Posts Tagged ‘Trade deficits’

The Thinker

Trade deficits don’t matter but tariffs sure do

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.

 
The Thinker

Do trade deficits really matter?

So we are having trade wars at the moment. Trump started all of them, first with a 30% tariff on solar panels manufactured in China but then on steel imports. It expanded into tariffs against Canada, Mexico, the European Union and more tariffs on China. Predictably these countries responded with counter-tariffs designed to give Trump’s biggest supporters a case of indigestion. And it’s working. Farming is typically a low margin business. With less demand, prices drop. With fewer crops being sold it is quickly making agriculture here unprofitable. Trump says that tariff wars are easy wins. That wasn’t the case in 1929 when they caused a global depression.

Trump acts like trade deficits really matter. Unquestionably they do matter to some businesses and people, i.e. those affected by them. After NAFTA was passed we lost a lot of our industrial base simply because countries like Mexico could manufacture stuff a lot cheaper than we could. To compete though in many ways we have upped our game. We are much more of a service economy now and we design leading edge stuff that is often manufactured elsewhere. Aside from Apple products, there is also stuff like my CPAP machine. This work is more specialized and the margins must be higher.

I don’t recall a time when the United States was not carrying a trade deficit. Perhaps we weren’t back in the 60s and 70s, but I was much younger then. And there are scattered months here and there when we do export more than we import. We have trade surpluses with some countries, like Canada. It’s a mystery then why Trump targeted that country. Mostly though it’s the other way around. While some sectors have suffered from all this free trade, I think overall it’s been a benefit.

One big benefit has been that trade has kept prices and thus inflation low. As long as these tariffs are in place, we are likely to see creeping inflation again. And Americans love imports. Low prices have helped us live beyond our means and our stagnant wages. It’s how companies like Walmart stay in business. Moreover, these imports increase competition and that too tends to lower prices. In many cases, the best quality products are available overseas. Take hybrid cars, for example. Yesterday I was in a neighbor’s Toyota Prius Prime and marveling at its engineering. This model may have been manufactured in the United States, but it’s an amazing value for the money. Since he too has solar panels on his house, most of the time he is driving using its electric motor. He’s getting very close to living carbon free, thanks to hybrids built and perfected overseas.

We have a choice of where we buy things. Most likely my next car will also be a foreign hybrid or fully electric car built or designed overseas. If I buy a Toyota Prius built in Japan and pay $30,000 for the privilege, while it causes a trade imbalance, it’s not like I didn’t get anything for my money. I get a great value in a car that gets 51mpg when it’s not running in fully electric mode. The effect of buying a foreign car is that some Americans (presumably) did not have a part in its design and manufacturing. Maybe that’s bad for the economy if we presume that whoever would have been building the car here in the states wasn’t doing work of similar or greater value. I’m not an economist but I’m not sure we can credibly make that claim.

In the case of hybrids and electric cars, American auto manufacturers are upping their game. In one case (Tesla) are providing a superior (albeit much more expensive) alternative. The Chevy Volt and Bolt are two other examples, although their cost is subsidized by generous federal tax credits. Tariffs on cars manufactured overseas do make our domestic versions more competitive, but only by raising foreign car prices. It doesn’t actually save buyers any money; in fact we pay a double penalty for tariffs: higher costs and potentially less competition.

There is certainly a convincing case to be made that China trades unfairly. To gain market share, it heavily subsidizes certain sectors like its solar and shipping sectors. It often doesn’t respect international copyright laws. In most cases though foreign products are cheaper because they can manufacture them for less. Often these industries are low profit. It’s unclear why we would want to compete in these low profit industries when doing so probably won’t give us a better lifestyle. Tariffs are at best a poor way for addressing these issues. They may work, but history is generally against you. Leveraging them in a large way like we are doing now is very dangerous, as the Great Depression attests.

In any event, the United States is not blameless. Even before these latest rounds of tariffs, we have been subsidizing many of our own industries through longstanding tariffs, including our sugar and peanut businesses. Free trade is one of these ideals that are rarely fully realized. When it is, someone is usually paying a price. Americans pay much more for sugar and peanuts than is necessary, and now we’re paying more for steel and solar panels too.

The evidence doesn’t seem to prove that trade deficits cause a country’s decline. In some ways they can demonstrate resilience. The strong U.S. dollar shows that we are a strong country in spite of these trade deficits. To me, trade deficits suggest that our knowledge economy is our real strength. Anything that we can do to continue to foster that, for example by allowing more technical people to acquire H1-B visas, should be a good use of government. On commodities like agriculture, we are highly efficient. In spite of the burgeoning world population, we can feed much of the world. Perhaps we should be strategically reducing the amount of farmland under cultivation to keep farming profitable.

I doubt that tariffs are the instrument we need. And I really am skeptical that trade deficits matter at all.

 

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