Tuesday, May 21, 2019

Using 25 Percent Tariffs to Escalate the Trade War With China Will Only Make Things Worse

This month has been an intense one for international trade. Trump postponed the auto tariffs on Japan and the European Union for 180 days. Trump even performed the unusual act of removing aluminum and steel tariffs on Canada and Mexico. In addition to all that hullabaloo, Trump decided to escalate the trade war with China. On May 10, 2019, Trump increased tariffs on $200 billion worth of goods. The tariffs on these targeted goods increased from 10 percent to 25 percent. Trump thinks he is saving the steel industry by doing so (see my analysis on aluminum and steel tariffs here to see why that is incorrect). He is also under the impression that the tariffs will bring in tens of billions of dollars. Trump thinks he is actually doing the citizens of the United States a favor. Imagine that! Let me get into why Trump increasing these tariffs is only going to make things worse on the international trade front.

For one, it is not as if Trump got his wish by having China surrender. Far from it. China announced retaliatory tariffs on $60 billion of U.S. goods, and surprise, surprise, Nasdaq declined by 3.4 percent. But it's more than a tit-for-tat tariff escalation that is ineffective in bringing about a trade agreement between China and the United States. When looking at the economic theory and history of tariff implementation, tariffs are a bad idea because tariffs make people poorer on the whole. Economic experts were surveyed last March about Trump's aluminum and steel tariffs, and all of them that answered agreed that the tariffs were going to make things worse. Not a single one agreed with Trump's trade policy. As the Congressional Research Service (CRS) points out in its February 2019 report, most economists agree that that tariffs are likely to have a negative effect overall. Additionally, estimates on Trump's tariffs generally show a modestly negative impact (CRS, p. 28). In case that were not enough, let's see how Trump's tariffs have worked so far.

  • Economic welfare of American consumers. A working paper from Princeton University concluded that the incidence of the tariffs fell on the American consumers (i.e., yes, it was the American citizens that paid the tax). More to the point, it cost the American people a monthly average of $3 billion in added tax costs and an addition $1.4 billion in deadweight loss (efficiency losses). The researchers found similar patterns in other retaliating countries (Amiti et al., 2019). 
  • Effects of the washing machine tariff. In 2018, Trump enacted a 20 percent tariff on washing machines. Researchers from the University of Chicago found that the tariffs brought in $82 million of tax revenue while increasing consumer prices by $1.5 billion, or $92 per washer. That means that the 1,800 washer production jobs created cost the American people $817,000 per job (Flaaen et al., 2019). 
  • Other macroeconomic factors. The tariffs had already had a modest, but nevertheless negative effect on the economy at large. According to the Tax Foundation's latest estimate, Trump's enacted tariffs have reduced the GDP by $52.2 billion [in 2018 dollars] and reduced the workforce by 161,751 people (or by 0.13 percent). The Trade Partnership estimated in February that if Trump were to enact these tariffs (which he did), then the GDP would decrease annually by 1.1 percent (or average annual costs of $2,200 per family).
  • Who has been affected the most by these tariffs? The centrist Brookings Institution released a report last October (Parilla and Buchet, 2018). First, they found that those specializing in metals and agriculture got hit especially hard. Second, rural areas disproportionately felt the cost of Trump's tariffs. Third, counties that voted for Trump were hit because of their reliance on tariff-affected exports, a finding that was confirmed by a later study (Fajgelbaum et al., 2019). And if you want to add to that, a Tax Foundation study found that poor families and single-parent households were hit harder (York, 2018).

I called it last year when I said that a full-blown trade war would not end well, and the current results are sadly confirming that prediction. It's unlikely that the trade war will end soon, and it's unlikely that it will get better before it gets worse. With my time as a professional market researcher, something I have learned is that the one thing that businesses hate even more than regulation is uncertainty (e.g., Kliesen, 2013). His actions signal that he isn't clear of how he wants to proceed with his perceived enemy, let alone his allies. The unpredictability that Trump has spread throughout the economy makes businesses think twice about their long-term investments. Trump is taking the opportunity to pick a fight with China, something that he promised back in his 2016 campaign. Trump had the best chances to deal with China by joining the Trans-Pacific Partnership and by using the dispute mechanisms through the World Trade Organization. He could have built a multinational coalition, too, but he has been burning those bridges by imposing additional tariffs on allies.

The idea of fighting tariffs with tariffs has been a real loser. There is no shortage of evidence showing how tariffs limit economic growth, increase costs to consumers and producers, lower employment, depress wages, and make it more difficult for businesses to compete in the global economy. Protectionism won't make this country great again. If anything, Trump's latest barrage of tariffs will show how costly his "Art of the Deal" will be for the American people.

5-24-2019 Addendum: The New York Federal Reserve found that Trump's latest 25 percent tariff is going to cost the average American household $831 annually.

8-23-2019 Addendum: The Congressional Budget Office (CBO) estimates that Trump's tariffs from January 2018 will have decreased the GDP by 0.3 percent (or $66B), or $580 per household per year. Aside from raising domestic prices, CBO points out that the trade uncertainty has diminished investment. Since there have not been broad tariffs implemented by a developed nation in recent history, the empirical literature is limited, i.e., we do not fully understand the full implications of Trump's trade policy.

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