A few weeks ago, I was talking to one of my lawyer friends. He told me there are two types of lawyers:
- Those who try to find a reasonable and practical solution to a given dispute, and
- Those who employ a “scorched earth” negotiation philosophy.
I think the tariffs on steel and aluminum imports announced by the Trump administration would fall into the scorched earth camp. Scorched earth negotiation tactics (“playing hardball”) can work, but they make more sense for one-time transactions. They are less successful (in my opinion) as a business philosophy when you want to have a productive ongoing relationship with the other party.
Why should we want free trade?
Free trade and specialization have driven a remarkable increase in living standards over the past century. The idea behind free trade is we should all specialize in whatever we can do better and cheaper than anyone else and then trade to get the things that others produce more efficiently. For example, I am not very good at cleaning houses, but my cleaning lady is great at it. So, I leave the cleaning to her and focus all my working time on providing financial planning services. On a more macro level, other countries produce T-shirts, toys, and electronics more cost effectively than Americans, and the United States produces airplanes, food, and complex machinery better than just about any country.
Why would anyone want to restrict free trade?
There is a concern that other countries are not playing fairly. Some countries subsidize certain industries (and/or have no environmental regulations), thereby making it difficult for American companies to compete. The idea behind the tariffs is to protect American jobs. That argument for the steel and aluminum tariffs announced last week would make sense if the tariffs were targeted at specific countries whose trade practices were deemed unfair. They were not. They were broad based on all steel and aluminum producers, most of whom are allies and good trading partners (e.g., Canada, Brazil, and Mexico).
President Trump has indicated that other countries have more to lose from a trade war because the United States imported $566 billion more goods and services from abroad than it exported.
There are two problems with trade deficits:
- An ongoing trade deficit is detrimental to the nation’s economy because it is financed with debt. The United States can only buy more than it makes because it borrows from its trading partners, who may want to be repaid someday.
- A second concern is that if US companies are not able to compete, factories will shut down, jobs and expertise will be lost, and the living standards for workers in that industry will decline.
The Trump administration hopes to reduce US trade deficits with protectionist measures. A month ago, President Trump announced tariffs and quotas on imported solar panels and washing machines, followed by last week’s tariff announcement on steel and aluminum. It is worth noting that roughly two-thirds of the entire trade deficit is the result of our trade imbalance with China alone.
What are the risks of imposing tariffs?
The big concern is that these tariffs may start a trade war. In fact, many trading partners have specifically said they will retaliate by imposing tariffs on American-made goods. A trade war could raise the cost of goods and lower living standards.
Consider these comments from economist Adam Posen, the president of the Peterson Institution for International Economics. He also sits on the panel of economic advisors to the Congressional Budget office.
“Steel is just a tiny input in U.S. gross domestic product (GDP)—which is why these tariffs are so crazy. You mess up your entire trading system for an industry that has a total of 80,000 jobs,” Posen argued.
By comparison, steel-consuming industries, which experts believe will be hardest hit by the tariffs, employ 6.5 million Americans and add about $1 trillion to US GDP, according to the census.
The stock market’s response the day following the tariff announcement was equally negative. US steel stocks gained a little over $2 billion while the rest of the S&P 500 lost nearly $350 billion in market value. This demonstrates the risk of protecting one industry at the peril of endangering all the others. It is also worth pointing out that more than 70% of the S&P 500 companies’ revenue and profit come from their trade overseas.
I am not a fan of these tariffs, and neither is almost any economist or even most of the Republican-led Congress. Nevertheless, a full-blown trade war is unlikely, and global economic growth is likely to continue. Have a great week.