bang for your buck. Even more automation should result along with few jobs (not what Trump wants)
- In time, if the cost of opening new plants and starting up new production is less than the 25% tariff, then that is probably what will happen.
- In the mean time, prices must rise to the consumer on a huge variety of products.
- On the import side since the importers know America cannot produce more steel in the short-term they will pass most of the tariff cost on to the buyer. (This is where I disagree with some analysis I've seen.) Because steel is elastic, that means U.S. demand for steel will decrease. At some point equilibrium will be found between supply and demand, but the bottom line, steel will cost more to the U.S. Somewhere between the original price and 125% of the original price.
- Since America imports so much steel, the lowering of import demand will likely affect foreign production and loss of foreign jobs (mainly in China).
- In the long-term, steel workers as plants begin to open or production of existing plants ramp up a little bit.
- In the long-term, American steel manufactures because sooner or later than will pass on the increased cost of production to the American consumer
- In the short, medium, and long-term, the American consumer will lose because everything will get more expensive right from the get go and stay that way.
- In the medium-term, when American production starts up, foreign producers because of curtailed demand
- In the medium-term, when American production starts up, foreign workers because of curtailed demand
- In the short-term, American manufacturers because of likely reduction in demand due to higher prices.
Do You Think Donald Trump's Trade Activities Will Help America or Hurt America
Will YOU Be Personally Helped or Hurt By Donald Trump's Trade Actions
Our allies have already started retaliating and have promised to do more starting July 1, 2018. The following are what I could find on the Internet:
- Maple Suryp
- Some prepared meals
- Licorice candy
- Jams and purees
- Personal care products and preparations
- Playing cards
- Sleeping bags and bedding
- Boats and engines
- Automobile control devices
- Boards, panels, consoles, desks, cabinets and other bases, equipped with two or more apparatus of heading for electric control or the distribution of electricity, including those incorporating instruments or numerical control apparatus
- Articles of aluminum
- Toilet Paper
- Household products
- Paper and paper products
- Orange Juice
- Peanut Butter
- Orange Juice
- Full list coming
- Scrap Aluminum
- Stainless Steel Pipes
- Ethanol products
- Soy beans
Keep in mind that for most of these products it is not the American consumer who pays the price through higher prices, it is the American manufacturer and worker who does via reduced demand.
Trade War With China - What It Means To You
Trump Taxes the Chinese
On Jun 15, 2018, the Donald Trump reignited his trade war with China, after first putting it on hold the month before, by imposing $50 billion in tariffs on 1102 items imported from China. As pointed out above, this is 25% (the size of his tariff) on goods coming into the US. The bulk of the tariffs start July 6 and the remainder after a period for public comment. China has promised to retaliate in the same amount.
The kinds of products being taxed by the US are things like:
- Aircraft tires
- Nuclear reactors
- Boat motors
- Ball bearings
- Printer/copier parts
- Electrical parts (to name a very few)
What you won't find on the list yet are items you can buy at Target and WalMart. Why? Because the American consumer would see an immediate price rise had they been included. We will nevertheless see a slower paced increase in prices because the targeted item are used in producing the things we buy or use.
One of three things MUST happen as a result of the new tax: 1) higher prices to the consumer, 2) lower profits for American industry, or 3) a combination of the first two. The previous discussions explain why. The other LIKELY thing to happen is lower stock prices. Right now, the tariffs are for only $50 billion worth of goods, but Trump announced on June 18, that he plans to impose $200 billion if the Chinese dare to retaliate - which they certainly will.
China Taxes America
The Chinese will, if they haven't already, placed $50 billion of tariffs on American products, mainly agriculture. While the American consumer may not be hurt by this (in fact, some may be helped a little bit), it is the American farmer, Donald Trump's base, who will fell the brunt from the Chinese tariffs. America sells A LOT of soy beans and other agricultural products to the Chinese because we have quality product and good prices. But, when the cost of agriculture goes up 25% in China, the Chinese consumer will look elsewhere for their needs and, unlike many things Trump is putting tariffs on, there are plenty of alternative sources. (Mexico is also going to place tariffs on American agriculture as well for the same reason.)
When prices go up drastically in China, demand in America is going to fall just as fast as will the profits of many farmers.
The $200 Billion Threat
Trump has threatened to impose another $200 billion on China should they be so insensitive enough to retaliate against him. If that were to pass, then the Targets and WalMarts will suffer immediate harm as consumers close their wallets to much higher prices. And this, right before the mid-term elections!
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© 2018 Scott Belford