I love the analogy one of the news anchors on CNBC used to describe recent trade wars:
“Trade wars are like parents fighting each other over divorce to get a better deal for oneself. However, they forget, in the process their children, who they care about the most end up suffering.”
If you’re wondering what the anchor meant, he was describing the two nations haggling over the trade and tariffs as parents and corporations or businesses as their children. What I love about the quote is it sums up really well the frustration of United States based corporations over their disrupted global supply chain.
Since Trump assumed office in 2017, he has constantly accused nations and trading partners of taking an unfair advantage of the United States. He blames huge trade deficit with China, illegal immigrants from Mexico, steel imports from South Korea, BMW and Audis from Europe, and milk subsidies from Canada responsible for squandering manufacturing jobs in the US. While Trump has succeeded to some extent playing the appeasement politics, he clearly has ignored the economic ramifications of his actions.
The thinking is that US can ride out a trade war better than other nations. Politics isn’t my forte, so I would refrain commenting on the politics of trade wars, but I do like to point out how this thinking is not only backward but also economically flawed.
It is not new to any one that basic economy is governed by supply and demand for a given set of goods. There’s always an optimal price and quantity, Q and P in the figure shown, at which we can reach equilibrium i.e. supply meets demand for the given price and given quantity.
Now, let’s put World Supply in the context. Let’s say China can produce the same product at a price P1 (< P). Say this product is an LCD TV, and it costs $400 (=P) to manufacture in the US, whereas China can manufacture it in say $250 (=P1). This lower price then would cause our supply demand curve to shift. Since TV is much more affordable to American consumers now, they are more likely to buy one. This decrease in price will increase the quantity consumed to Q2.
Here comes the interesting part; adding tariffs to the mix. Say the government has decided to add 20% tariff to all the TVs imported to the United States. This will increase the price of TV for retail consumers to $300 (=P2). Of course, increase in price will reduce the demand, and hence, retailers will only be able to sell say Q3 (< Q2) number of televisions. American consumers who would have bought a TV at $250 would now have to shell out $300, which still is lower than $400 – the cost of manufacturing a TV in the US.
Source: Research Gate
So, will tariffs help save American jobs?
In the short run, may be. In the long run, probably not. This would make sense, if price per unit after adding tariffs and extra shipping cost makes it more attractive to manufacture TVs in the US. However, in reality, the wage rate difference in most cases is such that even after adding 15-20% tariffs, it still is cheaper to manufacture most electronics in developing economies. A study by Peterson Institute of International Economics (PIIE) claims that Trump’s steel tariffs have raised the price of steel products by almost 9%, creating 8,700 jobs in the US steel industry. However, steel users pay a whopping $650,000 for each job created!
But wait a minute… what about revenue generated from tariffs?
If you’re still with me, you would have asked yourself what happened to the money we got after levying the tariffs? You’re right.
In this scenario, government will collect $50 in revenue on each of the imported TVs. Additionally, our Consumer Surplus will decrease although Producer Surplus will increase. However, even after taking into account the revenue generated from tariff, we lost the revenue generated by increased sales as shown in two pink triangles (societal loss). In economics, it is commonly known as deadweight loss.
If you want to learn more about deadweight loss, checkout this Khan Academy video. It does a great job explaining just that.https://www.linkedin.com/embeds/publishingEmbed.html?articleId=7583536898397877085
So, are tariffs good or bad?
Well, answer, as always, is not as straightforward; Good for some, bad for most; Mostly bad.
It is good if you worked at TV manufacturing facility and lost your job because of influx of cheap TVs from other countries. It is bad for American consumers who couldn’t buy a TV earlier, but now can because of decreased prices. Overall, as a society, economically, it is BAD. According to economists, free market trade is mutually beneficial for both the parties involved. It is imperative to understand, what may not be good for a specific set of individuals should not be confused with overall disadvantage to the country. Fantastic content creators at Crash Course helps explain that with a superb video.https://www.linkedin.com/embeds/publishingEmbed.html?articleId=8171820634765422249
In fact, US made similar mistake in 1930s by levying Smoot-Hawley tariffs, which exacerbated the economic depression, if not started it. If history has told us anything, it is that tariffs can do more harm than good.
So, what can we do instead?
US should focus on retraining people affected to align their jobs in what makes most economical sense given the inherent technological advantage it already has. For example, rather than re-establishing TV or steel manufacturing plants, US should focus on selling high-tech things such as pharmaceuticals, jet turbines, generators, aircrafts, and military equipment. This will not only help keep wages high for the workers but also won’t require them to work as many hours to maintain the required efficiency. Simply put, it is completely fine to import steel from Beijing, electronics from Seoul, or clothing from Bangladesh. In fact, we should be thankful to people who are willing to work 14 hours a day in dreaded working conditions, so that we can buy cheap electronics and clothes from Walmart or Target.
All in all, tariffs may be good for a handful of producers but at whose expense?
You guessed it ….
American consumers and taxpayers.
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