Article by NEWSREP guest author Alex Benson —
In the past two years, President Trump has enacted tariffs on $16 billion worth of Chinese and Canadian goods. Predictably, the Canadians countered with $12.6 billion in retaliatory duties against US exports. The Chinese followed. In addition, in his most sweeping action to date, the president slapped a 25 percent tariff on all foreign steel and a 10 percent tariff on aluminum imports. To this final duty, there are no exceptions. If General Motors wants to import foreign steel to help make cars cheaper for consumers, they must pay a 25 percent tax. If Budweiser wants to drive down production costs with aluminum from abroad, a 15 percent tax. No exceptions. Period.
In sum, we are firing the first shots of what may well become a global trade war; and, the president’s assertions to the contrary, like all conflicts, a trade war won’t be over by Christmas. If the conflict is allowed to escalate, it could be disastrous for the U.S. economy. Tariffs do not cause protracted crashes, but they can be their catalyst. For evidence of this, look no further than the effect of the Smoot-Hawley tariffs in 1930.
After the market crashed in 1929, President Hoover and Congress looked for a quick fix that would help the economy rebound before the 1932 election. Hoover’s 1928 campaign promise to help farmers by raising agricultural tariffs provided additional political cover for what was enacted: a massive tariff bill that raised the average duty rate by 50 percent. The result was a catastrophe: US imports and exports both fell by over 60 percent and GDP collapsed by nearly half in four years. The future President Franklin Roosevelt would run a successful campaign in 1932 in large part by decrying Hoover’s spendthrift policies and promising to repeal Smoot-Hawley and rid the market of its economic nationalism.
This is not to say that President Trump’s tariff policies will be as catastrophic as President Hoover’s. For one thing, the U.S. is a much larger economic actor on the world stage than it was in 1930. The dollar is the reserve currency of the world, and even with only 5 percent of the world’s population, the United States accounts for nearly 22 percent of world trade. In other words, the elasticity of demand for US goods is much steeper than it was in 1930.
Still, the president’s tariff policies could cause significant damage to the U.S. economy. Over 25 percent of US GDP is directly tied to international trade, and the remaining 75 percent goes abroad to purchase inputs for its production processes. This remaining 75 percent is less visible, but it’s where most of the damage wrought by higher tariffs will be concentrated. Higher steel tariffs might make domestic steel producers happy, but they would raise the price of manufacturing inputs for car, appliance, aircraft, railroad, and ship manufacturers, to name only a few—the economy is littered with additional examples. While aluminum tariffs might placate select domestic producers, no one who regularly buys canned soup, beer, cell phones, laptops, or children’s toys is going to appreciate those goods becoming more expensive.
Furthermore, if President Trump seeks to reduce the trade deficit, his actions will likely have the opposite effect. High tariffs actually increase the trade deficit in two major ways (among many others that are beyond the scope of this article). First, US exports will shrink as a result of other countries retaliating with tariffs of their own. Second, the now higher cost of foreign goods will force many consumers to buy from domestic firms, which in turn sends domestic firms looking for additional capital to expand production and meet the new demand. If the domestic savings rate has not changed, they must attract capital from abroad, further increasing the trade deficit.
These effects are not just theoretical. The U.S. trade deficit has actually expanded by 7 percent since 2017, despite the president’s tariffs (or, perhaps, because of them).
What is more, from a strictly economic perspective the trade deficit does not matter a whole lot, and bilateral trade deficits do not matter at all. That is to say, looking at either bilateral trade deficits (say, with China or Canada), or trade deficits generally, misses the real story conveyed when accounting for trade flows.
Trade flows are calculated using the value of the finished product, not value added. For example, while the value added to an iPhone by assembling it in China is only about $6, the Chinese are still credited in the international trade accounting with the entire $200 required to manufacture the device. When the finished iPhone is imported into the U.S., the $200 is added to the U.S. trade deficit with the Chinese. In this way, trade deficits by themselves don’t necessarily reflect an addition to or diminution of US GDP. Basic GDP accounting shows this: GDP = C + I + G + (EX – IM), where C = consumption spending, I = investment spending, G = government spending, and (Ex – IM) = net exports. The GDP equation adds both exports and imports to the total value of the U.S. economy. The insertion of the net export term (EX – IM) doesn’t show that exports are a driver of GDP growth while imports hinder it; net exports, as the final variable in the equation, is merely an accounting tautology made necessary by the fact that all imports have already been accounted for in the consumption and government spending variables. Failing to subtract imports from exports at the end of the equation would serve to double count the value of goods imported into the United States.
Imports are just as valuable to the health and growth prospects of the U.S. economy as exports. They should not be taxed or maligned by the highest office of the nation they played such an important part in building. Free trade makes both sides better off. Trade hurts some people, but we should be asking how to help these people, not stopping people from trading outright. Consumers shopping at Walmart hurt a small-town grocery store, but no one with any economic training or sense of morality will say that we should therefore place a 30 percent tax on all goods sold at Walmart. Why then does an invisible line drawn on a map make the same action permissible when it comes to US consumers buying from foreign firms? Economic laws don’t recognize borders, and a moral code is not abrogated by artificial classifications. We must recognize the truth of what we are proposing with any protectionist measure: using men with guns to prevent individuals from consensually trading with one another to the detriment of our moral center and the obstruction of continued growth.
The argument against trade protectionism is perhaps best summed up with an analogy. In times of war, a nation blockades its enemy’s ports. Why? Because forcing economic autarky is an extremely effective form of financial warfare. Goods become scarce, costs explode, and a labor shortage prevails alongside a dearth of raw materials and intermediate goods.
If a physical blockade in prevention of free trade is so disastrous, why then would we do the equivalent of partially blockading ourselves? What is the difference, in economic terms, between a foreign navy preventing foreign steel from entering our ports unless we pay them a 25 percent fee, and the U.S. government forcing consumers to pay a 25 percent fee to import foreign steel? The only difference is that the U.S. government will have more money, and should we really trust them to better spend that money than US consumers? We do not trust them with other tax revenues, and that is what tariffs are: a tax. Pure and simple.
Tariffs are a tax, and like all taxes, they are destructive. They reduce economic activity and distort incentives. President Trump might be well-intentioned, but his protectionist trade policies are misguided if the goal is to bolster US manufacturing and sustain the current economic expansion. The president wants to put “America First.” Unfortunately, he misinterprets the facts of international trade and misses on the prescription for expanding jobs in the United States. If the president continues on his present course, he will find himself haunted by the ghost of Smoot-Hawley and the specter of protectionism’s ubiquitous failures.
The president’s best path forward may be simply to get out of the way. He has followed a relatively hands-off policy with respect to the domestic economy, to the result of a booming stock market and the lowest unemployment rate in decades. Perhaps President Trump should heed the same advice from trade markets as that which was given to Alexander the Great by the philosopher Diogenes when the Macedonian conqueror asked if there was anything he could do for him: “Yes. Stop blocking the sun.”