The Reality of Tariffs

I hate tariffs. Anyone in our office can confirm that. Or anyone I know for that matter. I firmly believe that tariffs are an economic evil, second only to communism. Today I will lay out the problems with tariffs when they are employed for the long term. The last part of that statement is important – more on that later.

Tariffs distort prices and undermine consumer sovereignty. Tariffs make imported goods more expensive, encouraging consumers to buy potentially less desirable domestically produced substitutes. This disrupts the market’s ability to reward competitive producers. Tariffs make imported goods more expensive, encouraging consumers to buy domestically produced substitutes, even if they’re inferior or cost more. Tariffs encourage retaliation and trade wars. Tariffs often provoke retaliatory measures from trading partners, escalating into mutually harmful trade conflicts. This creates a "lose-lose" scenario, reducing global trade volume and prosperity.

Tariffs ignore the seen vs. unseen effects. Protecting a domestic sugar industry, for example, might save 1,000 jobs but raise food costs for millions of consumers and harm indigenous manufacturers. Tariffs also disrupt market driven innovations. In the 1980s pressure from Japanese auto manufacturers forced American auto manufacturers to innovate and produce a better product. Tariffs would have prevented this from occurring.

I could go on…and on…but this covers the basics of why tariffs are counter-capitalistic and foolish. Here are the very basic pros and cons.

There is No Free Trade

It’s true. Free trade in its pure form does not exist. While many countries have made significant strides towards reducing trade barriers, there is no actual free trade. Here are 10 factors that prevent the realization of completely free trade:

1. Tariffs and Quotas:
   • Most countries still maintain some level of tariffs or quotas on certain imports.
   • Example: Even under the USMCA trade agreement, the NAFTA replacement that Trump negotiated in his first term, Canada maintains quotas on U.S. dairy products.
2. Non-Tariff Barriers:
   • Regulations, standards, and bureaucratic procedures can act as de facto trade barriers.
   • Example: Differences in food safety standards between the EU and US.
3. Subsidies:
   • Government support for domestic industries can create unfair advantages in international markets.
   • Example: Agricultural subsidies in many developed countries.
4. Currency Manipulation:
   • Some nations are accused of artificially devaluing their currency to boost exports.
5. Intellectual Property Issues:
   • Disputes over patents, copyrights, and trademarks can impede free trade.
6. Political Considerations:
   • National security concerns or domestic political pressures often lead to trade restrictions.
   • Example: U.S. restrictions on certain Chinese tech companies.
7. Preferential Trade Agreements:
   • While these reduce barriers among member countries, they can create disparities with non-members.
8. Environmental and Labor Standards:
   • Differences in regulations can create uneven playing fields for international competition.
9. State-Owned Enterprises:
   • Government-owned companies may receive unfair advantages in international markets.
10. Digital Trade Barriers:
    • Restrictions on data flows and digital services are emerging as new forms of trade barriers.

While world trade has become more free since World War II, true free trade remains an ideal rather than a reality. Most international trade operates under managed trade systems with varying degrees of openness.

This is Trump’s Plan (I hope…)

Big, beautiful tariffs are not a winning long-term economic strategy. But that isn’t what Trump has in mind, hopefully. The president is using tariffs as a short- to medium-term lever to bring tariffs and other trade barriers down.

For example, on April 2 a host of reciprocal tariffs will go into effect against countries that have standing tariffs on US goods. By their nature, these tariffs will match the tariffs in place on our goods. Ideally this will cause tariffs to ease or be eliminated. If not, it will at least be a “fair” alignment.

There are also new 25% tariffs on Canada and Mexico. These tariffs contain many provisos and carve-outs for the automotive industry and other goods already covered by USMCA. New Mexican tariffs are being used as a lever to get more action out of Mexico on securing their side of the border against illegal immigration and narcotics. Although the White House insists the goal of tariffs against Canadian goods is to curb the inflow of fentanyl, the focal point with Canada is likely its quota system.

Canada levies quotas on several U.S. goods, particularly in the dairy, poultry, and egg sectors, as part of its supply management system designed to protect domestic producers. These quotas limit the amount of certain goods that can enter Canada tariff-free; imports exceeding these limits are subject to high tariffs – often exceeding 200%. This is why Trump is threatening Canada with a 200+% dairy tariff.

What about China? It seems that Trump considers no tariff too large for the world’s leading manufacturer and global rival of the US. This will, as stated above, drive up the cost of goods and drive down profits of companies manufacturing in China, as cheaper goods are selected over theirs. Trump isn’t out to wallop manufacturers or American consumers (I hope…). Instead he wants to re-domicile as much manufacturing as possible. Why? For very good reasons. There is an economic concept called the manufacturing multiplier effect. Here is how it breaks down:

1. Supply Chain Impact:
   • For every $1 spent in manufacturing, an estimated $1.82 is added to the economy through related activities.
   • Manufacturers require raw materials, components, and services from other industries, stimulating demand across the supply chain.
2. Job Creation:
   • Manufacturing jobs support employment in other sectors like transportation, warehousing, and professional services.
   • For every direct manufacturing job, an estimated 2.5 additional jobs are created in other sectors.
3. Innovation Spillover:
   • R&D in manufacturing often leads to innovations applicable in other industries.
   • Advancements in manufacturing processes can improve efficiency across various sectors.
4. Export Boost:
   • Manufacturing accounts for a significant portion of U.S. exports, bringing in foreign currency and supporting jobs in trade-related services.
5. Local Economic Support:
   • Manufacturing facilities often become economic anchors in communities, supporting local businesses and services.
6. Wage Effects:
   • Manufacturing jobs typically offer higher wages, increasing consumer spending power which benefits retail, hospitality, and other service sectors.
7. Technology Adoption:
   • The manufacturing sector often leads in adopting new technologies, driving demand for IT services and high-tech products.

This multiplier effect underscores manufacturing's role as a key driver of broader economic growth and development. Currently the US is the second largest manufacturing economy by output. Manufacturing accounts for about 11.3% of America’s GDP.

This, I hope, is Trump’s plan: Only enacting short- to intermediate-term tariffs that, in the end, result in lower tariffs and trade barriers globally for the long term.

The Worst-Case Scenario

The worst-case scenario is that Trump believes the US can tariff itself to prosperity. We can’t. No nation can. If this is the case, financial markets will continue in turmoil for the foreseeable future. This will derail his agenda and likely cost the GOP control of Congress in 2026.

The modern world in the grips of 19^th century mercantilist trade policy.

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