Monday, May 1, 2017

Trump, Steel Imports, and Tariffs: Why the National Security Argument for Protectionism Falls Flat

During his campaign, then-presidential candidate Donald Trump warned about the dangers of China, bemoaned the raw deal the U.S. was getting on free trade agreements, and how we should use more American products. Trump has moved closer and closer to advancing his protectionist agenda on international trade. On April 20, President Trump signed a memorandum authorizing the Department of Commerce to investigate whether steel imports affect national security. By using a 1962 law (Section 232) to turn steel imports into a national security issue, Trump could potentially put broad limits on steel imports under the guise of national security. This would be one of the Trump administration's first major act of protectionism. Let's ask some important questions here. Do steel imports pose a security threat to the United States? Is invoking national security a reason to impose trade restrictions? Is the steel industry that fragile that it needs government intervention to save it? Here are some points to consider when answering these questions:

1. Burden of proof. Much like with any policy issue, the burden of proof falls on the individual claiming that there is an issue. Any industry can claim that their industry is vital national security. No joke here: angora goat wool was protected vis-à-vis the National Wool Act of 1954 because their fleece is "necessary" to produce military uniforms, which is an example that shows how susceptible the U.S. can be to such an argument.

For Trump to be able to justify the restrictions on steel imports, he would first need to show how steel is vital for national security. He would then need to show how the U.S. is facing a heightened enough threat where such additional precautions are necessary in the first place. Afterwards, he would need to prove that we do not produce enough steel, especially if none of our allies want to export steel to the U.S. anymore. The last time the U.S. Department of Commerce conducted a Section 232 study to assess national security issues surrounding steel, was in October 2001. The Department of Commerce not only found that the U.S. military would only need 300,000 tons of steel for military purposes (p. 13), but also found that steel imports are not a threat to national security (p. 2). This report was written shortly after 9-11, took into account increased military spending due to 9-11, and still concluded that there was no national security threat.

Trump would finally need to show how a tariff or other trade restriction would not only improve national security, but improve economic conditions. Considering how freer trade makes for greater economic prosperity and how tariffs hinder economic progress, Trump would have an even more difficult time with that last one. Even Leo Gerard, who is the international president of the United Steelworkers, has testified in front of Congress admitting that tariffs for the steel industry have been insufficient at "leveling the playing field."

2. U.S. Steel Production. In the past decade, U.S. steel production has generally oscillated between 78 and 98 million tons. The International Trade Administration (ITA) puts 2016 consumption at 93.8 million metric tons. The capacity utilization rate is only at 72 percent, which is a metric showing that the U.S. economy is not even producing steel at full capacity. Another fun fact is that according to the American Iron and Steel Institute (AISI), only 3 percent of steel was used for national defense. Based on production numbers, the United States produces far more steel than it requires for national security reasons. 

3. Role of Steel Imports in U.S. Market. In 2016, the U.S. on average imported 2.496 million metric tons per month, which comes out to about 30 million metric tons for a given year. The importance that imports play a role is a metric known as the import penetration rate. The higher the ratio, the more important of an influence that imports have played. Looking at data collected from Trump's International Trade Administration, we see below that the import penetration rate has been on the decline for the past two years, which means that steel imports are playing less of a role in American steel consumption.

4. Imagining a National Security Crisis. I want you to imagine a national security crisis for a moment, whether it's something like a full-out war with Russia or China. I want you to imagine one not because I want one (G-d forbid), but because I want to present a scenario in which a) we should legitimately be worried about national security, and b) one that would require more steel for national defense than normal. As previously stated, we used about 3 percent of steel for national defense in 2015. In 2016, the United States spent $611B on its military, which is about $325B more than Russia and China combined. Even if the U.S. military were to quadruple its demand for steel to produce even more weapons and equipment than we already have, that would only be 12 percent of U.S. steel consumption given current production levels, which are high to begin with.

Worst-case scenario would be that the U.S. would solely rely on its own production because it doesn't have any allies or it is fighting its former allies. If this were the case, speculators would stockpile large amounts in anticipation. However, this has historically not been the case, and it would be safer to assume that the United States would have allies with which it would be trading. Looking at steel import data from the U.S. Census Bureau [Exhibit 3], major exporters of steel to the U.S. are Canada, Brazil, South Korea,  Mexico, and Turkey. It is believable that we would have at least some allies supplying steel. The main point here is a scenario in which we would need to solely or heavily rely on domestic steel production for national security purposes is very implausible.

5. Economic Implications. Trump might be using this pretext to also protect steel manufacturing jobs.  If so, he will be disappointed because manufacturing employment has been on the decline for quite some time. But if Trump wants to make America great again or improve our economy, he should think twice before imposing a tariff on steel. Tariffs drive up the price of a good or commodity. If the tariff were substantial enough, it would drive the price of steel up substantially, which would put U.S. manufacturers at a disadvantage to imports. Other countries would then be able to manufacture goods more cheaply, which would be all the more pronounced considering how many industries rely on steel as an input for production. There are far more individuals that use steel as an intermediate good to produce final goods than there are producers of steel, so whatever modest benefit to steel producers would be outweighed by the losses by manufacturers that use steel as an immediate good.

This is not mere economic theory. As a result of a Section 201 tariff on steel enacted in 2002, nearly 200,000 jobs in steel-related industries were lost within the first year as a result of this tariff (see study here). Not only do these tariffs make manufacturing more expensive for U.S. manufacturers, but it also makes it more of a struggle for Americans to buy washing machines, microwaves, lawn mowers, or any number of products that require steel.

Conclusion: Based on presented information about the U.S. steel market, there is scant evidence that U.S. steel production or consumption is facing a national security threat. Even in the off-chance that it were, Trump would need to prove that a tariff is the most cost-effective way to ensure steel supply, which he cannot. Not only is there a lack of evidence that steel imports are a threat to national security, we have evidence that tariffs and other trade restrictions on steel imports can and do cause negative effects.

Trump's naïveté on commerce ignores other realities about international trade. Much like I explained last week with Trump's "Buy American and Hire American" executive order, consumers are most concerned with finding a balance between price and quality. Sometimes, that requires manufacturers to purchase foreign steel. This leads to another axiom: those who trade together stay together. When trading with one another, countries prosper from international trade. Going to war not only increases military expenditures, but also stymies economic growth for both sides.

Take China as an example. China might be tempted to provoke in the South China Sea or in some other territorial dispute, but China also benefits greatly from trading with the United States and Japan. If China were to enter into a war and agitate its major trading partners, it stands to lose a lot more from war. I hope that Trump can see the benefits of international trade and how trade barriers do not make America great. However, his actions so far do not leave me hopeful. If Trump continues on the voodoo path of protectionism, it is going to a costly next four years for the American people.

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