With all the talk about Trumponomics in the wake of the presidential election, we thought it was important to discuss a major theme of the campaign, foreign trade. President-elect Trump pulled no punches when discussing his disdain for our foreign trade policy.
In short, he believes our trading partners are taking advantage of us through our overgenerous trade agreements, which should be renegotiated. But this is a touchy subject that fuels fears of unknown consequences.
One key, yet controversial, aspect of his plan is the introduction of stiff tariffs with some of our top trading partners.
What are Tariffs?
A tariff is a tax levied on imported goods by a host country. Tariffs have been around for centuries, first utilized in the U.S. though the Tariff Act of 1789.1 At that point in our history, it accounted for the vast majority of government revenue.2
Here’s how it works. Country A agrees to import widgets from Country B at $1 per unit. If the widget industry in Country A becomes harmed or Country A decides to start manufacturing widgets themselves, Country A may decide to strategically impose a 25% tariff on country B’s imported widgets. This would raise the price on imported widgets for country A’s consumers to $1.25, causing consumers to purchase less widgets from country B and raising the chances of buying them domestically instead.
This example demonstrates the argument for tariffs by the home country. Tariffs are considered a protectionist policy, designed to favor the home country.
There are other policies that are also protectionist, including subsidies, embargoes, value-added taxes and quotas. But some experts are equally skeptical of the merits of tariffs.
Today, the United States has a number of tariffs in force, the majority of which are agricultural in nature.
Most imported vegetables are subject to a 20% tariff, 25% for auto parts, 35% for canned tuna and Chinese tires.3 There are also major tariffs on other products such as 100% for European meats, 131% for shelled peanuts and a 350% tariff on imported tobacco products.4
Tariffs Under Trump
Some believe Trump’s tough stance was just for political gain and won’t come to fruition. After all, they argue, Congress still has to approve of any tariff before implemented. But that may not be the case. Some believe that Congress must approve the tariffs, but that’s not exactly true. According to CNN Money, Trump could always invoke the Trading with the Enemy Act of 1917, allowing him to impose tariffs on his own.5
Our current military activities in Iraq, Syria, Lybia and Afghanistan could qualify us as being ‘at war’ and allow him the power to implement tariffs.6 Trump also has the power to place tariffs on imports without Congressional approval during a “national emergency”, at least on a temporary basis. With respect to changing our trade policies, Trump is targeting two countries in particular-China and Mexico.
Trump has promised to place a 45% tariff on Chinese imports if the Asian giant doesn’t change its trade and currency policies.7 Some people think that the tariff could start a trade war with China. Trump’s contention is that China already has put tariffs on U.S. goods exported to China so he is just reciprocating. Trump has called China a ‘currency manipulator’, giving them an economic advantage over countries that let their currencies freely float and trade in the markets.8 He accuses China of keeping their currency within a trading band.
Basic economic theory says that a weaker currency allows a country to export more goods, improving its financial condition and leading to higher employment. In the case of China, the country could export its way out of the financial problems the country has been experiencing in the wake of the Shenzhen stock market collapse last year. Conversely, the strong U.S. dollar is harming our ability to export goods overseas (they can’t afford to buy the products with the weaker currency). This is one reason we currently have a trade deficit with China.
If we import a large number of products from China (China alone accounts for nearly 20% of all U.S. imports) our domestic industries could suffer, leading to layoffs.9 Job creation has been the cornerstone of his campaign, appealing to workers from states where manufacturing capacity has been decimated over the decades like Rust Belt states Pennsylvania, Ohio and Michigan. China has also been accused of dumping, or flooding a market with cheap exports designed to undermine an industry. The U.S. steel industry has allegedly been a victim of such practices, so it’s possible we could see anti-subsidy tariffs in retaliation.
But it’s not just China that is the target of Trump’s tariff policy. Our immediate neighbor to the south, Mexico, is also on his list. Trump’s surprise election victory led the peso to the lowest level in years, on the assumption that he might reverse the NAFTA agreement and stall trading between the two countries.
Trump has stated that he wants to place a 35% tariff on imported goods from Mexico.10 Putting tariffs on Mexico would be more involved because he must first dismantle NAFTA (North American Free Trade Agreement) before levying tariffs on Mexican goods.
Given Trump’s negative rhetoric of NAFTA during the campaign (put into place by Bill Clinton) it’s not out of the question and appears to be on his agenda.
One area this is worrisome is the automobile industry since Mexico has become a major manufacturer of automobiles over the last few years. In fact, the U.S. imported roughly 1.8 million cars manufactured in Mexico in 2014, according a CNBC report from the Center of Automotive Research. They argue a 35% tariff would add approximately $6,435 to the price of the average imported car and resulting in 6700 U.S. jobs lost.11 In other words, the Mexico tariff may not result in the job creation Trump hopes.
The Case for Tariffs
Economists and policy makers argue tariffs versus free trade ad nauseum. An argument for the use of tariffs is that it raises the revenue for the host country. This could lead to less domestic taxation. Further, with tariffs in place the number of imports falls, and local manufacturers earn more money (leading to job safety or creation). To see why this is important for the U.S., consider that 28% of our economic output came from manufacturing in 1959.12 By 2008, that had dropped to 11.5%.13 In fact, from 2001-2009 the United States lost a staggering 42,400 factories.14
Further, consider that 1.2 billion cellphones were sold globally in 2008. None were manufactured in the U.S.15
Automation and the shift towards a service economy are contributing factors. By returning to a more manufacturing-based economy, similar to what we saw in the mid-20th century, we could return to a more prosperous time for our economy, including more jobs. Keeping jobs in America is a cornerstone of Trump’s message.
The Case Against Tariffs
Critics argue that the downside would be a strapped middle-class America. While it might save jobs on the margin, tariffs could raise the costs of all the gadgets us Americans love to indulge in. This would mean less discretionary spending capacity and harm overall economic growth. To stay competitive, the companies would eventually have to move operations offshore thus negating any job creation. The Peterson Institute posits that the U.S. could go into a recession and lose 5 million jobs as a result of the proposed tariffs on China and Mexico.16
Some believe that free trade is an engine of growth for the global economy. Consequently, just a 15% tariff could take one full percentage point off of China’s GDP, according to a study by Daiwa Securities.17 So tariffs could have more drastic global effects, curtailing trade where we don’t want it dampened. This could have ripple effects with global financial markets, especially emerging markets.
Another concern is that our trading partners will retaliate by placing tariffs on our goods, leading to a trade war.
The First Hundred Days of Trump’s presidency should reveal a lot of what we can expect over the next four years. We will keep our readers posted on Trumps actual effects on trade policy and how it affects every-day Americans.