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Who will blink first?
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Who will blink first?

Richard Conway Weekly bulletin June 2018

President Trump’s latest round of tariffs on steel and aluminium imports from Canada, Mexico, and the European Union dominated the agenda last week, and many of the weekend’s papers focussed on the politics behind his latest protectionist move.

Few would argue that imposing import levies against long-standing allies of the US such as Canada and the European Union was a bold choice. But let’s briefly step back from the politics of the issue and ask a simpler question – do tariffs work?

At its most basic level, economic theory would say no. Ever since the British economist David Ricardo laid out the principles of comparative advantage at the start of the 19th century there has been a move towards more open markets and away from frictions such as import tariffs, quotas and controls. Specialisation and free trade have been expected to deliver greater consumer surplus, greater producer surplus, and on the whole reduce deadweight loss – making everyone better off. But that hasn’t stopped various politicians and governments from testing the theory out.

 

The common reasoning is that tariffs can, in certain circumstances, help to:

  • Protect ‘infant industries’;
  • Conserve non-renewable resources;
  • Safeguard strategically important areas of the economy;
  • Arrest the decline of ‘sunset industries’;
  • Save domestic jobs; or
  • Exert economic leverage on trading partners (or punish unfair behaviour on the other side of the table).

The latest measures by the Trump administration have largely focused on the last four of these.

The case for steel and aluminium as strategically important industries is a weak one. The US might be fifth in terms of global steel production (4.8%) and ninth in terms of aluminium (1.4%), but it is dwarfed by China in terms of overall volumes – the latter accounting for roughly half of global production in each case. Their combined contribution to US GDP is smaller still.

Arresting the decline of ‘sunset industries’ should certainly be a key concern of policymakers, but it’s unclear whether protectionism is the best way to achieve this. The idea that shielding inefficient and declining sectors of the economy from the rigours of international competition allows them to improve productivity, increase physical and intellectual capital, and re-enter the global marketplace better and more prepared than before sounds compelling. Unfortunately, like in the case of ‘infant industries’, the evidence from empirical studies doesn’t stack up.

Nor does the jobs argument provide a clear mandate. While in the narrow sense tariffs can provide a particular industry with some level of job security, this ignores the externalities. For a net importer of steel and aluminium, import tariffs increase prices for producers and consumers across the country, reducing net economic welfare and costing employment in other industries – enough to offset any increase in employment and increase in money spent by these workers. Sure, by spreading these costs over a larger number of workers and consumers the net effect feels like less, but that’s often not the case.

On balance, we can therefore say that tariffs will likely be costly to the US. Which brings us back to the idea of exerting economic leverage over trading partners, with a view to extracting concessions or promoting changes in behaviour. This Bulletin has in the past discussed in depth the dangers of tit-for-tat policies and the beggar-thy-neighbour climate of the 1930s – something we would all no doubt rather avoid.

However, much has changed in the intervening 90 years. US economic muscle is unlikely to have as much sway as it did then, particularly against a resurgent China and a European Union operating as a single negotiating unit. Nor are countries likely to be as quick to slap on reciprocal tariffs for fears of igniting a wholesale trade war, which would likely be as much to their own detriment as to that of the US.

Which all makes the question quite simple – who will blink first?

Upcoming data releases

PMIs due this week will provide a welcome update on the health of many of the world’s major economies. UK figures will be particularly interesting given Q1s drop in economic momentum, while German/Eurozone figures and US manufacturing PMIs should also provide talking points. The Reserve Bank of Australia is due to make a decision on rates this Tuesday, but against a background of tepid wage growth, high personal debt levels, and a weaker global backdrop we can expect central bankers to push a rate hike into the long grass. Australian GDP figures on Wednesday should provide greater insights with economists predicting a large bump in Q1 to 0.8% QoQ. German trade and industrial production data should round out the week this Friday

 

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