President-elect Donald Trump has called himself a tariff man,
saying that tariffs are the greatest thing ever invented and
that the word tariff is the most beautiful word in the
dictionary. He announced last week that he
would impose new tariffs on goods entering the US from
Canada, Mexico and China on his first day in office.
To be clear up front, this is not a political video.
It shouldn't matter if you love or hate Donald Trump.
The purpose is just to discuss the issues that exist in
international trade and the impact the tariffs or other
government actions might have on trade, employment and inflation.
We'll look at how they've worked and failed in the past and how
American tariffs today might be different to the disastrous
Smoot Hawley tariffs of 1930 Trump announced last week on his
version of Twitter. Everyone has their own version
of Twitter now. That he would sign an executive
order for a 25% tariff on all goods coming from Canada and
Mexico, and that these tariffs would stay in place until the
flow of drugs and immigrants from these countries into the
United States has come to a halt.
After the announcement, the Mexican peso fell 2% and the
Canadian dollar traded at its lowest rate to the US dollar in
15 years. Trump has already vowed to
target China with a 60% tariff and has discussed a 200% tariff
on some car imports. He says that goods coming from
China will be hit with an additional 10% tariff if China
doesn't do something to halt fentanyl smuggling.
Tariffs, which are controversial with economists, are core to
Trump's economic vision. He sees them as a way of
protecting American jobs, growing the US economy and
raising tax revenue. On the campaign trail, he told
voters that his tariffs would not cost Americans anything,
that they're instead a tax on another country, which many
economists described as being misleading.
U.S. trade with China has grown enormously over the last 25
years, and while it brought lower prices to US consumers and
higher profits to American multinationals, it came with
some downsides, too. And both sides of the political
aisle have been focused on how to better balance trade and how
to avoid losing access to strategically important goods
and industries. While Donald Trump is a divisive
politician where some people love him and others hate him,
his threats to impose tariffs on foreign imports are drawing
support from lawmakers of both parties.
Janan Ganesh wrote in the FTA few weeks ago that Trump's
biggest success during his first term in office was that he bound
the actions of his successors, saying that Trump moved the
consensus on a big issue, foreign trade, such that the
next president either couldn't go back or didn't want to.
During Trump's first term in office, the average US tariff on
Chinese imports rose from around 3% to nearly 20% when Joe Biden
took office. Four years later, instead of
reversing Trump's trade policies, he added more tariffs,
in particular on electric vehicles, and a protectionist
industrial policy that included subsidies and a Buy American
mandate. The Cato Institute, a
libertarian think tank, described Bidenomics as Trumpism
with a human face, or Olite Trumpism.
So let's try to understand the issues with international trade
that have been pushing the United States and other
countries in this protectionist direction, and if tariffs can be
expected to improve the situation or make things worse.
We'll discuss whether Trump could impose his tariffs
unilaterally on his first day in office, and whether the mere
threat of tariffs could be used to improve America's bargaining
power. So tariffs are quite simply a
tax on imported goods, which gets applied at the border when
a good is bought from abroad. This is a protectionist trade
strategy where the tariffs push up the price of foreign sourced
goods, incentivizing consumers to switch to domestically
manufactured goods, giving domestic manufacturers room to
increase their own prices. The benefits that domestic
manufacturers receive come at the expense of consumers, who,
all else equal, pay more for the goods that they buy.
For this reason, tariffs are redistributive, taking income
from the household sector and transferring it to protected
businesses. Now, there's nothing too
surprising about that idea, as all taxes are redistributive.
But critics of Trump's plan say that they're not just
redistributive, but that they'll be inflationary and harm the US
economy. His defenders, on the other
hand, point out that this didn't happen during Trump's first term
and that the Biden administration looked into
removing Trump's tariffs when inflation was high.
But their analysis showed that the change was unlike likely to
make a big difference. Because a tariff is charged at
the border, it does push up the price of imports, which is
inflationary. Some of that impact is offset by
changes in exchange rates, where the currency of the tariff
charging country rises against the currency of the country
being subjected to tariffs. Additionally, foreign companies
sometimes reduce their prices in order to remain competitive.
An analysis by LPL Financial found the tariffs imposed in
2018 hit producer prices more than consumer prices in the
United States as wholesalers absorbed some of the price
increase. Now long term viewers are
probably aware that I believe in free markets and limited
government intervention in trade.
From a free market perspective, the correct response to foreign
government subsidizing exports is to do nothing.
In fact, an argument can be made that a country should welcome
other nations export subsidies, which Milton Friedman has
described as a form of foreign philanthropy, saying that if
another government wants American citizens to enjoy it's
goods and services at artificially low prices,
Washington should tell them to bring it on.
The problem is that persistent subsidized imports can
eventually displace domestic production of often
strategically important goods. The worry is that unfair foreign
competition can bankrupt domestic producers, after which
prices can be hiked up by a foreign owned monopoly.
The example often given of strategically important
production is steel, which I discussed in a recent video
about how Britain was planning on paying huge subsidies to
foreign owned steel mills to keep them open in the UK.
Some of the top comments said that if China's willing to ship
steel to Britain for less than it costs to produce the billion
# subsidies should instead be spent on buying Finnish steel
and setting it aside as a strategic reserve.
Trump is arguing that tariffs on America's trading partners are
necessary to protect US businesses and the American
worker at a time when US manufacturing jobs have dropped
from their peak in the late 1970s.
Trump supporters point out that some of his tariffs did appear
to work when he was last in office, giving the example that
tariffs on imported washing machines may have created new
jobs as they were imposed at the same time as Whirlpool was
building a new factory in the United States and the tariffs
helped the new factory to succeed.
The results of trade policies like this are unfortunately not
always clear, as there are a lot of moving parts, and it can be a
bit like dietary science, where a person excludes sugary drinks
but then eats a bit more food, offsetting most of the benefit.
The Federal Reserve analysis of Trump's first term tariffs found
that a lot of the benefits were offset by the higher costs of
imported raw materials that American manufacturers had to
buy, as well as from retaliatory tariffs from other nations.
Overall, they found that there was a small decline in the
number of US manufacturing jobs during Trump's first term, but a
number of factors, like the start of the pandemic, could
explain that outcome. Now, it's become a bit of a
cliche when talking about Donald Trump to say that you should
take him seriously, but not literally.
And while that might be a cliche, it's still probably
true. So while the specifics of what
he will do about trade once in office are not clear, the thing
that is really clear is that foreign trade is the topic he
cares the most about. You can find videos online
dating back 40 years of Trump on daytime talk shows.
Being mostly pleasant doesn't until the topic of foreign trade
comes up. Back then Japan was his main
target. Well, today it's China.
Janan Ganesh wrote a few weeks ago.
The trade is almost all that Trump cares about, with
immigration coming in as a distant second.
He says that over the last 40 years, Trump has had an intense
belief that to run a current account deficit with another
nation is to lose to it. I think that the exact mechanics
of how Trump plans to deal with trade are not clear, but I think
it makes sense to take him at his word that this is the issue
he cares the most about. Exactly how he'll put tariffs in
place is maybe the most unclear part of his plan, but I think
it's unlikely that he'll do it on Inauguration Day, as he has
said, as that would likely require him to declare a
national state of emergency. Which is what Richard Nixon had
to do to proposed 10% tariffs on all imported goods when he
suspended the convertibility of the dollar into gold in 1971.
Nixon put those tariffs in place to prevent American producers
from being disadvantaged in the expected exchange rate
volatility around that announcement.
Now, if tariffs were applied to Canada and Mexico and applied to
things like oil and gas, it would be quite inflationary,
which is the opposite of what Trump promised on the campaign
trail. So I don't think that this is
awfully likely. The USMCA trade agreement, which
replaced NAFTA in 2020, is up for a scheduled review in 2026,
and it seems extremely likely that Trump will use that deal as
a bargaining chip to negotiate with Canada and Mexico over
things he cares about, like immigration.
This is exactly what he did in the past.
In 2019, under the threat of tariffs, Mexico agreed to step
up immigration enforcement to prevent migrants from entering
Mexico from Guatemala in the South and to stop them from
leaving to the US in the north. While it's reasonable to expect
Trump to try and extract concessions during these
negotiations, both Mexico and Canada do run persistent trade
deficits, much like the United States, and so overall they are
on the same side as the United States on this issue.
It's worth remembering that during his first term in office,
Trump's cabinet mostly moderated his protectionist instincts
along with the stock market reaction, which he saw as a
measure of voter approval. It looks like he might have a
less conservative cabinet this time around, but likely still
cares about the stock market. So what are the problems in
international trade that Trump is aiming to fix?
Well, the hyper globalization that began in the late 1990s
made the world better for most people.
It almost eliminated extreme poverty and reduced global
inequality. Consumers in wealthy countries
benefited from cheap imported goods, which kept inflation low
and standards of living as measured by per capita income
increased around the world, while the average person was
doing much better than before. Blue collar workers in developed
countries were struggling as manufacturing work moved abroad
where labour was cheap. While global inequality had
fallen, inequality within the United States had grown.
On top of all of this, Western governments were getting
concerned that China and some other surplus economies were
engaging in unfair competition by subsidizing manufacturing
while imposing restrictions on foreign companies in exchange
for access to their markets. This became more of an issue as
China developed and could no longer claim to be a poor
developing country. Western economies began to see
it as a problem that China had the highest manufacturing share
of GDP and the lowest consumption share of GDP in the
world. By agreeing to absorb China's
excess production deficit, economies like the United States
were allowing their most aggressive trade partner to set
their trade policies for them. The economist Michael Pettis
argues that surplus countries subsidise their manufacturing
industries and pass on the costs of these subsidies to deficit
countries like the United States.
He argues that a free trade country with open capital
markets when trading with a planned economy is not really
engaging in free trade. They're instead accepting the
inverse of their trade partners trade and industrial policies.
So how does China subsidise exports?
Well, Chinese exports receive considerable direct subsidies,
but the indirect transfers they receive are even larger.
Chinese power plants and banks are mostly government owned,
meaning that policy makers can decide to give cheap energy and
low interest rate loans to favoured businesses.
There are a variety of other ways a government can support
it's manufacturing sector too, most of which involve transfers
from the household sector to the business sector.
Trade surplus countries often have undervalued currencies.
This helps exporters at the expense of importers.
Manufacturing businesses are usually exporters and households
are net importers. Keeping interest rates
artificially low helps borrowers at the expense of savers.
And once again, businesses are net borrowers and households are
net savers. Overspending on transportation
infrastructure like railways, roads and ports supports
businesses at the expense of households too.
Repressive labour laws, restrictions on worker mobility
and low penalties for pollution additionally help the
manufacturing sector at the expense of the household sector.
In China, industrial zoned land is an order of magnitude cheaper
than residential land. Another transfer from households
to businesses. When all of these policies are
combined, there are huge transfers from households to
businesses in China, meaning that while businesses can
prosper, households can't afford to consume the goods that are
being manufactured now. In a closed economy, this would
mean that businesses would be forced to either raise wages to
increase consumption or reduce production due to a lack of
demand. In a globalized trading system,
the surplus production can be exported.
This trade surplus doesn't necessarily give China an
advantage. It's a result of flawed policies
and the means of dealing with a huge disadvantage, which is
extremely low domestic demand. This doesn't just affect China,
however, as a surge in a country's exports that are not
balanced by a surge in imports means that manufacturers in
deficit countries find themselves partially funding the
Chinese subsidies with their lost income.
The imbalances in China move the production of goods away from
where they might be most efficiently manufactured under
the law of comparative advantage and cause all sorts of trade
distortions. When exports are high and
imports are low, a country starts accumulating the currency
of its biggest trade partners as savings.
Chinese savings are not high due to any culture of frugality in
China. It's simply a function of
keeping wages low and exporting without importing.
You don't just keep the proceeds of trade in dollar bills in a
vault either. You usually invest them in
things like bonds. So China's excess savings are
mostly sent back to the United States, where there are deep
capital markets. This means that there's more
capital in the United States than is needed for investment
purposes, which can be seen in the huge cash balances that U.S.
companies are sitting on. So can Trump's tariffs offset
Chinese subsidies and help to rebalance global trade?
Well, possibly, but not if Trump just puts tariffs on Chinese
imports. The reason this wouldn't work is
that if the United States refused to buy Chinese goods but
continue to buy from other countries, this would just push
the problem to another trade partner.
Unable to sell EVs in the United States, China would ship them to
Europe, undercutting European EVs.
European manufacturers, unable to compete in their own markets,
would ship European EVs to the United States, and the overall
problem would be exactly the same.
If China continued to keep consumption low while exporting,
Chinese savings would continue to be exported to the United
States too. The Chinese trade surplus would
remain as big as before even if it fell against the United
States, and the US trade deficit would continue to grow too.
So tariffs applied on a country by country basis are unlikely to
have any notable effect. They would really need to be
applied equally to all trade partners in order to work, but
this would be very politically contentious as it would involve
upsetting America's allies who are not really to blame for the
imbalances in global trade. If China is already an
aggressive trade partner and the US joined them, every other
country would be forced to follow suit as otherwise they
would be paying the cost. This is the biggest problem with
government trade intervention. A number of journalists have
expressed concern that Trump's trade plans are worryingly
similar to the Smoot Hawley Act passed under Herbert Hoover,
which contributed to the problems of the Great
Depression. I made a video a few weeks ago
about the Great Depression, and a notable difference between the
late 1920s and today is that in the 20s America was the world's
biggest exporter and had much more to lose than it does today
in a trade war country. Who need to export are in a much
weaker position than countries that are absorbing excess
supply. While the Smoot Hawley Act was a
terrible idea, I don't believe that it was to blame for the
Great Depression, and I don't believe that new tariffs would
lead to that scale of economic catastrophe.
Trump has said in interviews that he would love to entirely
replace income taxes with import tariffs.
I think this is mostly bluster and shouldn't be taken too
seriously. The Peterson Institute, a mostly
centrist think tank, wrote a report on this recently,
pointing out that last year the United States imported $3.1
trillion worth of goods, but raised around $2 trillion in
income taxes. Tariff rates would thus have to
be over 65% to replace the income tax, and that's assuming
no fall in imports, which would be extremely unlikely with 65%
tariff. Replacing income taxes with
tariffs just couldn't work. A number of big U.S. companies
have been stockpiling goods in preparation for Trump's tariffs.
The Economist reports that Microsoft, Dell, and Hewlett
Packard are among the American tech companies that are rushing
to import as many electronic components as possible before
the new administration takes office in January.
While this might help them in the short term, I doubt that
they could import enough components to get them through
years of potential tariff. It's difficult to predict how
Trump's trade policies will work. the US could act
unilaterally as they do, run the largest trade deficit in the
world, and there's plenty of supply in the world and the
thing that is scarce is demand, which is what the US brings to
the table. A better option might be for the
United States to work with other large deficit economies like
Canada, Australia and the UK, where combined they make up
about 70% of global deficits. If they struck a deal where they
as a group placed tariffs on countries that run large
persistent surpluses, that could help to rebalance global trade.
If countries wanted to sell to that block, they would either
have to take steps to boost domestic demand or cut
production. Other countries wouldn't have to
really agree, as most of the rest of the world are trying to
export rather than agreeing to import.
If they wanted to sell to these countries countries, they just
have to agree to the terms. A rebalancing of trade like this
would be extremely painful for surplus countries like China,
Germany, Japan, Russia and Saudi Arabia, but it could be expected
to boost American manufacturing and allow American businesses to
compete internationally without slashing wages.
This rebalancing would also mean repatriating the capital, which
has been flowing into the United States for decades.
Foreigners own around 20% of all U.S.
Securities outstanding, and as trade rebalance, these savings
would have to be repatriated back home, which would have to
occur in an orderly manner. It's very difficult to predict
what Trump might do in his second term in office, other
than to say that he'll amp up trade negotiations while likely
keeping an eye on the stock market as a measure of his
success. As always, I'll be interested to
hear what you have to say in the comments section.
Thanks for tuning into this week's podcast.
If you found it interesting, do send a link to a friend to help
it grow. Have a great week and talk to
you again soon. Bye.