Tariffs: Analyzing Pros And Cons

Summary

• The concept of Free Trade has been incredibly popular in the United States in the past 35 years.
• Free trade is usually very positive in the short term.
• Long-term economic planning, however, requires a more careful analysis.
• Tariffs can be useful (although painful, short term) to correct imbalances created from policies that were good in the short term but led to excess imbalance in the long term.

As a general rule of thumb, for the long-term economic planning of a country, two important risks arise when considering free trade:

A) Exporting your nation's technology to another country to use its low cost labor (over time, an ever-growing amount of it is made by your suppliers and you lose the manufacturing labor skills, leading to supplier dependence).

B) Overly depend upon natural resources from another country (if your economy becomes dependent on that natural resource, the supplier has significant leverage).

In the United States, we are fortunate to have a significant abundance of natural resources (importantly, both food and energy - including oil now) and a relatively healthy, though weaker than past periods, manufacturing sector.

Yesterday, Donald Trump announced tariffs on steel and aluminum. Is this a wise policy that promotes the United States' long-term strategic interest to maintain a healthy domestic steel industry, or is this likely a policy implemented with short-term political gain in mind?

To analyze the question, we must ask the following questions:

1) How much of our steel do we produce internally vs. import?

2) How concentrated is our exposure to our suppliers? Will we be beholden to just one country, or is the source diversified enough that if one supplier became hostile we would have alternatives?

3) Do our suppliers exploit a significant labor cost difference to produce product at an unfairly low price?

United States Steel Production Vs. Imports

It turns out that the United States produces a significant amount of our own steel internally. In recent years, around 70%.

United States Steel - Sources Of Import

It also turns out that the United States sources steel from a broad, diversified base of suppliers.

United States Steel Production Competitiveness

This question is significantly more detailed in the analysis and beyond the scope of this article, as it requires analyzing the source of raw materials (which includes a significant amount of scrap), domestic energy prices and energy subsidies, and, to a much lesser degree, wages. For the purpose of determining whether or not we are 'losing' to other nations on steel because of wage discrepancies, however, we can see that wages are a very inconsequential component of the total cost of production:

Further, while the cost of production varies, and the below does not show Mexico or China, we can compare the United States' cost to Brazil, and also to the rest of the world:

Conclusion

While tariffs probably need to be considered in a range of areas given the United States' current trade imbalances, steel does not appear to be an area of:

i) Gross imbalance from domestic production vs. domestic demand (need).

ii) Exploitation of another country's low labor cost or poor labor policies.

iii) Over-reliance on any one supplier or trade partner.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Blue Pacific]

Of the trade with our top 5 trading partners, trade with Canada & Mexico are the most balanced.

Rank Country Exports Imports Total Trade Percent of Total Trade
1 China
115.8 462.8 578.6 15.9%
2 Canada
266.8 278.1 544.9 15.0%
3 Mexico
231.0 294.2 525.1 14.4%
4 Japan
63.3 132.2 195.5 5.4%

[SA-NJ52]

I am sad that I was right here. The Donald will remove the tarriff if Canada and Mexico agree to Trump's ridiculous demands.

According to The Balance:

http://bit.ly/2qe2dxA

The United States Has a Deficit With Its NAFTA Partners

Canada, the United States, and Mexico are partners in the world's largest trade agreement, NAFTA. The trade deficit with Canada is $18 billion. That's only 3 percent of the total Canadian trade of $582 billion. The United States exports $282 billion to Canada, more than it does to any other country. It imports $300 billion. The largest export by far is automobiles and parts. Other large categories include petroleum products and industrial machinery and equipment.

The largest import is crude oil and gas from Canada's abundant shale oil fields.

Note the last line. America's refineries have been built to process Canadian heavy crude. NAFTA was pushed by Reagan and then signed by Clinton because of the need for energy security. Canada guaranteed American energy security under NAFTA. Now this is less than an issue with fracking but that was the basis for the deal.

Americans make a big deal of Canadian supply management for dairy. Yet the massive dairy subsidies to American farmers is ignored in the NAFTA debate.

http://bit.ly/2FUxR86

Grant

[SA-NJ52]

The fellow from Nucor lied on CNBC on Friday by saying the steel tariff was directed towards China. This author and others show that this is a complete fabrication. He attacked Larry Kudlow, who for the first time, I agreed with his view on tarriffs.

http://cnb.cx/2FRMTeM

The real reason for the tariff is to put Canada in a position of imposing countervailing duties so The Donald can cancel NAFTA. The Donald has declared his candidacy for 2020 and he wants to keep Wisconsin, Michigan, Ohio and Pennsylvania in the Republican camp. As if Pittsburgh, now a medical centre, will want to return to smokestack industries like steel.

The last steel tariff imposed in 2001 exempted Canada. This is not going to happen this time.

Grant

[AlexTheCat3741]

gandc - He also wants the Republican Party to continue its control of Congress though missing is the level of support needed to deliver the campaign promises that they all made. President Trump has been doing the job and delivering what is not dependent upon Congress or defied by the Courts, but the Republican Leaderhip has been mostly, "Missing in Action." The 2018 Midterm may produce much needed Primary Challengers for Establishment Republicans and Republican candidates to fill Democrat seats who have supported nothing. New more supportive Republicans may fill two Senate seats in each MS and AZ and one in TN to help.

[IOB]

Thank you for a thought provoking article. Everyone who has taken a number of economic classes "knows" that protectionism is bad. The U.S continues to import goods and export dollars. Other nations take these dollars and buy Treasuries, which supports our eventually destructive habit of spending more than we are willing to tax ourselves. We are loosing good paying jobs and fundamental industries. I'm not sure if tariffs are the right answer, but was glad to see someone willing to challange conventional wisdom.

[AlexTheCat3741]

What typically happens when our "Captains of Industry" are dealt a positive hand that gives them advantage in increasing market share, is raise their prices to advantage their corporate bottom line and compensation packages. Nothing wrong with that except that doesn't produce the intended long term plan of an administration that is attempting to increase job growth in our Country. We will see what happens when the tariffs are put into place and implemented.

[Lance Brofman]

All protectionism is destructive. However, protecting basic materials like steel and aluminum is particularly harmful since it makes products manufactured in America uncompetitive in the world market.
Senator Reed Smoot and Representative Willis C. Hawley probably did many things in their careers, but history only remembers them for the Smoot-Hawley tariff of 1930 which remains today as the prime example of the damage that protectionism can do. Protectionism is the progressivism of fools. Gandhi was a great statesman but a horrible economist. Just as the ignorant in the USA argue that American workers who earn $15 per hour should not have to compete with Chinese workers who make $2 per hour, Gandhi thought that Indian workers should not have to compete with American and European workers who have the benefit of modern machines. As a result India adopted protectionism. In 1947, the per capita income of India was similar to countries such as South Korea. By 1977 the per capita income and standard of living in South Korea were many times that of India. India has since largely abandoned protectionism and has benefited immensely from free trade. Just as David Ricardo proved would be the case when he developed the concept of comparative advantage...'
https://seekingalpha.c...

[Ben Gee]

If the US want 100% balance trade, US consumers will have to be ready to pay US prices for everything.

[Lance Brofman]

There are stupid tariffs and very stupid tariffs. A very stupid tariff is a tariff on steel and aluminum that increases the costs of every product made in the USA that uses those metals. This increases consumer prices and makes products produced in the USA less competitive relative to those made outside the USA using steel and aluminum priced at the world market rather than the artificially propped-up protected US steel market.

A less stupid tariff is the retaliatory tariff that will be put on US motorcycles (Harley Davidson) that will not raise any costs on any EU producers, or raise prices for anyone in the EU, except for buyers of motorcycles.

Protectionism can save jobs. In the USA the best measurement of the cost per job saved to the rest of the country is about $1 million per job saved. Saving one job might provide $100,000 in gains to the worker and the employer who benefit from the protectionism, but cost the rest of the country $1,000,000. Since the million dollars is just one third of one cent per person in the USA, no one notices it.

To save a million jobs via protectionism would cost the country a S1 trillion which would be about the same impact as a very severe recession. To save 10 million jobs via protectionism would cost the country a S10 trillion. That would make the USA a poorer country than Mexico. That would mean it would be likely the people born in the USA would be going to Mexico to work as servants and dishwashers. The degree of impoverishment that would result from that much protectionism is usually only associated with severe natural disasters or wars. Trump is no Reagan on trade. Trump is a protectionist. Furthermore, the prospect of the Trump administration negotiating bilateral trade agreements featuring quotas is frightening...."
https://seekingalpha.c...

[Blue Pacific]

Generally if a tariff causes friction the bad trade deal already happened, which created the imbalance in the first place.

[Blue Pacific]

In this case specifically though it’s unclear what our objective is. If it’s to produce 100% of our own steel, then that is a new policy/objective, so the shift in policy creates the imbalance.

[Blue Pacific]

Well there are two components:
1) State of current technology;
2) Skill & efficiency of labor at implementing that technology

Pick any trade, be it plumbing, welding, electrician, etc. It generally takes a minimum of 2-3 years experience to become capable enough to do these jobs consistently, efficiently, safely and at scale. Let's say your society didn't do any of these for, I dunno, 25 years. If the place that was doing it for you decides not to do it anymore, you've got a pretty big problem on your hands. Sure, you could get a bunch of people ready in a couple years, and you can do shoddy work to get emergency things done in the meantime, but to replace what was lost would take many, many years.

You see this is action when an experienced developer, contractor or businessman decides to take an existing idea/concept to a new country and train their people to do the same thing. Usually the first several attempts are very poor. If its a big construction project, lots of issues - both quality, structural, etc. If its an industrial project, much more safety issues, delays, reliability, etc.

Then, there is a the technological angle. Let's suppose we had stopped manufacturing cars here in 1975 (in many ways, this is kind of what happened to our auto industry vs. Japan in the 1980s - ours was stuck in time as theirs advanced significantly).

If we stopped manufacturing cars here, and then tried to start again today but hadn't kept up on the technology of the manufacturing process, it would take us probably decades to figure out how to catch up with best-in-class manufacturing processes today. It took our domestic auto industry probably 15-20 years just to bridge the quality gap that Japan had created between us in the 1980s.

So it is not impossible, but it takes significant time and comes with substantial frictional costs.

[SA Editor Daniel Shvartsman]

That makes sense, thanks. I was thinking on a shorter timeframe. So in potential imbalances, it sounds like the argument is the country can have friction now with tariffs or risk friction later if the supplier exercises its leverage one way or another.

[SA Editor Daniel Shvartsman]

"over time, an ever-growing amount of it is made by your suppliers and you lose the manufacturing labor skills, leading to supplier dependence" - how does this play out in practice? If we didn't produce steel or cars here, wouldn't we still remember how to do it? Or how long does it take to forget?

I think that's a naive question, but just wondering how to think about this issue. Thanks for the article!