Tariffs: possible short term gain, sure long term pain

by | Mar 23, 2018 | Markets, Economy, & Government | 3 comments

If you want to be a competent economist without having to suffer through grasping abstract ideas, many of which are flawed, as well as mastering higher mathematics, all you have to do is remember the words of the great 19th century economist Frederic Bastiat. He reduced the lesson of economics to one sentence: The art of economics consists of looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups. Apply this principle to tariffs and you will correctly assess the eventual outcome.

How will tariffs affect American workers and consumers?

At first sight, tariffs appear appealing. The idea is that they save American jobs by raising the cost of foreign competition. Politicians like to use them as a way of signaling their intentions to put America first. The problem, however, is that tariffs in the long run result in (1) higher prices for consumers, (2) a net loss of American jobs, (3) reduced pressure to compete and innovate — ultimately the only source of durable income growth — and (4) retaliation, whose ultimate result is that everyone – Americans and foreigners alike – is worse off. Less mutually advantageous, voluntary trade means that people can’t buy as much with their money. Empirical analysis of the effect of tariffs has verified these conclusions over and over. The benefits of free trade is one of the few tenets of economics that economists generally agree on, regardless of their political persuasion.

Even though the costs of tariffs to America greatly outweigh the benefits, they are hard to see because they are widely dispersed. Everyone can see the steel mill that is restarted, but no one can see the jobs lost in businesses that use steel, and the reduced competitiveness long run of businesses benefitting from the tariff.

Workers in companies protected by tariffs benefit in the short term. But tariffs increase the prices of goods (services) that downstream producers use as an input. Ultimately the cost increase results in higher prices to consumers (1) , especially those with low income. Higher prices also mean less demand for goods that otherwise would have been purchased. Less demand for these goods means fewer jobs.
Let us apply these somewhat abstract notions to the proposed tariff on steel. David Stockman in his indispensable Contra Corner [a steal at $29/month] describes the effect as follows:

“…there are only 376,000 US jobs in all of primary metals including steel, aluminum, copper, nickel and sundry lesser metals and alloys. By contrast, downstream metal using industries employ upwards of 8 million in durable goods alone and 960,000 in the auto sector, which happens to average about 3,000 pounds of steel and aluminum per vehicle. 

Self-evidently, the 25% and 10% tariffs on steel and aluminum, respectively, will raise their input costs by those percentages, whether customers use domestic or imported metals because the purpose of these tariffs is to put a high domestic floor under what are otherwise world market based prices. Accordingly, the Drumpf tariffs will send economic harm cascading downstream—to say nothing of the virtually certain chain reaction of retaliation and counter-retaliation that these moves will foster in the global trading system.”

One argument for a tariff on steel is that a strong steel industry is a prerequisite for a strong national defense. Even if this point were true, it does not justify imposition of a tariff. The U.S. produced about 82 million tons of steel and imported another 14 million from Canada, Brazil, and Mexico. The defense industry uses about 3.5 million tons, a small fraction of which is used in defense of American soil. In an emergency domestic steel production could be diverted to military use.

There is, however, a  serious trade problem, and if not addressed, it will lead to further erosion of the purchasing power of regular Americans. The United States has run a trade deficit for the last 43 years and has run up a net cumulative deficit of about $15 trillion, or $11 trillion net of the surplus in services. This is a sure sign that American workers for the first time in our history have become less competitive in world markets. I do not think we have gone stupid and lazy, and I do not think that hiding behind tariffs, thus becoming even less competitive, is the answer. The cause and cure of the problem have been misdiagnosed. Part of the problem is, as Charles Koch of Koch Industries said, “ Our entire economy is rife with cronyism, resulting in regulations and subsidies that are destroying competition, opportunity and innovation.” Cronyism is a symptom, however, of the root cause – the policies and practices of the Federal Reserve, aided and abetted by a cheerleading, compliant Congress and executive branch. We shall describe the dynamics and astoundingly destructive consequences of this unholy alliance in a subsequent blog.

(1) Technically, the degree to which the cost of a tariff is either absorbed by a user of an imported product or passed on to the consumer depends on the elasticity of demand at the consumer level. The more inelastic the consumer demand, the more the tariff cost is passed on to the consumer and vice-versa.

If you want to become a good armchair economist in a short period of time, you can do no better than to read Henry Hazlitt’s classic Economics in One Lesson.

 

3 Comments

  1. I understand the gist of this compelling article against tariffs, however aside from lowering wages through dismantling unions in the steel industry, what would bring the steel industry back in cities such as Cleveland, Pittsburgh, or Detroit?
    Or has that ship sailed and those cities look to new industries to take their place?

    Reply
    • Colby, The honest, and I think correct, response is that the steel industry would not come back unless it innovated such that the quality and price of its products were competitive on global markets.

      Let me use an example to try to persuade you that the costs of protectionism in whatever form eventually substantially outweigh the benefits. Suppose that the wineries in Fauquier County persuaded the supervisors to put a 50% tariff on all wine imported from elsewhere and (for the sake of discussion) we now had to travel 100 miles to buy a bottle of wine. What would happen? Everyone would see that wine owners and employees would become richer. What we wouldn’t see is that:
      1) The extra money consumers spent on wine is money not spent on other goods and services. Owners and employees of these businesses would have less money.
      2) If there were no tariff, consumers could have gotten both the wine they wanted and have money left over to buy other stuff they wanted.
      3) The higher price of wine would reduce demand for wine.
      4) The wine tariff would encourage other Fauquier County businesses to lobby for a tariff on their goods as well. Eventually, the residents of Fauquier would be paying higher prices for goods of at best equal quality to what they could have gotten elsewhere. Some people might start moving out. If so, the protectionism would lead to a net reduction in business opportunity. No people, no income, no local business.
      5) Wineries themselves would feel under less pressure to improve and innovate. Like someone who stops working out, less challenge means less fitness.

      In sum, protectionism is not only damaging to people’s wealth — dollars don’t give consumers as much buying power as they would have otherwise — but also it engenders poor habits in producers. They may become fat and happy in the short run, but they are at greater risk of debility and heart attack in the long run. This pattern, by the way, is exactly what we observe when labor unions succeed in persuading politicians to give them government-enforced protection.

      Reply
      • Excellent answer Sam. I loved the wine comparison. So without extreme brilliance in innovation in the steel industry, that ship has sailed. Those northern rust belt cities seem to be coming back with other industries leading the way. I guess the representation of the Pittsburgh Steelers will leave future generations of fans wandering “Dad, why are we called the Steelers?” Thanks for the reply!!

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Sam Mitchell is a researcher by trade. For almost four decades, Sam's job has been to invest other people’s money as well as his own. The total amounts involved have been in the billions of dollars.

Sam lives or dies economically according to whether the findings and conclusions from his research are correct.

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