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Anything that inhibits trade, in the long run, results in lower prosperity for everyone globally.
Tariffs, between the U.S. and its trading partners, represent one of the worst forms of taxation for several basic reasons. As explained in last week’s column, tariffs are taxes – taxes that are paid for by the consumer. When tariffs are placed on goods imported from China or Mexico, those tariffs are paid by American consumers and collected by the U.S. Treasury.
Tariffs destroy demand. For most of the goods being consumed, raising the price means the volume of goods purchased will decline. If fewer imported goods and services are being purchased by American consumers, then the businesses producing those goods and services will be less prosperous and employ fewer people. In short, tariffs kill jobs in the country the goods and services are being produced. It would be easy to say, “That is great! Why should we care about somebody living in China or Mexico?”
Certainly, the leaders of the United States should make the best interests of its citizens a priority, but 95 percent of the world’s consumers live outside the U.S. With the world’s largest domestic economy, the U.S. is the world’s largest importer of goods from other countries, but the U.S. is also the world’s second-largest exporter of goods to other countries (second only to China). U.S.-developed (and still proprietary) fracking technology has already upended the global energy markets. As the U.S. has gone from a net importer to a net exporter of oil, and exportation of oil and natural gas continues to grow, the U.S. could become the world’s largest exporter within a decade. Open markets work in the country’s favor. It has been estimated that free trade improves the standard of living for the average American family of four by $12,000 a year. If we want to sell our goods and services to other countries, we cannot institute protectionist policies.
Unfortunately, the current trade disputes are destroying trading relationships that took years to build and replacing them with mistrust and acrimony. As we raise the cost and the difficulties of trading with us, many of our trading partners are moving from a “We love doing business with the U.S.” point of view, to a “We have less interest in doing business with the U.S.” perspective. Even if they still want to do business with the U.S., to the extent that the lower volumes of goods we have purchased from them has destroyed businesses and jobs in their economy, they will be less able to afford to buy goods and services from us. Acrimonious trade relations create greater friction in multiple ways (speed of clearing customs/getting through the border, additional and ancillary regulations, lower reliability/raised risk of doing business), all of which result in lower prosperity for both the importing country and the exporting country.
Tariffs are not only taxes; they are regressive taxes, for two basic reasons:
- Since many of the goods imported, from economies with low-cost labor, are basic living materials, raising their price by 25 percent is a much larger burden to those in the lower income bracket. Example: the cost of a cell phone represents a larger percentage of a low-income consumer’s disposable income than it is for a high-income consumer. If you are making $40,000 a year and pay $1,000 for a phone (a phone that goes up in price to $1,250 including the tariff), you are paying a far larger percentage of your disposable income toward this tax than a consumer making $500,000 a year. Not only are tariffs a regressive form of taxation, the rate at which they are regressive accelerates/becomes increasingly more regressive on lower income levels.
- To the extent that the cost of the imported goods rises as a result of tariffs, other goods become more expensive/represent an even larger percentage of the remaining disposable income that a low-income consumer has left. Even if a consumer has committed to buying all other goods from producers in the U.S., the amount of those goods they can afford is less.
A little history lesson…
As our country was being founded in 1776, Adam Smith published “The Wealth of Nations,” which further established his place in history as the ‘Mozart’ of economists. Smith created the concept of the ‘invisible hand’ as he argued that competition in free markets is the most efficient way to allocate resources. He argued that not only do regulations on free markets not work, they are almost always counter-productive.
A little over 200 years later, as Ronald Reagan and Art Laffer were proving that lowering marginal tax rates dramatically stimulates the rate of economic growth, they relied on the wisdom of the ‘Quincy Jones’ of economists, Milton Friedman. Friedman championed, and expanded on many of Smith’s principles concerning free markets. For Reagan’s goal of shrinking the Federal Government, Friedman provided intellectual support and comic relief (“If you put the Federal Government in charge of the Sahara Desert, within five years there would be a shortage of sand.”). In his book ‘A Monetary History of the United States, 1867 – 1960,’ Friedman outlined why the recession of 1929 “might have been a garden-variety recession,” but instead became the Great Depression because the Smoot-Hawley Tariff Act of 1930, which instituted high tariffs (of ~18 percent to 20 percent) on imports into the U.S., killed global trade.
Following World War II, the creation of the International Trade Organization (ITO) and the dramatic reduction of the Smoot-Hawley tariffs (through the creation of the General Agreement on Tariffs and Trade, or GATT), produced the opposite result. The United States expanded its markets after World War II by helping to rebuild all of the countries that had been destroyed by war (Japan and Germany are shining examples of this). In addition, those actions arguably introduced a middle class for the first time into many of the world’s economies, which was responsible for pulling billions of souls out of poverty in the decades that followed.
The bottom line
Open markets are good for everyone, and while negotiating fair trade deals makes sense, raising tariffs (which are regressive taxes on U.S. citizens) does not. Whether you look at airfreight volumes, railroad volumes or truck freight volumes, the economy worldwide has dramatically slowed and the ongoing trade disputes have significantly raised the risk of a recession both in the U.S. and globally.
Stay tuned…