Ahhh… Tariffs (sigh)

I grew up in Ecuador, in the 80s, at a time where foreign trade was terribly restricted.  Both imports and exports were controlled by the Central Bank, and there wasn’t a free floating currency.  Heavy tariffs were applied to “protect” local industries, while certain imports were outright banned, because they would result in a flight of foreign currency.

In the early 90s, Neo-liberalism took ahold of the economy, and it was liberalized.  The Sucre was allowed to float – not quite freely, but freeishly: upper and lower bands, with a small gradient that would allow for a maximum and minimum level of devaluation (a phenomenon referred to as ‘a snake in a tube’).  Imports were open, and you could buy a plethora of foreign products.  Although tariffs were still in place, the economy looked a lot more open.

The beauty of free trade:

Anybody who is a free-market advocate such as me, would agree that free trade between countries allows for market forces to set prices, and let supply and demand take care of business.  Some of the benefits of global free trade include:

1. Lower prices. A company doesn’t need to manufacture all products in one country, but can split manufacturing into different countries, and make a really big manufacturing plant in one country that supplies one product to the rest.  This is called economies of scale.
2. Sourcing optimization. Allows different components to be made in different countries (whether it’s proximity to the raw materials, skilled workforce, or cheap labor), and then put it together in a different location
3. Tax optimization. With free trade, companies can sell from a lower tax environment.  This translates in lower or no sales tax for buyers, as well as better corporate tax rates for companies.

I could spend the rest of the article spilling the beans about why unrestricted trade, with unregulated markets, and minimum taxation and government intervention is ideal… but we can leave that for another post.

So, what’s the catch:

While unrestricted trade helps companies lower their costs which translates into lower prices for consumers and also helps develop countries by creating a workforce, it has a flip-side: Countries like Vietnam, Cambodia, Bangladesh, etc. have developed largely since clothing companies started manufacturing abroad.  But, for every job created in the developing world, one was lost in the developed world (this ratio can be as high as 10 to 1)  This has led to manufacturing being severely hindered in the US and virtually disappearing in countries like the UK.

Another problem is government interventions in the form of subsidies.  Government subsidies have long been the main reason for WTO arbitrations in the past decade.  If a government subsidizes a company or industry, it could affect peers and competitors locally and abroad.

Finally there is dumping.  Dumping is the practice of selling goods below cost to disrupt a market either by obtaining an unfair placement, or by driving away competition.  Some instances of state sponsored dumping (in the form of subsidies) can last for a long time, making it impossible for companies who play by free market rules to compete.

A president that keeps his promises!

Donald Trump’s election campaign promises included protecting the local industries (coal mining, manufacturing, and steel mills).  And after over a year of keeping his promises, he’s done it again.  Can you believe the nerve on this guy? who does he think he is keeping his campaign promises like that?  I guess after a long history of presidents ditching their campaign promises as soon as they took (Oval) office, it is hard for the public to fathom the fact that Mr. Trump is like no other president (American or otherwise), and that he is planning on making good on his campaign promises.

Among these promises are protecting the manufacturing sector, coal industry, oil and gas (in order to make America energy independent), reducing regulation and red tape (I can write something on the impending reversal of Dodd-Frank.  Leave a comment if you would like to read about it). etc.

Tariffs never work

We are now looking at tariffs added to steel and aluminum imports.  These might generate further tariffs on American products abroad.  In the end of the day, tariffs never work, and this is why:

Country A and Country B are apple producers.  A has thousands of acres devoted to the growth of apples, uses the latest technologies, is efficient, and the apples are cheaper and tastier than in B, they sell for 100.  B’s apples are smaller, less tasty, and because B cultivates them in a haphazard way, they are more expensive, and sell for 125.  Customers in B prefer to import the cheaper, higher quality apples from A, than to buy the local apples.  B’s apple growers are going bust, so they ask the government for help, and the government applies a 100% tariff on A’s apples.

Apples from A still cost 100, but B’s residents can purchase them for 200 (100 + 100% tariff), while the B produced apples sell for 125.  So, logic tells you that the average apple eater will pay 125 for the local produced apples, and if they want to treat themselves they will splash out on an import.

Reality works different: B producers figure that all competition from abroad is priced at 200, which means that anybody willing to buy an apple should be prepared to pay that, so they hike their prices up to 200 (or 195 if you will, to keep the price competitively).  So apples became more expensive in country B, and the consumer ended up footing the bill.  This drives inflation, and if more imports were affected with tariffs, then the aggregate effect in the economy.  Big loser? The people in B.

There are though, examples where heavy protectionism works, like Switzerland.  A heavily protected milk and beef industry, that seems to thrive.

I agree with many of President Trumps policies to date, but I have to say… tariffs isn’t one of them.  History has taught us that tariffs will always come back to haunt you.