In President Trump’s first weeks back in office, he has made it clear that he will call out longstanding friends and foes without distinction if they don’t comply with his administration’s demands.
He risks – practically invites – a trade war with China, a traditional economic rival. But he’s also going toe-to-toe with Mexico and Canada, our biggest trading partners as well as our closest neighbors. Meantime, he’s dunking on Panama and Colombia and has hinted at actions against Russia, India and members of the European Union.
In essence, we seem to be at the brink of a large-scale trade war.
“Previous Administrations failed to fully leverage America’s economic position as a tool to secure our borders against illegal migration and combat the scourge of fentanyl, preferring to let problems fester,” according to the White House.
The White House fact sheet omitted any mention of protecting American jobs, which is usually the first thing that comes to mind when considering reasons for imposing tariffs. Nor did it talk about the revenue the tariffs would generate for the U.S. Treasury – revenue it would no longer have to draw from income taxes. Nor did it claim to be in retaliation for specific tariffs or unfair trade practices targeted at America, although recently announced levies on steel and aluminum imports cite national security interests.
Could we win this trade war against the world? The short answer is, yes. We’re the world’s biggest economy, and we buy our groceries with the currency all other countries hoard like gold. Is it a gamble? Also, yes, if we make the mistake of attacking on too many fronts at once and don’t have the stomach for the collateral damage.
We don’t have the space here to go into all the strategies and tactics we could be using in this trade war. Some are carefully calibrated. Some involve rapid maneuvers. Some are entirely defensive in nature. All we know about what the Trump White House is prepared to bring to bear is what we’ve seen in its opening salvo.
That would be tariffs, the heavy artillery of a trade war.
What tariffs are, and who pays for them
Tariffs are taxes imposed by one country on goods imported from another, acting as trade barriers, according to the non-partisan, center-right, pro-business Tax Foundation.
While tariff proponents describe them as a tax on foreign businesses, it’s the local importer who bears the cost. CNBC takes the example of an automobile transmission imported from Korea to be installed in an American-assembled SUV.
The importer – in this case the automaker – “would transfer it [the tariff expense] up the line to the wholesaler, to the distributor, and ultimately to the consumer,” says Rice University economist David Gantz.
As artillery is wont to do, tariffs draw incoming fire. The countries we aim them at – China, for instance – are likely to ding our exports with tariffs. That’s why it’s called a trade war. While this means Chinese consumers would be out of pocket, Beijing would consider that acceptable collateral damage because U.S. farmers sell much of their harvests to China, and they could find themselves harmed financially if this key market went away.
This has happened before. In response to the crash of 1929, President Hoover signed the Smoot-Hawley Act, which raised tariffs on 20,000 imports. This was at a time when tariffs were considered the regular way governments made money, before income taxes became the primary method. The new law raised them only a fraction of what the current administration is proposing. Even so, historians consider Smoot-Hawley one of the factors that turned a sharp economic contraction into the Great Depression.
A century earlier, in response to the U.K. dumping raw materials on the U.S. at below-market prices, President John Quincy Adams decided to do nothing, figuring the crisis would pass. But he had to be seen as doing something, so he proposed a tariff bill that was deliberately awful and could never pass a Congress divided by regional interests. Anything that would be welcomed by the manufacturers in the North would bound to be demonized by the agrarians in the South and vice versa. But whoever was in charge of whipping votes against it screwed up, so the so-called Tariff of Abominations became law, Adams became a one-term president and Southern secessionism began to gain traction.
Why we can win
Despite the old-timey image of the “Yankee Trader,” foreign trade accounts for only about 25% of the U.S. economy. That’s less than half the world average, according to the World Bank. The Mexican and Canadian economies have two things in common: Both are about 70% reliant on trade, and the U.S. is the biggest importer of goods from both countries. No doubt about it, we are in a position to throw our weight around.
Can we? Yes. Should we? Maybe. The fentanyl issue is a real point of contention with Mexico and China as well – a 7% per year drain on U.S. GNP, not to mention the end of 200 American lives per day – although Canada has next to nothing to do with it. The immigration issue can be complicated because there are political and economic realities to consider. Even most supporters of an aggressive deportation of illegal immigrants would acknowledge that the U.S. needs immigrants for labor reasons. We have jobs here in the U.S. that not enough Americans will do but foreign immigrants gladly will.
To an economist, immigration is just another term for labor, and the free flow of labor provides the same benefits as the free flow of goods, which tariffs, and other trade barriers reduce.
For that matter, so does the free flow of services and the free flow of capital. When it comes to services, America has a persistent surplus – not a deficit! – of around $25 billion per month. That’s how much more we sell travel packages, financial services and other non-tangibles than we buy. The trade deficit in goods, to be fair, is about four times that.
Capital flows – foreign direct investment – is much less fettered. Americans invest around $6.7 trillion per year abroad, while foreign interests invest around $5.4 trillion here. Tariffs could actually narrow that gap, which isn’t that bad in the first place, by forcing countries that had been exporting to the U.S. to open up factories here instead. This is particularly true for Canada’s auto parts industries; the supply chain to build a car looks like a ping-pong match between Michigan and Ontario.
But factories are expensive to build. A manufacturer moving production to the U.S. is betting that American tariffs will remain in place for long enough to justify the capital expenditure of building the factory, which is asking a lot given that U.S. economic policymakers come and go and have varying agendas. When a factory does move here, that’s great because it means more employment opportunities. The question is, how important are those factory floor jobs to the U.S. economy? Currently, manufacturing accounts for about 10% of GDP, which is significant. While it has declined steadily since the early 1970s, it was never more than 25% – or roughly where China and South Korea are today.
Factory work was always more important in terms of the American mythos than of the American economy. There’s something strong about it, while careers requiring extensive classroom training and desk work have always been seen as less macho. When U.S. policy makers of both parties decided more than half a century ago to let the factory jobs drift offshore, they assumed that erstwhile steel, textile or chemical workers would get retrained, freeing them up for new opportunities that would pay even better. But to a large extent, that never happened. The private sector apparently thought that retraining should be part of a government program while the government apparently thought that the private sector would invest in its own future workforce. Few individuals took the initiative themselves. Maybe that’s why we’re in this situation to begin with.
Nothing could possibly go wrong, right?
Let’s acknowledge that we can and very likely would win a trade war against any country we decide we want to smack down. So, what do we win?
The main point of tariffs historically is to protect established industries which are crucial to national security and new ones which need incubation before they are world-class competitive. Computer chip making is an excellent example of both. The Biden White House, which also saw strategic advantage in targeted tariffs and kept up most of those set by Trump’s first administration, slammed the door on imports of Chinese EVs. But we can’t fortify one industry without leaving another exposed. What happens when other countries start erecting barriers for trade in smartphones and suddenly, all around the world, it costs twice as much to buy an American iPhone than a Korean Galaxy?
Another possible benefit would be increased government revenue. The tax cuts President Trump signed into law during his first term expire at the end of this year. It would be quite a coup if he were able to propose an even more aggressive income tax cut, paid for by higher tariffs. Practically speaking, it just means that income tax revenue will be replaced by what’s effectively a sales tax. People who work for a living and have few or no investments could end up paying more tax throughout the year, but that’s hard to track. If they’re not paying attention – and, pardon our cynicism, most aren’t – they’ll believe they’re actually paying less because they won’t owe Uncle Sam as much on April 15.
Both Trump and Biden believe in using tariffs as leverage in non-economic disputes. Biden called it “diplomacy”. Trump calls it “negotiating”. In Vegas, it’s often called “bluffing”. If you’re a whale at the $2 table, it doesn’t matter if you’re bluffing or not; Panama and Colombia are going to fold because they can’t take the chance. Mexico and Canada, though, have already called the president’s bluff. They will again, and Japan, South Korea, Germany and the U.K. will also stay in the game. China is the only major rival who we’re not actually bluffing, and we import more from there than from any other country, including our next-door neighbors. Fast fashion may get a lot more expensive, and we’ll all have to explain why to our kids.
At the close
It’s true that we have a trillion-dollar-a-year trade deficit, and China accounts for around one-third of it. (It’s mitigated slightly by our trade surplus with Hong Kong.) That’s the highest trade deficit in the world, but we’re the largest economy in the world. The trade deficit accounts for between 4% and 5% of U.S. GDP. For Japan, New Zealand, Greece and Latvia, net imports-to-gross domestic product ratios are roughly the same.
And just how harmful are trade deficits? We’ve been running one every month since August 1985 and the U.S. economy has only gotten stronger.
Your opinion on all this may be more sanguine. President Trump might well be using the same tactic that presidents Reagan and Nixon used so effectively against the Soviet Union, when we needed our rivals to believe that we might be just irrational enough to pull the nuclear trigger. But today’s threat is economic, not existential. We’ll all find out together if what both proponents and detractors of this strategy call “the madman theory” is effective in a trade war.
