Economics

Trade Wars

Using Tariffs for Political Gain

Robert Spendlove and Joseph Mayans Jul 9, 2018

Equity markets have been on a roller coaster ride since President Donald Trump’s announcement of wide-ranging tariffs on imported steel and aluminum. The news also brought swift rebuke from world leaders and resulted in tit-for-tat political posturing.

Since then, several nations have announced retaliatory tariffs because of the U.S. announcement and China could face additional penalties on billions worth of imports to the U.S., according to the president. While many economists have decried his actions as protectionist and harmful to the economy, the situation may be more nuanced.

Background

The U.S. has run a global trade deficit for more than four decades, and in recent years China has been a primary driver of that deficit. Many politicians and economists have accused China of engaging in unfair trade practices and sheltering its industries, while the U.S. allowed greater access to its market.

This created an uneasy relationship between the world’s two largest economies, especially as numerous goods-producing industries have declined in the U.S. During the last 30 years, the U.S. steel industry has faced immense pressure from globalization and struggled to compete on the world stage.

Currently, only about 5 percent of the world’s steel is produced in the U.S., while China produces nearly 50 percent; a change that has been acutely experienced in “rust belt” communities.

In an attempt to level the playing field, the Trump administration recently announced plans to impose tariffs on steel and aluminum. The president is considering applying the tariffs to several countries in the world, including some of its top trade partners. However, the majority of the tariffs will be directed at China. By doing this, the president makes good on his campaign promises to revitalize impacted communities in America and level the playing field with China.

Winners and Losers

With changes as drastic as what the president is considering, it is important to understand the impacts. There is no doubt that China has violated fair trade practices for years, and if these trade talks could end or cut back on those practices U.S. companies would benefit. Also, American steel and aluminum producers may benefit in the short-run, because less foreign steel would be imported to the U.S.

However, there will likely be more losers than winners, especially if the talks lead to a wide-ranging trade war. Supply chains are highly globalized and interconnected, and any additional tariff (tax) levied along the way is typically passed down the line to consumers in the form of higher prices.

In the present case, those industries that rely on foreign steel and aluminum — such as auto and aerospace manufacturing, construction, and food processing — will be adversely affected. This could be a net negative for the economy, especially because those industries are much larger than the steel and aluminum producing industries. In 2002, President George W. Bush imposed tariffs on imported steel but was forced to lift them early. One study estimated those tariffs cost 200,000 jobs and resulted in $4 billion in lost wages.

Lessons From the Past

A classic example of tariffs leading to a widespread trade war is the Smoot-Hawley Tariff Act of 1930. The goal of the act was to protect agricultural production in America against foreign imports. However, the items covered quickly expanded from just a few targeted products to more than 800 different industries. As the tariffs expanded, other countries around the world retaliated, imposing tariffs on many U.S. goods. 

The resulting global trade war severely depressed already struggling economies and extended the destructive impact of the Great Depression. In 1934, President Franklin Delano Roosevelt reversed the tariffs. But the negative impacts of the trade war took years to overcome, with many countries refusing to lower their tariffs on American products even after the U.S. reductions.

Finding a Path Forward

Although tariffs and trade wars are proven to reduce overall economic health, they often remain a politically popular move. Politicians tend to focus on the short-term benefits of looking tough on trade rather than the longer-term costs of protectionism. Hopefully, cooler heads will prevail in the current trade standoff, and all sides will find a path that encourages mutual benefits and better trade policies. Trade disputes are generally harmful to everyone involved, but if used to spur meaningful change to unfair practices they could be beneficial.

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