President Donald Trump has announced the planned imposition of a new, 25 percent tariff on imported steel and a 10 percent tariff on foreign-made aluminum entering the United States. This has brought about threats of trade retaliation by a number of America’s trading partners. The menacing clouds of a possible trade war are showing themselves on the global horizon.
Claiming that other countries are taking advantage of the U.S., as reflected in American trade deficits, Trump, in one of his infamous tweets, has declared that “trade wars are good, and easy to win.” How and why? Trump asserted: “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!”
An Individual’s Trade Deficits and Surpluses Balance Out
Let us think this through a little bit. Suppose I pay $100 for my food from a nearby grocery store, but the grocery store owner and employees only buy, in return, $10 worth of economics lectures that I would be happy to deliver. Clearly, I am experiencing a trade imbalance with this grocery store in the form of a $90 trade deficit. I buy far more in the store than the people working there buy from me. And according to the president, I am, therefore, being taken advantage of by this grocery store.
What might I do if I personally acted upon Trump’s analysis of my situation? I could stop buying $90 worth of food items that I’ve been purchasing at this grocery. The store and I would, now, be in a reciprocal trade balance. I spend $10 dollars on the items for sale in this business establishment, and they turn around and spend that $10 on economic lectures that I’m offering to sell. The trade balance is equal.
But now I have a problem. I’m short $90 worth of food items that I previously had been purchasing at the grocery store. Having reduced that dollar amount of food “imports” into my personal household, I may decide that I’ll now produce it “domestically” at home on my own property.
I am now poorer in terms of my material standard of living.
But I’m an economics professor, not a farmer. For the sake of the argument, let’s put aside the fact that I don’t own any farmland or farming equipment. If nothing else, agricultural production is not my specialized niche in the social system of division of labor. So, no doubt, my efforts to undertake “import-substitution” domestic food production will end up costing me more to generate the same amount of food output than the $90 I had been paying at the grocery store.
Say that my “homeland” production of food requires me to expend a dollar outlay of my labor time and related farming equipment and resources totaling a cost of $115. That is, it now costs me $25 more for me to grow and supply myself with the same amount of food that I used to buy at the grocery store for $90. This means that $25 worth of other goods and services that previously I had been able to produce and sell and then use the proceeds from to buy $25 of desired consumer goods from others in the marketplace will have to be foregone. I am now $25 poorer in terms of my material standard of living.
Of course, my ability to spend $90 more on food in that grocery store than the store personnel buy from me in the form of economics lecture services only arises from my ability to earn $90 more from others who do purchase my lecturing services than I purchase of the particular goods and services sold by them in the marketplace. So looking over all my exchanges with all my trading partners, my balance sheet of total purchases and total sales balance out at the bottom line.
Higher Import Taxes Mean Higher Prices for Goods
I would suggest that the conclusions drawn from the situation of an isolated individual have their counterpart in understanding the same process over a large number of interdependent individuals living and working within a particular country.
Suppose President Trump follows through with his threat to impose that 25 percent tax increase on steel imports into the U.S. In 2017, America imported almost $30 billion of foreign steel into the country. According to the U.S. International Trade Administration, 16 percent of that steel came from Canada, 13 percent from Brazil, 10 percent from South Korea, and nine percent from Mexico and Russia, respectively. Smaller amounts come from Turkey, Japan, Taiwan, Germany, and India.
U.S. manufacturers who use steel in their production processes will find it necessary to increase the prices of the finished goods they are offering.
If the rationale for the president possibly imposing this higher import tax by executive authority is due to “national security” concerns, then the Trump administration must have some really deep insider information that America is facing eminent dangers of war from countries with whom it has shared decades-old political and military alliances or, with the exception of Russia, nations with whom America has close peaceful relations.
If the import tax is implemented, this will require the foreign sellers to raise their prices for the steel they sell to American buyers by some amount up to the full 25 percent of the import duty. They may try to absorb a portion of the higher cost of selling their steel in America, but there is a limit to which they are willing and able to eat into their own profit margins, which partly depends on consumer “elasticity” for that imported steel; that is, by how much do sales go down when they raise their price by some specific amount?
To the extent that U.S. manufacturers who use steel in their production processes experience higher costs for purchasing that input, they too will find it necessary to increase, to one degree or another, the prices of the finished goods they are offering to consumers and other producers on the market.
Consumers may not feel the full 25 percent tariff increase for every one of the goods they purchase that has steel content in its manufacture. But the prices they pay will reflect to one degree or another the (marginal) higher costs of production due to more expensive steel.
Import Tax Redistributions from Consumers to Producers
Each individual buyer may only be burdened by many small increases in the costs of the many steel-using goods they buy. But all those little-bit of higher prices here and little-bit of higher prices there will add up to tens of millions of dollars of added revenues for the domestic steel producers.
For instance, in 2017 about 30 million metric tons of different types of steel were imported into the U.S. at that cost of almost $30 billion, again according to the U.S. International Trade Administration. Suppose that the price of steel per metric ton rose just 15 percent. That would raise the cost of imported steel by $4.5 billion.
This means that over $9 billion would be redistributed from the steel-using American public into the pockets of U.S. steel manufacturers.
In 2017, domestic American producers produced about 82 million metric tons of steel, and it sold at an average price of $740 per metric ton for all types, generating total revenues of $60 billion. A 15 percent increase in this per tonnage price would generate an additional $9.1 billion in extra revenue for U.S. domestic producers.
This means that over $9 billion would be redistributed from the steel-using American public and business community into the pockets of U.S. steel manufacturers. Over two years, 2016 and 2017, the steel industry spent a total of around $20 million on lobbying activities in Washington, D.C., according to the Center for Responsive Politics. By any standard of measurement, a $20 million dollar investment that results in a $9 billion payoff would not be considered too shabby.
But even if it were only to be half—$4.5 billion—in total additional revenues for U.S. steel producers due to the import duty on foreign steel, that would come to about a $40 per capita cost on every household in the country to benefit the steel industry. That is enough to buy two or three pairs of children’s shoes on sale at Walmart. This is almost equal to 10 percent of the average total amount that men above 16 years of age annually spend on clothes. It is an amount that would be enough to buy at least six Big Mac meals at McDonald's. It is equal to purchasing over 30 dozen eggs. It is enough to buy at least 10 Starbucks lattes.
All of these types of individual lost purchases for all the individuals in the U.S. as a whole will represent the cumulative costs for the 325 million people in the United States, and all to “protect” through an increased import tax around 150,000 jobs in the steel sector of the economy, out of a total labor force of 161 million people.
Subsidized Foreign Goods Are Not Damaging to America
But, it is sometimes replied, many of these foreign steel imports are sold in the United States at prices subsidized by governments in the countries from which the steel is coming. This may very well be true, but this means that American manufacturers and consumers are then given a bargain. We get something for less than we otherwise would have had to pay for it.
If another country’s exports are being subsidized, the complaint should be made by the citizens of that other country.
Americans then have to produce and sell fewer exportable goods to buy those imports. American resources and hours of labor that do not have to go into producing more goods for export to pay for higher-costing imports are freed up to use and invest in ways Americans otherwise could not have afforded to do. Those resources and labor hours are available to make more goods and services to satisfy other domestic demands for desired products. Or to be used to buy different and attractive importable goods that previously could not be purchased. Our standards of living are increased.
If another country’s exports are being subsidized, the complaint should be made by the citizens of that other country, who are taxed to fund the subsidy, and whose take-home paychecks are reduced to provide a “crony” privilege to a special interest group at their expense.
Of course, it is also possible that the exported good was not being subsidized. Instead, the foreign seller had found a competitive, cost-efficient way of producing it for less and thereby selling it to Americans for less, while still making a profit. From the American buyers’ perspective, in both cases the outcome is the same: a desired product is obtained at a lower price and, thereby, the buyers are economically better off.
The Trade Balance Always Balances
If the foreign seller does sell more in America and increases his earned dollar revenues, he will have increased his financial capacity to demand more American exports he might find attractive to buy that previously were beyond his reach.
Even if he does not find American goods attractive to buy or not in an amount equal to the dollar earnings from his exports to the U.S., holding those dollars gets him nothing. He may, instead, trade those dollars on the foreign exchange market for some other currency that he’d rather have for his own buying purposes on the global market.
We see that the “fear” of trade imbalances and being “taken advantage of” are completely misplaced.
But who would be selling that other currency in exchange for dollars, other than someone who wants dollars to do... what? Buy American finished goods, or directly invest in a potentially profitable business in America, or invest indirectly by depositing those dollars in an American financial institution to earn the interest income that makes that alternative an attractive one. The latter choice increases the pool of savings in the U.S. economy and assists in funding investment projects undertaken by Americans.
Once we look beyond what is immediately seen and follow the process through several additional steps, we see that the “fear” of trade imbalances and being “taken advantage of” are completely misplaced. (See my article, “Trade Deficits Don’t Matter, Unless Caused by Government”.)
Instead, what America is facing are the illogical trade policies of an economically illiterate president in the White House. President Trump’s decisions do not only threaten to make Americans poorer than they, otherwise, have to be, but might set in motion the opening shots of an international trade war that could drag the world into a downward spiral of global hostility, economic instability, and worsening standards of living for hundreds of millions of people around the globe.