Tariffs

The Global Trade War Comes Full Circle

Economic reality is always more complex than politicians pretend it is.

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It has always puzzled me that anyone would believe that protecting the U.S. market with tariffs is a good idea. Yes, U.S. consumers might increase their demand for domestic goods because duties on imported foreign goods make them relatively more expensive. But these duties also create massive market distortions and malinvestments, which often backfire against the very industries that are ostensibly being protected.

Case in point: the steel industry and Trump's steel tariffs. Back in March 2018, President Donald Trump announced that he would be imposing 25 percent tariffs on foreign steel. The idea was to make the price of foreign steel so expensive that domestic consumers of imported steel would start to consume more domestic steel. For those who defended the steel tariffs, it didn't seem to matter that at the time 70 percent of U.S. steel consumption was already domestically sourced. The president expected more, and the steel executives who disliked foreign competition cheered him along.

American steel consumers were suddenly forced to buy more expensive steel (whether foreign or domestic) because the president thought it was a better way for them to spend our money. Never mind that the U.S. steel industry often didn't even produce the type and quality of steel on which the tariffs were imposed. And never mind that steel-consuming American manufacturers and workers begged their government to not punish them for the way they run their business. Tariffs went up.

As a result, the price of steel went up for a while, the U.S. steel industry fired up its mills, and U.S. steel output went up dramatically. For a while, it seemed like it was all working according to Trump's plan—for the domestic producers of steel, that is, not for consumers. As U.S. companies were still trying to figure out their options, some had no choice but to shift their demand and increase purchases of domestic steel. The industry responded by adding more capacity than they would have had without the protection.

Yet because they were responding to an artificial and temporary increase in demand triggered by the tariffs, as opposed to real market signals, they failed to recognize the global economic slowdown and the subsequent reduction in overall demand. As a result, prices of steel went down quite dramatically. That's what we economists call malinvestment, and as a result, the older, less productive blast-furnace steel mills are now paying a dire price as they're unable to stay profitable even with the foreign competition out of the way. And because misery loves company, the furnaces suppliers are in trouble, too.

As Bloomberg's Matthew Townsend and Joe Deaux recently reported: "Suppliers to blast furnaces are sounding the alarm. In laying out his vision for iron-ore miner Cleveland-Cliffs Inc. at a recent conference, CEO Lourenco Goncalves painted a bleak future for what makes up the overwhelming majority of his current customers." The article adds that since "Trump announced the tariffs 16 months ago, U.S. Steel has lost almost 70% of its market value, or $5.6 billion, and idled two American furnaces in mid-June that couldn't be run profitably at the lowest prices since 2016."

One takeaway from this story is that markets are extremely effective at striking the right balance by taking advantage of dispersed knowledge. That's a skill politicians lack. There are reasons why consumers were buying foreign steel in the first place. U.S. steel was often too expensive, not the right type or quality, and needed a serious reshaping of the industry that had too many inefficient producers.

Another takeaway is that reality is always more complex than politicians pretend it is. A great lesson of economics is that global markets are connected in surprisingly intricate ways. As such, something that looks like a simple fix can quickly turn into a serious issue with unintended side effects.

That said, it's hard to feel sorry for these steel executives. They have been clamoring for the very protection that may end up doing them in. In fact, one reason for the global slowdown is the Trump trade war, which started with the steel tariffs, produced uncertainty, increased costs, and triggered a disruption in the supply chain. As the saying goes, what goes around comes around.

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  1. There is a basic rule of thumb that everything the government does, is a market distortion which introduces inefficiency. Whether it’s regulations, subsidies, or taxes, they are artificial intrusions which distort prices and cost more overall. How can it be otherwise? I cannot imagine any circumstances where artificial, arbitrary, and capricious expenditures reduce overall cost.

    About the only sympathy I have for central planners is that when you look at what it takes to implement prices, it sure does look like an incredibly inefficient way of doing things. Little stickers all over — UPC codes — what a waste of time and effort and treasure! Wouldn’t things be a lot cheaper to make if you simply took what you needed and other people made what was needed, all guided by bureaucrats?

    I bet it would be more efficient — if people were honest, if the economy was entirely static — if weather never happened (space colony?) — if people never tried to do things better or think up new products.

    But the moment you have any of those factors, you have a dynamic economy, and you need clues to what is efficient. As soon as you have greedy dishonest lazy people, you need accountability. Nothing else comes close to prices for overall efficiency.

    I think that is what most people can’t see. It’s like insulation on wires. Imagine how much cheaper wiring would be if you could guarantee wires in a design would never touch. No wind or rain, no vibration, no ignorant person reaching in for an oil filter or lost socket. That’s what prices are — the insulation which keeps things going.

    1. Good analysis, and an interesting observation that a space colony would have the potential of being less dynamic – thanks!

    2. – 1000000

      1. Be interesting to know what you think is wrong with that.

        1. -10

    3. Very good post.

      Free markets are not only the most efficient economic systems they are also the most moral.

      How quickly I see people abandoning principle on the feeble excuse that perfection is not possible.

      International trade and markets are nothing more than the choices of millions of individuals. Each one acting for their own reasons. If we do not object to further erosion of our liberty to buy and sell as we see fit then there is no point in libertarianism at all.

  2. “Economic reality is always more complex than politicians pretend it is.”

    Or that magazine ideologues pretend it is.

    “It has always puzzled me that anyone would believe that protecting the U.S. market with tariffs is a good idea.”

    Of that I am not surprised. Anything more complex than “needz moar corporate profits” befuddles Reason writers.

    Maybe if they had read more Adam Smith. He favored tariffs to offset local taxes on production:

    “It will generally be advantageous to lay some burden upon foreign industry for the encouragement of domestic industry, when some tax is imposed at home upon the produce of the latter. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former. This would not give the monopoly of the borne market to domestic industry, nor turn towards a particular employment a greater share of the stock and labour of the country, than what would naturally go to it. It would only hinder any part of what would naturally go to it from being turned away by the tax into a less natural direction, and would leave the competition between foreign and domestic industry, after the tax, as nearly as possible upon the same footing as before it.”

    1. Taxes are usually a necessary evil to have a government run society.

      Income taxes, tariffs, sales taxes, fees, fines, corporate taxes, payroll taxes, etc. all do effectively the same thing- give government revenue to spend.

      The key is to keep a tiny and limited government so the tax burden is kept to a minimum. We currently have a bloated Nanny and Police State.

      1. Reason: Free trade is when American workers pay payroll and income taxes, while Emperor Xi pays no tax on exports to the US.

    2. Living standards were far lower in the 18th and 19th than the present day—the reason why we have such high standards of living today is because of increased international trade and the subsequent division of labor and specializations of new industries. Because of increased free trade in the last century is the very reason why you enjoy your cheap electronics etc. Why this is so difficult for so called libertarians to grasp is a mystery.

      1. the reason why we have such high standards of living today is because of increased international trade and the subsequent division of labor and specializations of new industries.

        The West became wealthy long before trading with totalitarian regimes like China. The real source of wealth in the West is scientific progress and free markets within Western societies.

        1. Obviously scientific progress in the West plays a part in its advanced societies and overall high standards of living. No one is disputing that. The data overwhelmingly points towards the negative effects of increased tariffs, you can argue all day long about Trump being ahead of the game lalala whatever, but he is merely utilizing tariffs like his predecessors that had the same negative effects on the economy. Show me the evidence that these tariffs are helping and not hurting soybean farmers, the steel mills, the lobster industry etc. I’ll totally agree once you present the facts.

          1. Show me the evidence that these tariffs are helping and not hurting soybean farmers, the steel mills, the lobster industry etc.

            Tariffs have the primary effect of increasing the price of Chinese goods, reducing US consumer spending (on Chinese goods), transferring less money to a hostile, totalitarian regime, and generating revenue for the US government. All of those are good things as far as I’m concerned.

            I neither know nor care what the effect on soybean farmers, steel producers, or the lobster industry is; those industries have benefited massively from subsidies and regulatory capture, and even if tariffs now cause them to lose a little money, they’ll just have to live with it.

      2. Living standards in the USA in the 18th and 19th centuries was better than most other countries and mercantilism was very prevalent.

        While I agree with you that increased free trade is a reason for greater American wealth. Another reason is that the USA has not had its wealth decimated by war or nationwide natural disasters.

        Free trade is fantastic is all trading partners agree to that foundation. Currently, Communist China, the EU, Canada, Mexico, etc do not agree to free trade.

        1. There is not a single nation on the planet that completely adheres 100% to a free trade policy. However, the countries that provide a more open market and lower taxes/tariffs are more prosperous. Ireland, Luxembourg, Hong Kong, Switzerland, Singapore etc. That is what many of you aren’t grasping, sure you can argue that “well there is no free trade policy anywhere on the planet” ok, so your solution is protectionism? Clearly the economy is far more intertwined internationally with supply chains and multinational companies that arguably some of which aren’t tied to any one country due to multiple locations.

          1. ” Ireland, Luxembourg, Hong Kong, Switzerland, Singapore ”

            Small tax havens cashing in on corporations making profits in countries with higher taxes and declaring their profits in the tax haven. The strategy can’t be universalized.

            1. It cannot be universalized but those competitive strategies can be utilized the US. Duh.

        2. Actually living standards were quite miserable up to around the turn of the century. It wasn’t until the 20th century that life expectancy exponentially increased and economic standards improved to the point where a middle class was sustainable.

          1. It wasn’t until the 20th century that life expectancy exponentially increased

            Well, until effective hygiene & antibiotics became widespread.

        3. “Free trade is fantastic is all trading partners agree to that foundation. Currently, Communist China, the EU, Canada, Mexico, etc do not agree to free trade.”

          I dispute Reason’s idea that purchasing from foreign slavers like Emperor Xi makes for “free” trade as long as the tariffs are 0%, as I dispute generally that enriching Emperor Xi has no downsides.

          1. Free trade with China doesn’t just benefit XI and his cronies, it has increased prosperity for billions of Chinese thus putting pressure on the Communist Party.

            1. We’ve *decreased* pressure on the Communist Party by collaborating with them to deliver growth to China. That growth has increased their credibility with the Chinese people, not decreased it.

              It’s a decreasing rate of growth that is a threat to the Communists. Their growth rate has been declining over the long term. Still about double ours.

      3. Free trade, eh? You mean the very thing Trump is trying to increase, by employing tariffs as leverage to get every other country in the world to finally be as open to trade as the US has been?

        “There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. To judge whether such retaliations are likely to produce such an effect, does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles, which are always the same, as to the skill of that insidious and crafty animal vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.”

        – Adam Smith

    3. Maybe if they had read more Adam Smith. He favored tariffs to offset local taxes on production:

      “It will generally be advantageous to lay some burden upon foreign industry for the encouragement of domestic industry, when some tax is imposed at home upon the produce of the latter. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former. This would not give the monopoly of the borne market to domestic industry, nor turn towards a particular employment a greater share of the stock and labour of the country, than what would naturally go to it. It would only hinder any part of what would naturally go to it from being turned away by the tax into a less natural direction, and would leave the competition between foreign and domestic industry, after the tax, as nearly as possible upon the same footing as before it.”

      This doesn’t seem to be a very good defense of tariffs in general. He’s basically saying that if a government is dumb enough to impose a tax on its own industry, it should impose a tariff on foreign industry to level the playing field.

      Wouldn’t the ideal solution be to NOT tax domestic producers in the first place, so that you don’t have to put a tax on foreign goods and make consumers suffer even more?

      1. Yeah, sure. And you should feel free to continue theoretical pontifications to your heart’s delight, but you need to also face reality and the real world. So, once all domestic taxes are abolished, then you’ll have a point.

        1. And you should feel free to continue theoretical pontifications to your heart’s delight

          I’ll concede that point. If a government can’t levy taxes in some fashion, there is no government.

          However, I’ve never seen Trump use that as justification for his tariffs. I’ve never heard him say that his tariffs are meant to offset the taxes that we levy on our own products. So I doubt he got his inspiration from Adam Smith.

          “….This money will come from the massive Tariffs being paid to the United States for allowing China, and others, to do business with us. The Farmers have been ‘forgotten’ for many years. Their time is now!” – DJT

      2. “Muh anarchy”

        States cost money.

        If you’re going to tax, our inverted scheme of high taxes on local production and low taxes on foreign imports is the *opposite* of what the US did in it’s rise to superpower status.

  3. If a bartender from the Bronx with no formal training in meteorology knows enough to control the climate of the entire planet, surely controlling the economy of one single country can’t be that difficult.

  4. “Economic reality is always more complex than politicians pretend it is.”
    This is just as true for PhD. economists.

    1. +100

  5. Veronique de Rugy, Ph.D.,

    I didn’t know that they give out Ph.D’s in propaganda.

    Boehm, Sullum, Welch, and Gillespie must be still working on theirs.

    1. Pr.D.’s

  6. But these duties also create massive market distortions and malinvestments, which often backfire against the very industries that are ostensibly being protected.

    You know what else creates massive market distortions and malinvestments? The debasement of the currency, quantitative easing, massive government and private borrowing, welfare spending, burdensome regulatory regimes, and Keynesian stimuli. And what kinds of distortions do they create? Among other things, massive consumer spending, in large part on Chinese-made consumer goods, large numbers of Americans leaving the labor force, and abnormally low savings rates. None of those government policies are going to change any time soon, and neither is the massive government debt. To criticize tariffs, essentially a minor consumption tax, on the basis that they “distort the market” is absurd, since, to the degree that they do anything at all, it is to alleviate some of the bad consequences of existing bad government policy.

    In other words, you are treating the already badly distorted US and Chinese markets as if they were a desirable free market outcome being distorted by new policies, but that view is divorced from reality.

    In practical terms, the fact that tariffs make consumer goods more expensive in the US and yield government revenue is a feature, not a bug. If only they did more of that. To the degree that that seems to lower standards of living in the US, that’s a consequence of the fact that Americans are borrowing slightly less against the future of their children when they are prevented from consuming excessively.

    1. +100

    2. “In other words, you are treating the already badly distorted US and Chinese markets as if they were a desirable free market outcome being distorted by new policies, but that view is divorced from reality.”

      Bravo!

    3. Maybe we should specify that what causes the really problematic market distortions in the way of tariffs is protectionism rather than just a simple levy on all imports.

    4. “You know what else creates massive market distortions and malinvestments? ”

      Taxes on labor.

      Reason: Free trade is when American workers pay payroll and income taxes, while Emperor Xi pays no tax on exports to the US.

      1. +1000

  7. Good article.

  8. “It has always puzzled me that anyone would believe that protecting the U.S. market with tariffs is a good idea. ”

    Your imbecility could be mitigated by taking up the topic with Adam Smith.

    https://nationaleconomicseditorial.com/2018/07/28/interview-adam-smith-tariffs/

    “But these duties also create massive market distortions and malinvestments”

    So does all other taxation. Yet tariffs can create good incentives and investments, too. The big problem here is this offhand reference to the “market,” which only exists as an elaborate construct, and this reference implies that there is a perfectly uniform construct that has been imposed upon the entire globe. That’s ludicrous, of course.

    What should be puzzling to anyone with a three digit IQ is just how stupid we’ve been to think it’s a good policy to burden our own domestic industry with prohibitive taxation and labor, environmental, and other regulations, and then let the products of industry from third world slave labor and Communist nations waltz in freely through the back door.

  9. “as opposed to real market signals”

    Again, this reference to the “real market” is doing all of the work, but it is pure nonsense, a reference to absolutely nothing.

    “As a result, prices of steel went down quite dramatically.”

    Funny how, if steel prices are up, that’s proof of the disaster of Trump’s tariff policies. And if steel prices are down? Again proof of the disaster of Trump’s tariff policies. Funny!

    “they failed to recognize the global economic slowdown and the subsequent reduction in overall demand. As a result, prices of steel went down quite dramatically. That’s what we economists call malinvestment”

    Well, it sounds like the problem was a failure to project demand, not the tariffs. Surely, the steel producers should be smart enough to recognize the distinction between overall market demand and rising market share driven by cost barriers.

    1. Surely, the steel producers should be smart enough to recognize the distinction between overall market demand and rising market share driven by cost barriers.

      Even if they can make the distinction, what should be their response? Not invest in more steel production capacity, so when the slowdown comes, they don’t have any malinvestment (unusable production capacity)? But if they don’t invest, then they only make more money, not more steel: it becomes a pure wealth transfer from domestic consumers of steel to domestic steelmakers. The domestic consumers of steel simply pay more, but get the same as before.

      1. Not only that. Both factors create uncertainty. Supply and demand factors are one thing. Betting on a trade war and what the president or premiere of China may choose when he wakes up tomorrow is another. What is happening is political not merely economics.

        1. What is happening is political not merely economics.

          Of course: I was analysing a political operation’s (steel tariff’s) economic effect.

      2. “it becomes a pure wealth transfer from domestic consumers of steel to domestic steelmakers. ”

        No. First of all, Canada, Mexico, Australia, Brazil, Argentina, and South Korea are not subject to the steel or aluminum tariffs. So there is zero protectionist effect vis a vis all of those countries. Second, the U.S. has placed industry at a disadvantage in all kinds of ways through taxation and regulation. So, while it is a wealth transfer to the government just as all taxation is, it is one that helps to balance out very harmful effects of other government policy.

        Why Free Trade Doesn’t Work: an Allegory

        You own an artisanal bakery that makes the best $2 baguettes in town—business is booming. In fact, business is so good that a German bakery opens up across the street. You’re not worried: their $3 baguettes are good, but not that good. You’re sure you can out-compete them in good ol’ American fashion—and let’s be honest, who’s ever heard of German baguettes?

        A month later you notice baguette sales are down. Why? You walk across the street to compare sales with the German bakery, and you see a sign: “Baguettes Now $1”. How could they possibly afford to bake such cheap baguettes? The lederhosen-clad owner tells you that the government is paying for his flour—that’s why his baguettes only cost $1. “That’s not fair!” you exclaim. “What can I say?” he replies………..

        Read the rest: https://nationaleconomicseditorial.com/2018/10/16/free-trade-doesnt-work-allegory/

    2. The trade war is partly responsible for the global economic slowdown.

  10. “U.S. steel was often too expensive, not the right type or quality, and needed a serious reshaping of the industry that had too many inefficient producers.”

    Exactly. And what we are seeing now, and what we should hope will succeed, is that very reshaping that was needed, and it was prompted by tariffs.

    1. Yes more government intervention is what industry requires in order to generate needed reshaping.

      It would actually be more efficient to have government simply order the reshaping directly rather that fooling around with these half measures.

      1. Managed trade is managed trade.

        Trump offered free trade to our trading partners and was refused.

        1. Trump offered free trade to our trading partners and was refused.

          So? That’s their loss; Trump still ought to get rid of all US tariffs (i.e. introduce free trade unilaterally).

          Trump identifies with his voters who crave protectionism.

          http://emilkirkegaard.dk/en/wp-content/uploads/Bryan_Caplan_The_Myth_of_the_Rational_Voter_WhyBookos.org_.pdf

          1. Do you find it strange that every other country just shoots themselves in the foot, according to your view? Why can’t the US just send around a memo from our brilliant economists, to the Europeans and others? Then everyone would realize they’ve just been harming themselves all along, right?

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