The art of the trade war: Putting tariffs into perspective

Sponsored Article: Since February 2018, when the Trump administration announced tariffs on steel and aluminium imports, we have seen a circus develop around trade and its impacts on the U.S. and global economy.

Here, Payden & Rygel argues that despite the headlines, protectionist tendencies from politicians are something we have seen time and time again. And yet, tariff rates today are among the lowest in history while economic textbooks have proved useless in analyzing a world where global supply chains have blurred the lines between winners and losers in any “trade war.”

“Ponder and deliberate before you make a move.” —Sun Tzu, The Art Of War

With the “trade war” underway, why not see what is written in the textbooks. In fact, we took out an old copy of one of our economists’ college textbooks, Principles of Economics by famed author Greg Mankiw. Chapter 9, in the sixth edition, entitled International Trade, was particularly useful. Wielding the standard supply and demand curves familiar to all Econ 101 students, Professor Mankiw explains how tariffs serve as a tax and result in “deadweight loss.”

Deadweight loss is a fancy phrase for the difference between the loss faced by consumers and the gain enjoyed by domestic producers coupled with the increase in government revenues from tariffs. How does deadweight loss work? Simply speaking, a tariff increases the price of producing goods for global producers, who reduce the quantity of goods they supply. The domestic producers take over and supply more quantity at a higher price (which is still lower than the price global producers are facing). The loss faced by the consumer outweighs the benefit to the government and the domestic producer. Deadweight loss. Lower economic growth. Roll credits.

Right? Well, if it were that simple, economists would not be shouting from opposing street corners at one another, each with their own claim about what really matters.

This is not the first tariff battle

Wind the clock back to a fine Saturday morning in 1987. You stroll out to your yard, bathrobed with coffee in hand, and retrieve your New York Times. In it, you find an article suggesting trade issues “came to a head because of years of frustration over trade discord with the Japanese and the bulging American trade deficit, which has cost many manufacturing jobs in the United States.” [1]

No, “Japanese” is not a typo. This article was published more than three decades ago, during Ronald Reagan’s presidency, when the United States was locked in a trade battle with Japan, worried that the Japanese would assume pole position as the global economy’s leading innovator and producer.

Today, it seems the Chinese have replaced the Japanese as U.S. Public Trade Enemy #1, at least in the minds of certain U.S. politicians. These politicians believe that workers in the U.S. are losing their jobs to lower cost labourers in China and are unable to find other work in industries not impacted by trade.

This is nothing new. Since the time of Alexander Hamilton, who preached protecting U.S. manufacturing, U.S. politicians have not been shy when it comes to enacting protectionist policies. In fact, as recently as 2002 George W. Bush enacted tariffs on steel.

Tariff rhetoric in recent decades has proved to be more noise than signal. In fact, tariffs in the U.S. remain close to their lowest point in history. Duties are collected on just 1.5% of total imports (see Figure 1). Further, the average global tariff on all products fell from 13% in 1996 to a little above 9% in 2012. Average tariff rates in the U.S. and China have plunged over the last two decades from 15% to under 7%, respectively. Meanwhile, world trade has almost tripled. [4]

Will the latest trade battle be any different? We doubt it.

“Therefore, just as water retains no constant shape, so in warfare there are no constant conditions.” —Sun Tzu, The Art Of War

So what has changed in global trade since the tariffs of years past? Supply chains. Nothing is truly “Made in America” or “Made in China” these days as labels suggest. In the “textbook world” we have domestic and foreign producers. In the real world, there are no such demarcations.

The story of how the goods we use every day are made is more complex than product labelling might indicate. When U.S. firms collaborated across borders in the 1960s they mainly sent domestic-made components to a foreign country for assembly. Much has happened since, and global supply chains have become increasingly complex, something that can be illustrated using the example of automobiles.

“The whole secret lies in confusing the enemy, so that he cannot fathom our real intent.” —Sun Tzu, The Art Of War

U.S. automobiles and automobile-related industries are receiving much focus in the ongoing trade war, and analysts expect the U.S. to impose some form of tariffs on car imports by the end of 2018. Trump’s focus on the auto industry makes sense: the auto industry is the largest manufacturing industry in the U.S.—it employed 3.4 million workers in 2017 [5], and contributed 3.5% to GDP. U.S. car brands [6], however, are less “American” than in the past. Ten years ago, some U.S. car brands got at least 90% of their components from the U.S. and Canada, but in 2017 no U.S. car brands sourced more than 75% of their parts from North America. [7]

Auto tariffs should, according to our textbook, give the U.S. auto industry a better chance at competing against foreign producers. Introducing tariffs on auto imports, one might think, should make foreign cars and car parts more expensive, thereby making it more attractive for consumers to buy U.S.-made cars. The auto industry, however, does not live in our textbook, but in a complex and globally interconnected economy.

Despite being sold by U.S. companies, most U.S. car models contain large amounts of foreign components, and many cars sold by foreign producers contain large amounts of U.S. components. The share of U.S.-produced components is even higher for some “foreign” cars than for “American” ones: 65% of the components in a “Japanese” Honda CR-V, for example, are North American, whereas just 60% of the “American” Ford Escape’s components are North American.

Cars.com created the American-Made Index, which uses data on “where a car is assembled, its domestic-parts content, where its engines and transmissions come from, and how many U.S. factory workers its parent automaker directly employs relative to vehicle sales” [8] to determine how “American” a car is. Four of the top ten cars on Cars.com’s 2018 American-Made Index are made by “Japanese” Honda.

This issue is not just with automobiles but can be found in other sectors, too. U.S. tariffs on Chinese imports are applied mainly on products within aerospace, information and communications technology, robotics, and machinery. According to estimates from the Peterson Institute for International Economics (see Figure 2), 86% of the computer and electronic products that the U.S. imported from China in 2017 were produced by non-Chinese firms. U.S. tariffs on imports will undoubtedly hurt Chinese firms, but could hurt the Chinese operations of U.S., European, Japanese and Korean firms—who primarily own the targeted firms—the most.

“In the midst of chaos, there is also opportunity.” —Sun Tzu, The Art Of War

The complexity of global supply chains means that it will be impossible for the U.S. to shield non-Chinese firms from tariffs on the products the U.S. imports from China without abandoning the trade war altogether. It is also difficult to understand the impact tariffs have on “foreign” goods that are really “domestically-produced” goods.

The same complexity also means that firms are able to protect themselves from adverse impacts of tariffs. As early as January, Sergio Marchionne, the former head of Fiat Chrysler, announced that his company could move assembly of the very popular Ram pickups to Michigan, from Mexico, avoiding tariffs that could arise if the trade relationship between U.S. and Mexico breaks down. However, they would continue to make vehicles in Mexico for export with all the other countries with whom Mexico has free trade agreements. [9]

We know not what is on the mind of policymakers, whether there is a “trade war” on the horizon or if it is just a ploy to negotiate. What we can say with certainty is that trade is more free today than it has been historically, protectionist political tendencies are nothing new, and the impacts of trade and protectionism are much more complex phenomena than in your economics textbook. Don’t be so “tariff-ied.”

Sources

1. Boyd, Gerald M. “President Imposes Tariff on Imports against ” The New York Times, April 18, 1987. https://www.nytimes.com/1987/04/18/business/president- imposes-tariff-on-imports-against-japanese.html
2. Hufbauer, Gary C. “Next Move in Steel: Revocation of Retaliation?” Peterson Institute for International Economics, October 2003. https://piie.com/sites/default/files/ publications/pb/pb03-10.pdf
3. Smialek, “Lessons From 2002 Show Economic Bang From Steel Tariffs Was Tiny” Bloomberg, March 4, 2018. https://www.bloomberg.com/news/articles/2018-03-04/ lessons-from-2002-show-economic-bang-from-steel-tariffs- was-tiny
4. Based on World Trade Organization data
5. Calculated by combining Automobile dealers, Automotive parts, accessories, and tire stores, Automotive equipment rental and leasing, and Automotive repair and maintenance categories from the Bureau of Labor Statistics’ Labor Force Statistics
6. Kim Hill, Adam Cooper, and Debra Menk (2010). “Contribution of the Automotive Industry to the Economies of all Fifty State and the United States” Center for Automotive Research
7. Johnson, David. “How American Is Your Car?” Time Magazine, March 2, 2017. http://time.com/4681166/car- made-american/
8. Mays, Kelsey.“Cars.com 2018 American-Made Index: What’s the Most American Car?” com, June 21, 2018. https:// www.cars.com/articles/carscom-2018-american-made-index- whats-the-most-american-car-1420700348632/
9. “Trade wars threaten to disrupt American firms’ global supply chains” The Economist, May 3, 2018. https://www. com/business/2018/05/03/trade-wars-threaten- to-disrupt-american-firms-global-supply-chains

This article was first published in the latest edition of Payden & Rygel’s Point of View: Our Perspective on Issues Affecting Global Financial Markets.

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