When Protectionism Clashes with Free Trade
By Teodor Teofilov
Trade wars are exactly what they sound like. It’s when countries attempt to attack each others’ trade via taxation and quotas. One side imposes tariffs on goods imported from the other, which in turn, retaliates using similar forms of trade protectionism.
A tariff is a tax on a product manufactured abroad and theoretically, this taxation means that domestic consumers are less likely to purchase such goods as they become more expensive. The idea behind this is that people will choose to buy local products that are cheaper and bolster their country’s economy. However, that’s not how things always turn out.
The effect of this can hurt both nation’s economies and increase political tensions between countries.
President Trump made the point of “America First” during his election campaign and promised to cut the U.S. trade deficits. He is convinced that it hurts the country’s manufacturing and has pointed out on Twitter on numerous occasions that the US has to do more to tackle them.
A trade deficit is a term that means the difference between how much your country buys from another country and how much you sell to that country. The U.S. currently has a big trade deficit with China, which last year was about $375 billion and the President isn’t happy about that.
They usually begin when a country tries to protect a domestic industry, such as the steel and aluminum tariffs imposed by President Trump in March.
The aim of the 25 percent tax on steel and the 10 percent tax on aluminum was to protect the domestic industry. According to the Council on Foreign Relations, the steel industry employs about 140,000 people. Almost 161,000 people are directly employed by the aluminum industry, according to The Aluminum Association.
Overall the two industries provide work for about 300,000 Americans, which is 0.1 percent of the U.S. population.
The top five steel producers are China, the European Union (EU), Japan, India and the United States. However, China is far in front of everyone, accounting for 49 percent of the 1.7 billion metric tonnes of steel produced globally last year, according to industry group Worldsteel.
The U.S. kept its promise to impose 25 percent on $34 billion worth of Chinese goods on July 6. China retaliated by also slapping equivalent tariffs. The escalating trade war between the two countries promises to have one adverse effect on all sides – consumers will pay more for goods.
President Donald Trump has declared that trade wars are “good, and easy to win.” However, if economists are to be believed, that assertion is fake news. In economic wars of attrition, the victor is the nation that loses least and this might just be the beginning of tit-for-tat tariffs, which may hamper global trade and growth.
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. Example, when we are down $100 billion with a certain country and they get cute, don’t trade anymore-we win big. It’s easy!
— Donald J. Trump (@realDonaldTrump) March 2, 2018
The situation between the two largest economies might escalate, as Trump said on July 5 another $16 billion worth of Chinese goods will be targeted in the coming weeks. He also reiterated his threat to impose tariffs on all Chinese goods – imports from China totaled $462.6 billion in 2016.
Supporters of the tariffs accuse Beijing of stealing intellectual property – which means design and product ideas. Trump wants to cut the trade deficit with China – a country he has accused of unfair trade practices since before he became president.
Trump’s trade war on Chinese goods started with tariffs on solar panels and washing machines in January and has now escalated to incorporate about 10,000 products.
Not everyone is ecstatic about the two economies clashing in a cycle of taxation.
“While our 900 member companies continue to suffer from not having a level playing field in China, they are still extremely clear: increased tensions in the US-China economic relationship will negatively impact their operations in China,” said American Chamber of Commerce in Beijing chairman William Zarit to the Financial Times.
“This act is typical trade bullying,” a spokesperson at China’s Ministry of Commerce said. “It seriously jeopardizes the global industrial chain, … hinders the pace of global economic recovery, triggers global market turmoil and will affect more innocent multinational companies, general companies and consumers.”
China has threatened to take its complaints to the World Trade Organization, which is the intergovernmental organization that regulates international trade.
“The American side’s behavior harms China, harms the world and also harms itself,” China’s Ministry of Commerce said in a statement.
What History Teaches Us About Trade Wars
To get a better understanding of what the effects of trade wars can be, we need to go back in time to 1689 when the British King William of Orange imposed tariffs on imported spirits. The idea was to encourage the British population to drink their own alcohol while he offered tax benefits to help drive British subjects to distill their own spirits from, “good English corn” in an attempt to increase the sale of national produce. The result of this was the gin craze.
Approximately one-quarter of the residents of London were employed in the production of gin by 1721, according to accounts of the English Excise and Revenue. This equated to nearly two million gallons of tax-free product a year. The majority of the spirit was moved outside of London but were it to remain in the city (about 600,000 people), this would be 1.6 cups of overproof spirit, per person, per day, for an entire year.
“For the next 50 years, England was in the grip of the so-called gin craze,” said Arnold Stephen “A. J.” Jacobs, an author, journalist, lecturer, on Weekend Edition Saturday on National Public Radio. “Newspapers wrote about the surge in crime and death and unemployment. Pundits were especially upset because women started drinking gin and allegedly neglecting their kids.”
This is only a small example of how protectionism can influence a country. There are also the examples of the British imposing taxes on goods sent to the American colonies that led to the Boston Tea Party, and the Opium Wars that started because Britain had a trade deficit with China, which in turn prompted Great Britain to illegally take Indian opium to the Chinese. Both had less than pleasant consequences.
The most profound example of a trade war and protectionist mentality in the U.S. was the Smoot-Hawley Tariff Act of 1930. It was a response to the difficulty and struggle of the Great Depression and raised duties on hundreds of imported goods.
At the time, Congress set America’s trade policy, and there were none of the contemporary international negotiations that are in use today. At the time protectionism was the norm and it is understandable why the government introduced the act.
The idea of the Smoot-Hawley Tariff Act was to deal with the effects of the Great Depression by protecting U.S. industry and agriculture from foreign competition. However, the effect of this piece of legislation helped lengthen the economic downturn.
The world learned from this experience. The U.S. introduced the Reciprocal Trade Agreements Act of 1934 and granted the president the authority to hammer out trade agreements with other countries. Following this, U.S. trade policy became global and strategic. On the world scale, the General Agreement on Tariffs and Trade was created in 1948 and out of it was born the World Trade Organization in 1995.
The new norm for such agreements was give-and-take. Each country would liberalize trade to the extent that others can liberalize theirs. International negotiations are used now to prevail over protectionist pressures and it is now recognized that trade is a global happening, which generates national interdependence and interconnectivity. Or in other words, globalization.
Effects of the Gamble
There is a consensus between the majority of economists that for prosperity to exists, countries need to specialize in what they are good at producing and not try to make and consume everything domestically. This is because not every country has the necessary resources to produce everything on their own.
For example, smartphones contain rare earth elements that come from mines mainly in one country, China, which is responsible for nearly 93 percent of the world supply. This makes it nearly impossible for other countries to produce the device we can’t live without, as their land may not be able to provide the necessary resources.
The only way that prosperity can be achieved through specialization is for nations to trade resources between each other and allow a certain level of capital and labor mobility.
One of the effects of the escalating trade war between China and the U.S. could be that other nations may benefit.
Gary Hufbauer, a nonresident fellow at the Peterson Institute for International Economics told Mercy A. Kuo, a weekly columnist at The Diplomat, that American companies could reorganize their supply chains to low-cost production countries like Peru, Mexico, Indonesia, Malaysia and Vietnam. He said that this isn’t likely to move a lot of production back to the U.S.
“Likewise, Chinese firms that buy high-tech industrial inputs from the United States will move some of the production to “safe” countries like South Korea, Canada and Australia,” Hufbauer said. “But the Chinese government will strongly encourage Chinese firms to produce many of these inputs at home, even though the cost will be much higher.”
The growing dispute between the worlds largest two economies can lead Europe to being the biggest beneficiary, according to analysts at Citi. They argue that the rising tariffs would allow European corporations to gain a competitive advantage over American firms.
There are two arguments for that. First is that while tariffs will hurt the businesses of European companies in the U.S., they will have the chance to compete in the Chinese markets. The second is the damage that the U.S. will receive on its international reputation, which should allow the EU to become the trading partner of choice for major economies.
The tariffs imposed by the Trump administration on Chinese goods will make businesses from China more likely to do business with Europe, which will boost profits and could have an overall positive impact on gross domestic product.
Such an outcome would strengthen ties between Europe and China and could leave the U.S. in an unfavorable position.
What are the effects?
The escalating trade war will increase the prices of imported goods immediately, and it already has. The costs will rise by the same amount as the tariffs in place. This gives a competitive advantage to domestic companies producing that product because their prices would be lower by comparison. Theoretically, the domestic producer will receive more attention and business from local customers and as the business grows, they should add more jobs.
However, domestic manufacturers tend to rely on foreign raw materials and parts, which would become more expensive. This, in turn, will increase production costs and cut profits. The business will be left with three choices: either raise prices, cut jobs or do both.
According to the Alliance of Automobile Manufacturers, even U.S. produced steel will cost more once foreign imports are eliminated. This is “threatening the industry’s global competitiveness and raising vehicle costs for our customers.”
After Trump announced the tariffs, U.S. industries were immediately affected. Layoffs were announced by Mid-Continent Nail in Missouri as prices of steel became too high for them to be profitable. Wisconsin auto parts manufacturers and the bourbon industry have already felt the damage.
Harley-Davidson, which President Trump held as a company that would flourish under his policies on trade and tax, has announced that some of its production will move abroad to avoid EU retaliatory tariffs. Similarly, the Maine lobster industry is suffering from Chinese tariffs on seafood, and California cheese makers are having their markets in China and Mexico disappear.
Tariffs on U.S. exports are making them more expensive and as a consequence, exporters will have to cut costs and lay off workers in order to keep their prices competitive. Worst case scenario, if American companies fail, it could mean further cost cuts and even going out of business.
Trade wars tend to stifle economic growth in the long run, creating more layoffs as foreign countries retaliate. Around 11 million jobs depend on exports in the U.S., according to the National Trade Association, and all of them could be under threat because of the trade war.
The trade war could cost the global economy about $800 billion, or 4 percent in reduced trade and slow world economic growth by 0.4 percent, according to Oxford Economics. This is happening right as oil prices and interest rates are going up, which is bad.
Trade wars tend to weaken the protected domestic industry over time, as without competition from abroad, companies don’t need to spend on research and development and innovation. Furthermore, the quality of the local produce declines when compared to the equivalent foreign goods, which are traded in other countries outside of the trade war.