Make America Mercantilist Again: 6 False Premises That Underpin New US Tariff Policy

In this blog posting, I make the argument that using tariffs to reduce trade deficits and increase domestic economic well-being will be counterproductive. Furthermore, the claims made by the President (and his Commerce Secretary) to support tariffs related to steel and aluminum imports are based on false premises.

Household net worth vs trade deficits

In a previous posting, I defined mercantilism as economic nationalism for the purpose of building a wealthy and powerful state through restraining imports and encouraging exports. In the 16th to 18th centuries, mercantilism was characterized by European countries exploitation of their colonies to increase their own wealth especially through the accumulation of gold or silver. In today’s world, mercantilism – some might dub it neo-mercantilism – features some countries (such as the US) treating the economies of other countries (such as China) as rivals and acting as if trade is a zero-sum game; that is, there is only so much demand for particular goods at home; so economic nationalists seek to maximize the domestic share of the production of such goods, no matter what the cost or consequence. Such actions don’t generate unintended consequences; they generate negative economic effects that cost all but the privileged groups that gain protection. Cynics might call this crony capitalism.

As Jeff Miller has pointed out ( displayed in the table below), Congress has granted the President wide powers to use tariffs, quotas, fees, or the freezing of assets of foreigners.

President control of foreign trade policy

In Case Against Commerce,  Douglas Irwin describes how presidents were given the power to set tariffs in order to keep Congress from supporting some industries and regions of the country at the expense of others. It is ironic that our current president has turned this logic on its head. He specifically seeks to help some industries, and regions of the country, at the expense of others. Put differently, tariffs are a tax imposed on some with the proceeds used to help others. Such concerns, however, are in addition to what I argue here.

Economists of virtually all stripes argue that tariffs reduce economic well-being. For example, see the Grumpy Economist (John Cochrane) who typically supports free market approaches or Paul Krugman whose views often align with those who wish to intervene in markets.

As portrayed in the above graph, U.S. wealth has risen along with trade deficits. Part of the reason is that the rest of the world has found it attractive to invest in the US and by an accounting identity, inward capital flows must equal both trade deficits and a domestic savings shortfall relative to domestic investment in plant and equipment.

The President’s tariff policy, however, is not only bad for economic reasons. The assumptions that underpin the tariffs on steel and aluminum are based on false premises as Andy Rothman details in his Sinology column, which I summarize below.

1.      Massive overcapacity in China’s steel and aluminum industries has swamped the U.S. and global markets with subsidized metal.
Rothman: China has 50% of global steelmaking capacity, but it accounts for 45% of global steel consumption. China recognizes that it has too much capacity and has reduced its steel workforce by 25% over the past three years. The gap between production (55%) and consumption (53%) of aluminum capacity is even smaller, and its exports have fallen markedly over the past decade.

2.      Tariffs on steel and aluminum will inflict enough pain on China’s economy that Beijing will change its policies.
Rothman: China’s combined exports of steel and aluminum to the U.S. account for less than 0.2% of all Chinese exports and less than 0.03% of the GDP of China. These industries play a relatively modest role in the current Chinese economy, and, for a variety of reasons including excess capacity and very dirty air and water, recent economic growth has become  more dependent on consumption and less dependent on exports.

3.      The American steel industry is dying and needs protection from imports.
Rothman: Steel production and capacity in the U.S. has risen steadily since the trough of the recession in 2009 and netted positive earnings for major steel producers for the most recent 22 quarters. The primary reason for the decline in employment in the steel industry in the U.S. is rapid increases in productivity.

4.      Imports of steel and aluminum threaten American national security.
Rothman: Defense Secretary Mattis has stated that “U.S. military requirements for steel and aluminum each only represent about 3% of U.S. production.” Furthermore, “41% of steel imports come from countries with which the U.S. has collective defense agreements.”

5.      Tariffs on steel and aluminum will not cause serious collateral damage.
Rothman: Based on a March 5, 2018 report by the Trade Partnership, “five jobs would be lost for every job gained” in steel and non-ferrous metals. Additionally, “two-thirds of the lost jobs affect workers in production and low–skill jobs.” These results assume that there will be NO trade retaliation. Our previous experience with tariffs on imported steel, which President Bush imposed in 2002, featured a decline in employment across the steel industry in addition to those in steel consuming industries.

6.  Participation in the WTO has been bad for the U.S. economy.
Rothman: President Trump’s own Council of Economic Advisors (CEA) report (February 2018)  (page 251) that “the United States has won 85.7% of the cases it has initiated before the WTO since 1995 … In contrast China’s success rate is just 66.7%.” Furthermore, the CEA notes that trade expansion and economic growth go hand in hand. For example, since China was admitted into the WTO in 2001, the value of US exports to China have grown by 580% and its agricultural exports by 1,000%.

None of the above observations takes into account how our trading partners would respond to our new tariff policy. Our trading partners, however, are not unaware of the constituencies in the U.S. that could be hurt the most by tariffs on U.S. exports. This makes a bad policy even worse.

Restrictions on trade increase barriers to competition and, thus, impede economic growth by granting market power to incumbents. We complain when other countries do this. President Trump is using national security to improve the economic well-being of a small segment of the population at considerably greater expense for both consumers and other producers, many of whom export to our partners. Our concerns about steel and aluminum workers can be addressed much more productively with job training and job transition assistance rather with tariffs which tax consumers and producers of products that use steel and aluminum as imports.

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