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New Tariffs and Their Impact

New Tariffs and Their Potential Impact

Website Administrator - Monday, March 05, 2018

At the end of last week, the news was dominated by President Trump's announcement to implement tariffs on imported steel and aluminum products. This has a lot of us wondering how those tariffs would look in practice. Our on-staff Chartered Financial Analyst charterholder Ryan Long shares his insight in March's first question of the week.

Question: What would be the impact of new tariffs on certain imports?

Economists and investors were surprised this last week by the administration’s announcement of upcoming tariffs on imported steel of 25% and aluminum of 10%.  This follows the implementation of tariffs on a variety of other specific items, such as washing machines and solar panels, which appear to be targeted to specific companies and countries.  These recent actions with steel and aluminum weren’t arbitrarily chosen product imports or tariff amounts; they were taken almost verbatim from a recent Commerce Department recommendation. 

This isn’t the first time steel has been targeted; the Bush administration slapped on a 30% tariff in 2002, with results described as somewhat chaotic, with prices skyrocketing and a loss of up to several hundred thousand jobs from industries that required steel inputs—like machinery, autos, airplanes and other transportation equipment.  Interestingly, in a similar tariff on certain steel in the 1980’s, it has been estimated that consumers lost $1 mil. for every steel job saved. 

In the economic community, the use of tariffs in country-to-country trade is controversial, mostly due to the artificial infringements on free trade.  Global free trade is considered the ideal standard environment, as it allows nations to produce what they’re best at producing, for internal use and/or export.  Assuming each nation is able to do efficiently accomplish this, each nation benefits from export income earned which can be used for importing goods that are less efficient or possible to produce.  If the system is relatively fair, everyone can win.  Of course, since all nations have different objectives, achieving perfect fairness can be next to impossible, which is where trade restrictions, such as bans or import tariffs are sometimes introduced to influence trade behavior.

Economists generally are less enamored with tariffs for a variety of reasons.  On the surface, the goal is to help U.S. manufacturers better compete on a more even playing field with foreign producers.  These have been especially geared to producers implicated in the category of ‘dumping’ at overly-cheap prices on our shores—the Chinese often being a scapegoat, but they have not been the only nation that produces cheap goods by any means.  A tariff raises the price of the foreign import to a higher level, making it less competitive.  For example, a consumer might be comparing the price of a $700 U.S.-produced washing machine to a $600 foreign-made model (for simplicity’s sake, assuming comparable quality, features, etc.).  If the impact of a 20% tariff is passed on completely to consumer prices (which may not always be the case in the near-term), the price of the $600 foreign machine is bumped up to $720.  For price-sensitive shoppers, the U.S.-made model moves from loser to winner.

However, over time, foreign producers can adjust their pricing and production locations, or, if tariffs become widespread through an economy for a large basket of items, currency levels can also adjust.  For instance, when the tariff on washing machines was implemented, key South Korean makers announced plans for new U.S. factories, intended to circumvent the tariff by building in the U.S.—rendering products as ‘domestic’ as opposed to ‘imported’.  In that particular case, while convoluted, there could be indeed some boost in the creation of some U.S. jobs in the affected industries directly (although it can negatively affect other domestic jobs indirectly in some cases).  However, only so many of these one-off adjustments can occur before retaliatory measures are taken, such nations turning the tables by applying tariffs to exported U.S. goods.  Net-net, this just renders a more contentious global trade environment, and an ongoing series of one-upmanship, where it’s less likely consumers or workers benefit, but politicians can claim they’ve ‘done’ something to address more problems that are more complicated at their core, such as saving a few jobs for the next few years while neglecting long-term fixes, such as the modernization of education systems or supporting job retraining programs.  Keeping uncompetitive or dying domestic industries on life support for longer has rarely resulted in a satisfactory or cost-effective outcome, but can be very politically popular in the near-term.

Long-term effects of tariffs are variable.  If prices are pushed higher than they would normally be or should be from a cost-of-production and supply/demand perspective, inflation could creep higher.  This is the ‘bad’ inflation that economies would typically like to avoid, the type that countries are the recipient of and raises the overall cost of living.  This is opposed to ‘good’ inflation, where moderate increases in consumer prices are a byproduct of stronger economic growth and monetary activity in the system.  It’s possible cooler heads may prevail, that widespread tariffs are only a threat to bring nations to the negotiating table, or that tariffs will remain targeted to certain products or nations.  Many traditional economists would agree that free trade broadly benefits everyone involved, and putting restrictions on this process tends to ‘gum up’ the system and create artificial inefficiencies at best and barriers at worst.

As it turns out, however, we import relatively little steel from China—the oft-named target—and we are actually net exporters of aluminum to them.  Much of our steel originates from Japan and Canada, whom we view as friendly trading partners.  This makes the news all the more puzzling, unless its intended to be more bark than bite.  While the economic impact of these few industries doesn’t look to be substantial, the symbolism and tone of trade policy more broadly is what has generated concern.

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