Tariffs

It appears increasingly likely that the new US Administration is going to apply import tariffs quite broadly.? Although there are numerous competing narratives emanating from people presumptively close to Mr Trump, the moral of his first term is that until he actually makes a decision, competing suggestions from acolytes posing as surrogates should be taken with a large dose of salt.

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For my part, I view the promise of tariffs as a means to an end, to whit Mr Trump's ability to finance his aspirations for an extension of his first-term tax cuts.? To do this he will be compelled to use the reconciliation process (there is no chance of him obtaining 60 votes in the Senate for a blatant giveaway to the ultra-wealthy and corporate interests) and he will need some amount of revenue to supplement the inevitably meagre cuts he is likely to be able to make to federal spending.? Hence the desire for broad-based tariffs as a source of offsetting new revenues.

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Naturally, I may be completely off the mark.? Mr Trump has also spouted a good deal of hot air about the salutary benefits of tariffs to our economy (they will be paid by our overseas partners, they will trigger a wave of investment in the US etc) and it's worth thinking through the logic of these possible impacts on our economy, since regardless of motive tariffs are probably on the way and they may have a wide range of consequences.

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Let's start with who pays the tariff.? For the most part, goods we import are characterised by normal margins with little room to cut prices, or else they are commodities traded in (and with a meaningful degree of access to) global markets.? Think of agricultural products, white goods, auto parts, ores, gas and crude oil.? For most of these imports there simply isn't room to cut prices 20% (assuming the US import tariff is set at 25% of the import price) so as to maintain a constant US price.? An exception could be Canadian crude oil, whose exports are limited by pipeline capacity, and associated refined petroleum products, since it's hard to move these products to Atlantic and Pacific ports.? Canadian gas may also have limited options, although the dependency of the US on these commodities in the Midwest and Northwest does offer some leverage to Canadian producers.

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So at the firm level, most exporters to the US will be unable to offset the impact of tariffs and prices in the US will rise or supply will be curtailed (meaning that products that are available will attract a scarcity premium and rise in price).? To offset this, exporting nations can seek to devalue their currencies relative to the dollar, and if tariffs are applied very broadly this is a likely eventuality.? Except the US will experience this as a stronger dollar, which will have the perverse consequence of damaging US exports and in any event is unlikely to please Mr Trump, who in the past has railed against "currency manipulators" about as much as he has lauded a strong dollar.

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To make matters worse, tariffs will provide an unwelcome fillip to domestic inflation leading to tighter money (this will also tend to raise the global value of the dollar).? And since in many emerging markets debts are dollarised, there will be a painful impact on the global poor and a further decline in purchasing power (meaning even less ability to import from the US) for these less fortunate countries.

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Then we need to consider the retaliatory consequences we face as a leading global exporter of goods and services.? While Colombia may have rolled over quickly in the face of US threats, it is unlikely the EU or China will be so pliable, and even second-tier powers like Canada, Japan and the UK will be unlikely just to sit back and accept Mr Trump's fiat.

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It's also important when the tariff schedule is published to look at the fine details.? Auto production has been widely reported to involve sometimes several back-and-forth border crossings between the start of build and the finished product.? A casually-imposed tariff may therefore tax the components of a vehicle several times as well as the finished product, leading to higher effective tariffs on this kind of product than the headline rate.? And since a 25% tariff is already a huge price premium on imported vehicles (the current average US new car price is around $40,000) demand is sure to suffer in the mid-market segment, especially with interest rates also higher.

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But what about capital investments?? Will capital inflows help balance the economic pain we will need to bear from a broad tariff regime?? Yes, but not immediately and there are important caveats:

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First, bear in mind that if overseas manufacturers want to invest in the US, they need to purchase dollars.? Thus the demand for dollars will rise and the currency will appreciate.? And our current account deficit will widen at least initially.? This effect is of course contrary to one of the stated intentions of tariffs, which is to reduce imports.

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Second, consider the complexity of manufacturing.? In the late 1970s and early 1980s the UK lost most of its domestic car manufacturing industry thanks to a combination of under-investment, atrocious management, assertive and obstructive trade unions, and finally the high interest rate regime ushered in by Margaret Thatcher.? The UK has since recovered its auto industry but almost all production is by foreign-owned companies.? Whatever organisational skills the British firms possessed were lost in the collapse of the domestic industry and could not simply bounce back.?Manufacturing organisations, especially where technology is an important component of the product portfolio, are inherently complex systems.? What this means in the context of the US is that we are likely to need foreign firms to invest in many sectors, and their profits and dividends may become a permanent outflow widening our current account deficit.

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Third, there is the practicality of finding enough skilled workers.? US unemployment measures leave something to be desired but we are close to full employment and seem about to drive out large numbers of undocumented immigrants currently performing many arduous, hazardous and low wage roles (think meat packing or industrial agriculture).? Low wage jobs are just not suited to the US (this is why illegal immigrants fill these roles far more than citizens) yet high wage manufacturing jobs demand skills that for many workers either have atrophied or were never present.? I, for one, would not know how to operate a CNC machine, for instance.? This is a soluble problem given time and investment in skills development but as yet, not much has been said about this.

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Obviously, with time and sustained investment we can rebuild more of our manufacturing base and tariffs could help this process, but it will likely not be a swift change and we will surely need to support workers transitioning into new manufacturing roles.

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In sum, widely deployed tariffs are unlikely to deliver a rapid rebirth of US manufacturing (and manufacturing employment), whereas they are likely to trigger higher inflation, higher interest rates, and a stronger dollar.? None of this will matter whatsoever to the billionaire class that stands to benefit from an extension of the 2017 tax cuts, but the average American is probably going to be worse off in the event of widespread tariffs, and the average Trump voter is likely to feel a disproportionate amount of economic pain.? As ever in politics and in life, caveat emptor.

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