Donald Trump walks back on his tariff threat as markets tank, industry pushes back: Why his tariff plan is unsustainable

The exemption from the proposed duties applies to goods shipped under North America’s free trade pact, the US-Mexico-Canada agreement (USMCA) , which Trump signed during his first term. On Tuesday, Trump had imposed 25 per cent tariffs on both Canada and Mexico, as well as an additional 10 per cent tariff on China. Beijing was slapped with an initial 10 per cent tariff last month, while both Canada and Mexico were able to successfully negotiate for a one-month delay. But if economic logic is to prevail, the Trump administration will have to roll back most of these tariffs in the due course. Here’s why:

The structural issues with the American economy

The US economy relies heavily on trade, and that’s part of its structural construct in the post World War-II era. This is because the American economy consumes more goods than it produces domestically at full employment. As a result, its imports are almost always higher than its exports, resulting in a trade deficit.

Why is that so? When a country consumes more goods than it produces domestically, it needs to source the additional goods from other countries through imports. And that is resulting in a high trade deficit – the gap between what it buys from other countries and what sells to them.

This trade deficit is a point of contention for Trump, which he’s used as the trigger for the imposition of tariffs on countries around the world. But what this simplistic assumption glosses over is the fact that till the time America consumes more than it produces, it will have a deficit with a lot of countries. This is also triggered by the fact that the labour costs in America are high, and so it does not merit economic logic for US workers to be producing this efficiently in the country, like say garments or consumer durables. So, other countries that have relative efficiencies in these sectors, primarily due to labour or raw material advantages, are more effective at producing these goods and shipping them to the US. The evolving labour productivity issue, and a shift of comparative advantage to developing nations explain the loss in manufacturing jobs in the US, and tariffs are unlikely to fix that fundamental issue. Plus, the role of the US dollar as an international reserve currency – another enduring post-war reality – has actually helped America finance domestic consumption of imported goods. The US, in that aspect, has a comparative advantage that no other countries have. And other nations would also be well within their rights in looking at this currency advantage enjoyed by the US as a discriminatory trend, just as Trump eyes the trade deficit as a discrimination “suffered” by the US. Also, the pretext used by Trump – fentanyl inflows – is also specious, especially when it comes to Canada, given that America’s northern neighbour accounts for less than 2 per cent of all fentanyl inflows into the US.

Mostly personal, not much economic logic here

For a man who is generally fickle with his views, tariffs are an issue where Trump’s been uncharacteristically consistent. In 1987, long before he voiced any intention to run for public office, Trump took out a full-page newspaper ad warning that Japan was “taking advantage” of the US, while pointing to the massive trade deficit between the two countries. Like most things with Trump, this was essentially a personal issue, which likely stemmed from the fact that the real estate developer had, just a few days prior to these ads, lost out on a bid for a grand piano in New York to the representative of a Japanese trading house. His views on tariffs have endured through these years, even though there is very little economic logic to the imposition of large scale tariffs by a country like America.

Mis-selling tariffs

Trump has consistently insisted that tariffs are paid for by foreign countries. This hardsell, has resonated within his base, but is blatantly false. It is, in fact, US importers — American companies or representatives of foreign companies in the US — that end up paying tariffs when these goods come in, and this money goes to the American Treasury. These companies, in turn, generally pass their higher costs on to their customers in the form of higher retail prices. That is one reason why tariffs fell out of favour as global trade grew after World War II and economists maintain that consumers end up footing the tariffs bill. Yes, tariffs can impact foreign countries by making their products pricier and harder to sell abroad, but there is collateral damage on both sides.

For instance, Canada and Mexico have announced retaliatory tariffs against American imports. That would matter to Washington, since Canada is its single biggest market, bigger than the UK, France, Japan and China put together.

The European Union has also hit back against Trump’s tariffs on steel and aluminum by taxing US products, from Harley-Davidson motorcycles to bourbon. China has imposed tariffs on American goods, including soybeans and pork to dent Trump’s agri support base.

A study by economists at the Massachusetts Institute of Technology, Harvard University, the University of Zurich and the World Bank concluded that Trump’s tariffs in his last term neither raised or lowered US employment. Despite Trump’s 2018 taxes on imported steel, for instance, the number of jobs at American steel plants was barely impacted. On the other hand, the retaliatory taxes imposed by China and other nations on US goods had “negative employment impacts,’’ especially for farmers, the study found. These retaliatory tariffs were only partly offset by government aid that Trump was forced to dole out to farmers, partly funded by the incremental revenues raised by the tariffs.

The auto, agri blowback

US tariffs, and the retaliatory duties that they’ve triggered, would upend two crucial segments of Trump’s voter base. Auto workers and farmers.

Over the last quarter of a century, the American cars industry has worked with policymakers to create an integrated supply chain with Canada and Mexico. Some parts of a car sold in the US are made in Canada, others in Mexico, and quite a lot are made in the US. A typical pickup truck made by the big three US auto majors – GM, Ford and Chrysler – moves back and forth across borders because of this integrated supply chain – sometimes up to seven times across the three borders. Now, with higher tariffs, each time an auto part moves, it will get tariffed. The price for an F-150 pickup truck, according to industry estimates, could go up from $10,000-$12,000 for a car that retails at around $45,000-$70,000. So, now, while the North American car industry will be at a disadvantage, those who benefit could include the German car industry, the Korean car industry or the Japanese car industry, because those cars come into America tariff free, at least till now.

What’s even more contradictory is the fact that it was Trump who replaced the North American Free Trade Agreement trade deal between the US, Canada, and Mexico with the new USMCA deal during his first term in 2018-19. Trump’s imposition of tariffs on Canada and Mexico now flagrantly violate his own USMCA, and highlight his disregard for negotiated trade agreements. Why should any other country get into a tariff deal with Washington when the US president himself does not adhere to a deal he himself signed. That’s a question being asked across many capitals, including New Delhi.

Also, China and the EU have been targeting American farm goods with higher tariffs, in surgical fashion. That would be particularly discomforting for Washington, going forward.

Broader macroeconomic impact

The radical economic outlook presented by Donald Trump prior to the elections includes plans to impose a 20 per cent tariff on all imports and more than 200 per cent duty on cars; a proposal to deport millions of irregular immigrants; and to extend tax cuts at a time when the US budget deficit is at record high. Trump, however, realises that he came to power on account of unrest among a section of American consumers about high inflation and their standard of living not having gone up as per expectations. His tariff war could only fuel this fire. In quantum terms, a 10-20 per cent tariff is really high for a country that has a weighted average tariff of only about 2.2 per cent.

Higher tariffs and a trade war would most certainly lead to higher inflation in the US. This, combined with runaway deficits and a possible dilution of institutional autonomy could lead to foreigners beginning to rethink whether they should lend unlimited money to the US Treasury — which has been a given thus far — analysts say. Such a shift could mark a possible watershed moment — of the scale, perhaps, of the decision in early 2022 to freeze Russian foreign assets, which forced central banks around the world, including RBI, to buy physical gold rather than derivatives or exchange-traded funds that track the yellow metal’s price. The US Federal Reserve’s decision to continue its rate-cut cycle depended strongly on the result of the presidential election — and experts believe that the full scale of the cycle may now be at risk. While Trump’s promised tax cuts and tariff barriers could end up stimulating the American economy, at least in the short term, analysts predict they could eventually stoke inflation — and likely force the Fed to end its rate-cutting cycle sooner.

That could have implications for the monetary easing plans of other countries, including India.

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