Donald Trump’s tariff hikes are not good policy

I am generally not in favour of trade protection. I grew up in a country that had very extensive protection (tariffs, import quotas) on manufacturing goods, which was justified on a number of grounds – capacity to shift to defense industries; stable employment; and more abstractly, an expression of becoming a ‘modern’ nation, leaving our agrarian roots behind. The initial move to impose high tariffs was that a young industry would take time to develop – the so-called infant industry argument, which goes back to the 1790 Report on Manufactures written by American economist Alexander Hamilton. The problem is that the infant never really grew up and the tariffs just became a cosy rent-sharing margin for unions and multinational corporations. Meanwhile consumers paid excessive prices for deficient-quality motor vehicles (among other products). It is clear that as trade opens up there are workers and regions that lose – and lose badly. The answer is not try to reinvent the past through protection. Rather, it is to use the government’s fiscal capacity to create new opportunities in these regions to ensure that workers disadvantaged by import competition can transit into new jobs with stable incomes. That option is often overlooked because modern governments have become obsessed with austerity. And, as I argue below, that obsession will in the context of Donald Trump’s tariff hikes, work against the European nations that are running ridiculously large current account surpluses.

I last considered the trade argument in this three part series:

1. The case against free trade – Part 1 (October 27, 2016)

2. The case against free trade – Part 2 (November 8, 2016)

3. The case against free trade – Part 3 (November 22, 2016).

What we learned in that series was that:

1. Early theoretical attempts (for example, Heckscher-Ohlin theorem) to justify so-called free trade (absence of protection) were shown to be flawed.

2. More recent developments in trade theory – the so-called ‘New Trade Theory’ in the 1980s – meant that economists could no longer argue that the results of the free-trade models held.

3. This shift in economic theory away from a blind acceptance of a proposition that free trade was always good, is quite apart from other considerations, which we might categorise under ‘fair trade’ issues.

4. When ‘free traders’ talk about the ‘free market’ and appeal to the narratives that appear in undergraduate economics textbooks they are being deceptive. No corporate leader aims to achieve that state. At a minimum, they aim to manipulate the ‘market’ they trade into to influence prices they can get and have to pay for inputs and end up with as big a margin on total costs as they can achieve.

They aim to create a unique product and drive competitors out of business as quickly as they can. If they can take over a competitor and increase their market share they will.

They seek to manipulate consumers into believing their product is best through advertising, which uses psychological tools that go well beyond the textbook idea that such interaction with the ‘market’ is just to provide ‘information’.

5. The 2007 book by Ha-Joon Chang (The Myth of Free Trade and the Secret History of Capitalism) demonstrates that the normal model of economic development, which has enriched the advanced nations such as Britain and the US, was not built on a ‘free trade’ platform.

Rather, they developed into rich nations through the use of industrial protection and government controls and supports.

None of the advanced nations would have achieved that status if they followed the IMF/World Bank approach.

6. The problem with the ‘infant industry’ justification is that the tariff wall provides a perfect environment for rent-seeking – so that the recipients of the protection have little incentive to innovate and become more competitive without the support.

The case of the Australia motor car industry is a classic example. The foreign-owned corporations profited from the tariffs and to avoid industrial unrest ‘shared’ some of the tariff benefits with the unions in the form of higher wages.

But by the 1970s despite effective protection rising, total employment was falling such was the competitive gains being made by Asian car manufacturers (Japanese initially) as the local industry failed to innovate.

In other words, the ‘baby never grew up’. Too many companies set up to exploit the tariff and too many models were produced for a market that could barely support one manufacturer producing at lowest-cost scale.

The level of protection was so high that it was estimated in 1985 that it would have been cheaper for the government to give all the workers in the Australia car building industry $A1 million each and close the industry (Source).

7. Rich nations such as the US and the European Union still maintain a complex array of tariffs on goods attempting to enter its borders. Japan, for example, maintains a highly protectionist stance with respect to its primary products (particularly against rice imports). These cases are generalised across most nations.

So when you read commentators, particularly Europeans railing against Donald Trump’s new tariffs on steel and aluminium (the precursor, probably to widening into cars), you have to realise that the protection levels in the EU are, on average, higher than they are in the US and many other advanced nations.

EU is not in a position to make trade threats …

When Donald Trump made his announcements, the bumbling European Commission President Jean-Claude Juncker immediately announced that the EU would increase tariffs on “Harley-Davidsons, Kentucky bourbon and bluejeans” in retaliation (Source).

This was after Trump has tweeted that “trade wars are good, and easy to win”.

On March 3, 2018, Trump clarified his position and said that the US would “soon be starting RECIPROCAL TAXES so that we will charge the same thing as they charge us”.

When assessing what the likelihood that the European nations will retaliate against the Trump moves one has to understand what is at stake on both sides.

Behind the EU tariff wall, we see Germany running massive trade surpluses of around 8 per cent of GDP, although the Netherlands is even higher (8.5 per cent of GDP in 2016).

The Eurozone current account surplus in 2017 was around 3.5 per cent of GDP. It is not just a ‘German’ problem.

The overall European mantra is to fete these massive trade surpluses and to implement domestic policies that suppress imports. Citizens seem to have dulled into the idea that selling off national real resources and denying the citizens access to them is smart policy.

And if the citizens then decide they want to purchase more from outside (imports) the policy bias is to crush that spending capacity with austerity.

It doesn’t make any sense.

In many of the Eurozone Member State cases, the shift in trade balances towards higher surpluses has not come from a boom in exports but rather from a suppression of imports as a result of the austerity.

The following graph shows the Current Account balances for the EU nations as at 2016. They haven’t changed dramatically since then.

By deliberately suppressing domestic demand and relying on exports for growth, the EU nations, particularly the Eurozone Member States are trying to ride off the back of import spending of other nations – particularly, the US, Japan, China and the UK.

And, then they complain that these nations seek to redress that imbalance.

Which suggests that in both the Brexit negotiations and the EU response to Trump, the EU is in the weaker position.

Germany’s four major exports are (Source):

1. Motor vehicles, trailers and semi-trailers – 234,387 million euros or 18.3 per cent of total.

2. Machinery and equipment n.e.c – 110,519 million euros or 14.4 per cent of total.

3. Chemicals and chemical products – 114,661 million euros or 9.0 per cent of total.

4. Computer, electronic and optical products – 110,519 million euros or 8.6 per cent of total.

In terms of where the exports go and imports come from for Germany, the following table shows the “Ranking of Germany’s trading partners in Foreign Trade” in terms of the Foreign Trade Balance in Euro 000s down to the 36th largest surplus.

For the – Complete publication.

US and the UK!

When the whole policy strategy (trade surpluses and domestic demand suppression) is so dependent on a few nations playing ball, who do you think is in the driver’s seat.

While the US is Germany’s largest steel export market, its major exports to the US (as shown in the Table that follows) are Cars, Machinery and Pharmaceuticals.

If the EU was to start threatening US imports such as Harleys then you can imagine what Donald Trump would do next – increase the tariffs on “Cars and motor vehicle part” and “Other vehicles”, which comprise 32 per cent of Germany’s total exports to the US and would go a long way to shutting down the Current Account surplus it runs against the US.

So the Juncker threats are hollow.

The same applies to the Brexit negotiations in my view. Britain has the balance of the bargaining power in those negotiations if it only had to stamina to use it.

In other words, the big German car manufacturers will not sit idly by while the German government or the European Commission plays out a ‘trade war’ with the US (or Britain for that matter).

The German car industry has not yet dealt with its massive fraudulent behaviour with respect to emissions. Cleaning that mess up (sorry for the pun) will be destabilising enough.

While Germany holds itself out as a sophisticated and efficient trading nation, its growth strategy is, in fact, rather crude.

Wolfgang Münchau’s latest Financial Times article (March 18, 2018) – In a trade war Germany is the weakest link – makes two really apposite points here.

1. “the ongoing collapse in the sale of diesel cars”, which the “German car industry placed a heavy bet on” and “invested in the wrong technologies for too long”, is a major threat to the German export machine.

2. “it is utter madness for the EU to have allowed itself to become so dependent on the export of a late-lifecycle product. Its entire business model turns out to have been based on the bet that Mr Trump would not become US president, that there would be no Brexit, and that you could cheat on emissions targets forever.”

So both Germany and the EU in general have been pursuing a rather myopic strategy which is vulnerable to responses like those outlined by Donald Trump.

The myopia lies in the fact that Britain and the US have become too important to the EU trade machine for them to be disregarded. Their concerns will have to be dealt with and in a way that is favourable to both nations.

As Wolfgang Münchau wrote:

… EU leaders are in a weak position and have relied for far too long on the US for its external security and, more recently, as the absorber of its structural current account surpluses. With his trade tariffs, Mr Trump has a single instrument to influence both the EU’s trade policy, and the defence spending targets of member states and their contributions to Nato.

One could argue that it is immoral to use trade policy in this way. But that argument loses force if you consider the morality of the EU’s policy to run a large and persistent surplus with the rest of the world. Or indeed of making defence spending promises they had no intention of keeping.

What is also obvious is that nations such as the Netherlands, Germany, and Denmark to name just a few European Union members running ridiculously large current account surpluses have the capacity to reduce trade tensions without resorting to defensive tariff responses.

Their massive trade surpluses result not only from the quality and attractiveness of their exports, but, also from their perverted domestic policies which have included suppression of wages growth and cutting purchasing power of pensioners and others.

To truly become global citizens these nations could abandon (or even relax) the austerity bias by stimulating domestic demand through improved wages and increases in the minimum wage.

That would help the beleaguered workers, especially those on low-pay.

Imports, including from the US and the UK would rise, which would help reduce the trade imbalances against the US and other advanced nations.

Does that mean Trump’s tariff increases are desirable?

All of the above should not be taken as an approval of Donald Trump’s approach to creating jobs in the US.

There is no ambiguity in the result that economists have known about for decades – that reducing tariffs hurts particular segments of the workforce.

Dani Rodrick has just published an interesting article in the Journal of International Business (December 8, 2017) – Populism and the economics of globalization – which argues that:

… low-skilled workers are unambiguously worse off as a result of trade liberalization … trade generically produces losers … redistribution is the flip side of the gains from trade. No pain, no gain …

Economists know this but are usually relatively silent on the losses while spruiking the gains from trade.

Dani Rodrick summarises literature that researched the gains from the introduction of NAFTA. He notes that the research found that:

NAFTA produced modest effects for most US workers, but an ‘important minority’ suffered substantial income losses … the effect was greatest for blue-collar workers: a high-school dropout in heavily NAFTA-impacted locales had eight percentage points slower wage growth over 1990–2000 compared with a similar worker not affected by NAFTA trade … wage growth in the most protected industries that lost their protection fell 17 percentage points relative to industries that were unprotected initially.

Those impacts are not trivial, “especially when one bears in mind that the efficiency gains generated by NAFTA apparently have been tiny.”

In that light, I thought this Deutsche Welle article (March 17, 2018) – German, French far-right voters felt abandoned, study finds – was pertinent.

The evidence is that:

Sociopolitical conditions and not anti-foreigner views drove discontent, the think tank found in its survey of regions where the far-right Alternative for Germany (AfD) and France’s National Front (FN) often scored in excess of 20 percent in last year’s elections …

Low wages and the collapse of social and transport infrastructure are the real drivers of anxiety about the future … feeling of being abandoned …

This is the environment that Donald Trump is now making waves within.

The problem is that, in my view, they are the wrong waves.

First, tariffs punish local consumers and do not necessarily lead to gains for local workers.

Australia’s case suggests that the tariffs create massive ‘rents’ that could be divided up between powerful multinational companies and unions but did not necessarily protect employment.

But the consumers of the protected products paid multiples over what the imported item would cost net of the tariff (the car tariff in Australia was at times over 50 per cent) and, as a result of the lack of innovation, had to put up with inferior products.

The joke in Australia in the early 1970s, before the imported market really started opening up, was that you could park an Australian-made car on the crest of a hill and the front and back of the car would sag according to the slope. They were bombs without adequate heating or radios, primitive comfort and unreliable performance.

The question then is even if the tariff protects a specific group of workers is that preferable to punishing all consumers via higher prices and inferior goods (especially when the workers being protected are punished as consumers as well?

It is obvious that reducing tariffs hurts the workers directly competing against the specific imports while it typically benefits the overall consumer.

Lower prices is preferable than higher prices for workers.

While the tariff hike threat might damage the EU nations, which might stimulate them to end their ridiculous mercantalist policy approach, the policy shift is unlikely to help American workers, particularly low-income communities.

The solution then is not to think the jobs that are disappearing due to trade with other nations can be protected or, indeed, once lost, regained.

I cannot see the steel belt industrial regions of the US become a global powerhouse again.

The secret is for governments to realise they have the fiscal capacity to introduce appropriate transitional adjustments.

In these blog posts – Australia’s response to climate change gets worse (November 15, 2009) – and – When jobs are being lost think macro first (January 21, 2013) – I discussed the concept of a Just Transition framework to ensure that the costs of economic restructuring do not fall on workers in targeted industries and their communities.

These sort of adjustments, require government support and intervention to ensure that displaced workers are able to transit into the new industries and jobs quickly.

National governments should introduce integrated employment guarantee/skills development frameworks to maintain income security and capacity building while regions adjust from old technology to new, smart processes.

On the question of incentives, I generally do not favour handing out public incentives to private firms. I see this as a denial of ‘capitalism’. If private firms want the returns then they should take the risk.

However, I do support public enterprise and partnerships with local not-for-profit co-operatives. There is so much need in the area of personal care and environmental care services now as populations age and the environmental damage of our past thoughtless industry and farming practices mount, that there is more than enough public sector work to be done to absorb displaced workers should that be required.

Second, many new jobs in these ‘smart’ manufacturing processes will be taken by robots, which will also increasingly provide services as they become more intelligent and dexterous.

The introduction of the – Job Guarantee – has to be seen as part of this increased public employment capacity, given that many of those displaced by industrial shifts will be those with low skills and little capacity to retrain to work in the high-tech sectors.

The public sector will have to play an increased role also in providing high skilled work for those who are displaced by robotic innovations.

As noted above, there will be growing demand for workers of all skills in the areas of personal care (as populations age) and community development, so there is little reason to fear the spread of robots.

The challenge of government is to ensure the distribution system maintains the capacity of workers who do not work in these high productivity sectors (where productivity is narrowly defined here) to enjoy real wages growth.

Third, this also suggests that a progressive agenda must be one that works to broaden the definition of productive work so that new areas of employment can be created within the public sector to provide on-going opportunities for local workers who lose out when trade undermines their jobs.

Please read my blog – Employment guarantees are better than income guarantees – for more discussion on this point.

The old definition of gainful labour was biased towards activity that supported private profit generation within labour intensive, large-scale assembly production models.

Through appropriate regionally-focused policy interventions, workers who find their employment is displaced by trade effects, can still contribute to society through meaningful work that both provides them with income security but also ensures that income and wealth inequalities are reduced.

If productivity is enhanced by the smart part of the local labour market, then everyone benefits! That should be the aim of public investment in these smart innovation hubs.

Dani Rodrik says that the:

… the gains from trade can be redistributed to compensate the losers and ensure no identifiable group is left behind.

He recommends “strong social protections and a generous welfare state” but recognises that one-off compensation policies are too easily reneged on by government.

That is why a coherent and permanent ‘Just Transition framework’ is required. A Job Guarantee, for example, is not an ephemeral response to trade-displacements in labour markets.

It is part of the permanent base line stability tools that currency-issuing governments should always employ.

Finally, there might be certain sectors (products) that need protection – say for national security purposes. Whether that is correct depends on a case by case analysis.

But that doesn’t require blanket protection.

Conclusion

Donald Trump’s tariff hikes are not good policy and will likely be counterproductive.

The US government has all the fiscal capacity it needs to ensure that the trade-displacing impacts on specific cohorts of workers and regions can be attenuated.

Using that capacity to create jobs in the regions impacted by import competition is a far better strategy than punishing all consumers with higher prices whether they be for final goods and services or intermediary inputs.

That is a dumb approach.

Dealing with the ridiculous trade surplus obsessions adopted by European nations is another matter altogether. In that context, Trump has the power and could force shifts in European thinking.

Don’t hold your breathe on that though.

That is enough for today!

(c) Copyright 2018 William Mitchell. All Rights Reserved.