Trade deficits don’t matter but tariffs sure do

The Thinker by Rodin

A couple of posts ago I pointed out that trade deficits don’t really matter. This is because trade deficits merely report the difference of the value of goods exchanged between countries. A trade deficit with China demonstrates that in general we get better bargains trading with companies in China than from buying them internally or from other countries.

Tariffs on the other hand do matter, a lot. Over the weekend Donald Trump, our “very stable genius” president demonstrated how profoundly ignorant he was on how tariffs work. Trump stated that tariffs are helping to pay down the national debt.

In the sense that higher taxes make deficits lower if spending is kept constant, Trump is right. But Trump apparently thinks it’s foreign countries that are paying these tariffs, like before a freighter from China unloads its cargo in Los Angeles the government of China wires the tariff to the United States Treasury. That’s not how it works at all. Chinese manufacturers don’t pay a tariff to bring their goods into our country either.

So who is paying? You: the American consumer. Tariffs amount to tax increases, but these tax increases are sneaky. Since you don’t buy directly from companies in China, you don’t see a tariff added to your bill of sale. But when a company you shop at does, like Walmart, they send a check to the U.S. treasury for the amount of the tariff.

Companies can absorb the tariff. Being profit-making though they will almost always pass the cost on to you by raising their prices. We saw this recently when Coke announced it was raising prices, because its cost for imported aluminum used to make its cans went up.

The Coca Cola Company of course can shop around elsewhere for aluminum. It looks like there is no better deal. The kind of finished aluminum they use is either not made in the USA or is cheaper to buy from China in spite of the tariffs. This is true of lots of products in our modern economy. One way for companies to make profits is to specialize. However, the tariff system seems to assume we principally trade commodities like oil and wheat, not rolls of aluminum with the exact thickness Coke needs for its soft drink cans.

Tariffs thus amount to sneaky indirect tax increases. Unfortunately, this is just the beginning of their detrimental effect on our economy. When we have to pay more for the same goods and services, this is inflation. And inflation from tariffs is already showing up. In June 2018, prices rose .4% from May 2018, largely due to tariffs. If this continues at this rate for the next twelve months, prices will be 4.8% higher annually. This is a significant increase in inflation compared to rates we are used to of 2% per year or less. It’s likelier though that the effect of tariffs is just beginning, and that soon inflation in June will seem like one of our better months.

As long as wages keep up with inflation, then perhaps inflation doesn’t matter. Our unemployment rate may be 3.9%, but wage growth has been anemic at best. In fact, most American workers have lost money because wage growth has not kept up with inflation. Unless Americans borrow money to make up the difference, which unfortunately they are doing at record rates, then without commensurate increases in wages they will consume less, dragging down the economy.

So it’s pretty clear that the real effect of tariffs is to stifle overall economic growth. Strict tariffs caused the Great Depression. While they allowed us to do more buying local, retaliatory tariffs as we are seeing now also made it hard to export our goods. With fewer buying our products, commodity prices for things we do make tend to collapse. So when the government charges tariffs, it is playing a very dangerous game. I’d like to think our administration knows what it’s doing, but Trump’s remarks this weekend show he fundamentally misunderstands how tariffs work. Apparently his supporters don’t understand either, as they roared their approval.

In any event, with recent tax cuts that benefit primarily the very wealthy, these modest tariffs will do little to boost tax revenues; the Post article puts the effect at .1%. But even the Post article understates the true cost of tariffs. Here are some of the other direct effects:

  • It increases government spending for social security, government pensions and many entitlements that are tied to the cost of living
  • It increases the cost of medical care, including Medicare, Medicaid and health care for veterans by pushing up prices for imported goods and services like certain medicines
  • It increases the cost of borrowing, as inflation tends to raise interest rates, which means the U.S. Treasury will have to increase interest rates to attract investors
  • Subsidies already announced will cost the government, for example the $12 billion the Trump Administration wants to give farmers to offset the effects of its tariffs

And then there are the indirect costs, which include:

  • Higher prices and inflation in general
  • Reduced employment in sectors affected by counter-tariffs
  • Lower profits as fewer goods and services are bought and sold
  • Likely increases in unemployment

Try as it might, the Trump Administration’s tariffs policies won’t do much more than partially offset tariffs’ downsides. It is likely to raise prices, reduce employment, feed inflation and reduce economic activity. Quite frankly, these tariffs are a disastrous policy.

But don’t take my world for it. The wreckage is already unfolding. It’s only going to get worse and may hit a crescendo around the midterms.