Do Tariffs and Trade Wars Help The Economy?

When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win.

Donald Trump, March 2, 2018 (Twitter)

There is a common misperception that exports are good for a nation and imports bad. It is better, however, to think of imports and exports as two sides of the same coin. Every mutually beneficial transaction, whether domestic or international, increases the well-being of both the buyer and the seller — regardless of whether an American is the buyer or the seller. Now, if you multiply this concept by all the transactions in the world, then you have increased both the wealth and well-being of the entire planet.

International Trade

The United States contains fewer than 5% of the world’s population, yet we consume about 27% of the world’s GDP. It’s not surprising then that in this country we consume more than we produce. Therefore, we import more goods than we export, causing what is called a “Trade Deficit.” Politicians complain vigorously about this deficit, believing that it means some other country is stealing our jobs and enriching itself at our expense (reminiscent of Mercantilist Protectionism). Let’s see if this is true by taking a look at the topic of international finance.

There are two components to international trade. The first is the relationship between the value of my country’s currency to the value of my trading partner’s currency. The second component is the value of the product, commodity or service to be sold. If I live in a country with a strong currency, I prefer to purchase products from a country with a weak currency because my strong currency is relatively more valuable. This makes the cost of products from that country cheaper. On the other hand, if I want to export products from my strong currency country to a weak currency country, then my products will be more expensive because my customer in the weak currency country has to spend more of his less valuable currency to compensate me for my more expensive currency. Therefore, strong currencies encourage imports and weak currencies encourage exports.

The reason for currency variations is “Fiat Money.” Unlike in the past when all nation’s currencies were backed by a commodity like gold or silver with an established commonly accepted value, currencies today are backed by the full faith and credit of the issuing nations. The Foreign Exchange Market (Forex), which is the largest marketplace in the world, oversees continually fluctuating prices, or “Exchange Rates,” for all trading partners in the exchange. The exchange rate is an exact denominational relationship between two currencies. Strong currencies are typically backed by fiscally strong governments with tight monetary policies; weak currencies are backed by fiscally weaker governments, or with looser monetary policies. Therefore, even the strongest, most fiscally sound governments are able to manipulate the value of their currencies by raising or lowering interest rates. High interest rates reduce the amount of currency in circulation by increasing the cost of money, low interest rates have the opposite effect, flooding the financial markets with cheap money. Therefore, if a government’s policy is to make imported products cheap, thereby increasing it’s consumer’s wealth, then policymakers will raise interest rates and maintain tight monetary policy. On the other hand, if policymakers wish to encourage exports, thereby protecting domestic producers and workers, then they maintain loose monetary policies. They also might include high tariff rates, import restrictions, domestic content requirements and subsidies for domestic producers. Keep in mind, however, that the main reason countries trade with each other is because it is mutually beneficial for both parties.

The U.S. imports oil from Canada, Saudi Arabia and other countries primarily because the price of oil on world markets (including the U.S.) is normally cheaper than the costs related to domestic exploration, leasing or purchasing oil rich properties and drilling new wells to meet 100% of the U.S. oil demand. We also have a huge appetite for consumer goods. Therefore, to the extent that we can purchase them cheaper from say, Chinese, Southeast Asian or Mexican manufacturers than from domestic manufacturers, our standard of living improves in exact proportion to the money that we have saved by purchasing their comparable, but cheaper products.

Let’s say hypothetically that my computer dies, so I go to an electronics store and look at two computers of similar quality, one built in China and one built in the U.S.; but the Chinese computer costs $100.00 less. If I purchase the Chinese computer, then I have $100.00 more in my pocket than if I purchased the American product, which means that by purchasing the cheaper computer, I am $100.00 richer. If you multiply this by similar examples, then millions of consumers are purchasing a variety of imported products, saving in aggregate trillions of dollars! Therefore, it is pretty easy to see the positive effect imported products have on our general standard of living. This is not to disparage our domestic producers, because there are many examples where our companies can out-compete foreign competitors. But, too often an uncompetitive U.S. manufacturer, demanding protection, will complain to Congress that his company can’t compete, for example, with China because of unfair business practices, lax government regulations, child labor, currency manipulation — or China subsidizes a government controlled business’s losses, which allow them to subsequently “dump” their products at artificially low prices in order to put our company out of business — leading them to dramatically increase prices and control the market.

Do these arguments against the Chinese (or any other country) hold any water? First, child labor: It wasn’t until 1938 that the Fair Labor Standards Act was passed by Congress. This was the first federal law regulating child labor that was upheld by the Supreme Court. And even then, certain industries, such as agriculture and newspaper publishing were excluded. In 2006, the National Agriculture Statistics Service released a report indicating that 431,730 youths, aged 12- to 17-years-old, were hired for agricultural work. Even more troubling is that according to the National Safety Council, due to pesticides and a high rate of injury, agriculture is considered the second most dangerous occupation in the United States. Finally, under U.S. law, children on farms can work at age 12 for unlimited hours before and after school.

How about currency manipulation? After the Great Recession, the Federal Reserve Board initiated Quantitative Easing (QE): this policy involved the massive purchases of long-term Government Securities. The goal was to keep interest rates low to stimulate the economy. The secondary effect of the Fed’s purchase of trillions of dollars of debt was that the value of the U.S. dollar went down relative to other foreign currencies, which through government intervention made American exports artificially cheap. This, in effect, was currency manipulation by the United States Government. Other Organization for Economic Co-operation and Development (OECD) nations followed, resulting in a currency war; similar in effect to a trade war. These countries also wanted to increase exports and bolster their economies, so they all executed their own versions of QE. And while currency manipulation by the U.S. ended in 2014, so did China. According to an April 11, 2017 New York Times article “Since the middle of 2014 it (China) has sold over $1 trillion from its reserves to prop up the Renminbi, under pressure from capital flight by Chinese companies and savers.” If we really want to blame China for currency manipulation, then we need to look at the period from 2005 to 2009. It was during this pre-Great Recession period that China appeared to purposefully devalue its currency in order to artificially inflate exports. Yet as recent as April 2, 2017, President Trump told the Financial Times: “When you talk about currency manipulation, when you talk about devaluations, (the Chinese) are world champions.” A legitimate criticism of the Chinese relates to their almost complete disregard for intellectual property rights.

Finally, what about the government ownership of major exporters? After 2008, the United States government bailed-out General Motors and Chrysler, effectively taking ownership control of both companies. By the summer of 2009, the federal government of the United States owned a 60% stake in the new General Motors after the company emerged from Chapter 11 bankruptcy. President Obama even fired GM’s chairman, Rick Wagoner. In a March 30, 2009 article, Wired.com writes:

The bottom line is Uncle Sam told Wagoner he’d have to take a hike if the floundering automaker was to get any more cash out of taxpayers. In addition to telling Wagoner to hit the bricks, the Obama administration wants to push Chrysler into a shotgun wedding with Fiat — or any other suitor that comes along.

As a matter of fact, there was eventually a deal between Chrysler and Fiat. Our federal government gave the UAW a 17% stake in GM and a 55% share of Chrysler. Politics matter! The UAW thanked Obama in the 2012 election by giving him decisive victories in key electoral districts of Ohio and Michigan. The auto bailouts ultimately cost the United States taxpayers approximately $9.3 billion. While the U.S. government is now out of the auto business, it is not inconceivable (or unconstitutional) that a future President may take complete control of a major U.S. manufacturer.

Tariffs

Going back to my hypothetical computer example: if Congress were to mandate a $100.00 tariff on every Chinese made computer sold in America, then each one of countless consumers would be $100.00 poorer. On the other hand, the American manufacturer does not need to become more productive and still is millions of dollars richer, because Congress has mandated that United States computer consumers must subsidize his company. Congress wins too, because for every one of our hypothetical Chinese computer sold in America, they collect an invisible tax of $100.00. Further, let’s assume that this action angers China so they retaliate by placing bigger tariffs on totally different American exports to China, hurting other U.S. exporters, and thus the trade war has begun. The results, which are universally bad, wind up hurting both economies. I should also mention that the only entities able to successfully lobby Congress for tariff protection are politically-connected companies and big unions, in other words, those who invest millions of dollars in political campaign donations. If, from a public policy standpoint, tariffs are such a good idea, then why not set a standard tariff rate applicable to all products equally? The answer of course is that an international trade war would ensue, resulting in a second Great Depression. And if, as a nation, we are serious about child labor abuses, then why should U.S. law exempt agriculture and newspaper publishing? The answer, of course, is that big agribusiness and news organizations are too politically powerful. Therefore, in the case of agriculture, they get to enjoy exemptions from child labor laws, gifts in the form of government subsidies, and trade protections such as tariffs and other import restrictions.

As previously mentioned, a communist country is able to control commerce within its own borders, however, it has no control over the international marketplace. The same concept is true in the United States. Our government can and does control the price we pay for all imported products. These protectionist practices provide benefits to those industries with political clout, but only in regard to the domestic market, which is about 20% of the global marketplace. Therefore, if you are only competitive at home because of government protections and/or subsidies, then your company is missing out on 80% of its potential market. Once the company attempts to export its products to another country, suddenly it has no U.S. government protection and must be competitive globally. Otherwise it will fail as an exporter. And if it does fail, what happens to the workers back home that would have been hired, or the factories, raw materials and equipment that would have been built or purchased? All this potential economic activity can never be realized because the company wasn’t forced by the marketplace to continually improve quality and customer service; while at the same time reducing costs through better efficiency and production methods. And as previously mentioned, when other countries impose retaliatory import restrictions against U.S. products, we are even less competitive. As a logical consequence, many U.S. companies don’t export, they simply manufacture in countries other than the U.S. for the world’s markets (where they must be internationally competitive) and their U.S. plants only serve U.S. customers, greatly limiting the manufacturing job opportunities at home.

I realize that there are several countries around the globe that impose stringent import restrictions against the United States, which therefore breeds retaliation. I also realize that the United States has joined with other countries, and regional blocks of countries in free trade agreements. However, the result is a series of piecemeal trade agreements, treaties, and punitive policies that wind up benefiting some countries and industries at the expense of others, and make some products artificially cheap, some artificially expensive and some completely unavailable. In other words, the international marketplace is a hodgepodge of mostly bad policies that generally hurt U.S. consumers and producers, as well as our trading partners. Again, it comes back to government policies that are created based on political considerations rather than policies that encourage maximizing value for the American consumer and the American taxpayer.

If another country wants to export products to the United States and they happen to be outside of a free trade zone, these are some of the tariff rates that they will have to pay at the border: sugar 26%, cars and tractors 12.5% to 25%, televisions 29%, shavers 35%, bicycles 35% to 41%, baby carriages 49%, and running shoes 35%.

A reasonable person may ask: why not bring all the major players of the world together and establish a unified free trade policy that is fair to all, including punishments for the cheaters? Why not create an international umbrella organization that would monitor and administer the policy? And, why couldn’t the United States take a lead role in spearheading this great idea? The answer can be summed up with two concepts: Politics and American Exceptionalism! Politicians need the money from donations, which come from individuals and organizations that benefit from the current system. And, America resists being part of any international organization that places it in a subordinate position. Our politicians want complete freedom of action without answering to anyone, even if the action is stupid, self-serving, counter-productive, violates international law, or lacks any semblance of common sense. Perhaps it is time for us to put in place a stronger constitution that forces politicians to help develop and abide by international rules and norms that would apply to every nation — including the United States.

(From the book Greed, Power and Politics, the Dismal History of Economics and the Forgotten Path to Prosperity, by Daniel Cameron)

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