Debunking Trump's Tariff Justifications, Part 2

National Security

Among the justifications for the lates tariffs, the Trump Administration asserted national security. “If the U.S. wishes to maintain an effective security umbrella to defend its citizens and homeland, as well as allies and partners, it needs to have a large upstream manufacturing and goods-producing ecosystem. . . Increased reliance on foreign producers for goods has left the U.S. supply chain vulnerable to geopolitical disruption and supply shocks.”

As we learned in the COVID-19, reliance on foreign supplies of goods was a problem. This was particularly the case with companies that relied on China manufacturing facilities after China shut down many of these factories on public health grounds. Many generic pharmaceutical drugs were only manufactured in China and were affected by factory shut downs. Similarly, at a time when stay-at-home orders resulted in a massive increase in demand for electronic devices such as laptops that depend on semiconductors, a drought in Taiwan caused a decreased production of these semiconductors by TSMC.

So are the Trump tariffs critical to the onshoring of the manufacturing of products critical to national security? Count me skeptical.

As a starting point, it is important to note that the Trump tariffs apply to all foreign goods, and thus any national security justification does not come close to justifying the massive tariff increase. The vast majority of goods that we import are not strategically important. We don’t have, and don’t need, a National Strategic Reserve for Barbies, sneakers and tee-shirts, and as painful as it would be, our Nation can survive shortages of these items. That is likely true of almost every good we import.

Even as to those items that are indeed critical to our national defense, the case for tariffs is weak at best. As a CATO Institute analysis noted, “the manufacturing industries most closely associated with “national security” (e.g., metals, transportation, defense, computers and electronics, pharmaceuticals, and medical goods) have prospered.” This is because the goods most critical to national defense are high margin items that were less likely to be offshored than low margin items like textiles and paper. As the CATO Institute analysis noted:

By contrast, the industries that are most closely tied to national security—including those now prioritized due to COVID-19—have not experienced significant historical declines and in most cases have expanded. (See Table 5.) This category includes the goods directly involved in national defense (e.g., tanks, missiles, and munitions), as well as those indirectly related, including metals, computer and electronic products (including or excluding semiconductors), motor vehicles, aerospace products, ships medical equipment, energy, chemicals, and pharmaceuticals. Although certain sub-industries’ output has risen and fallen over different periods (to be expected given business cycles, changing U.S. military operations, and other factors), the overall picture is one of stability and health, not decline.

As the COVID-19 pandemic taught us, however, there are some goods for which we had been too dependent on production in China or in other areas of geopolitical risk. For example, China is the sole source of about 20% of active pharmaceutical ingredients used in drugs used by U.S. consumers. Similarly, the U.S. computer and electronics industry had become highly dependent on semiconductor production by TSMC in Taiwan. While this production is currently safe, it is at serious risk in any Chinese attack on Taiwan.

While these are indeed critical vulnerabilities, there are better solutions than tariffs. The problem with tariffs is that they impose increased costs on U.S. consumers. This is particularly a problem for products such as semiconductors that are components in other products made in the U.S. A tariff on semiconductors will only make U.S.-made products that use the chips much less competitive on the global market.

For these critical products facing unacceptable geopolitical risk, there are better tools. In many cases, no government action is required. The market will adjust once the over-dependence issue is identified ensure that there are diversity of sources of the critical material. As a result of the pandemic issues, for example, Apple diversified its production outside of China, with new facilities in India and Vietnam.

Sometimes government action is needed. The key is to use incentives that will offset the higher cost of building and operating a facility in the United States. During the pandemic, for example, the Department of Defense used its Defense Production Act authority to invest $1 billion over five years in companies that would build domestic biomanufacturing facilities.

The most prominent example of government action is the bipartisan CHIPS Act that, through a combination of tax credits. loans and subsidies, has incentivized the building of advanced semiconductor fabs in the United States. According to an analysis done by Semiconductor Industry Association and the Boston Consulting Group, “the United States will triple its domestic semiconductor manufacturing capacity from 2022—when the CHIPS and Science Act (CHIPS) was enacted—to 2032. The projected 203% growth is the largest projected percent increase in the world over that time.” I represented both Intel and Infinera in their CHIPS Act grants, and just these two companies alone will be building new fab facilities in California, Oregon, Arizona, Ohio, Pennsylvania and New Mexico as a result of the CHIPS Act. The CHIPS Act can be a model for other areas where increased domestic production is deemed critical to national security.

I get that the CHIPS Act can criticized as “corporate welfare.” It is indeed a taxpayer subsidy of private enterprise. The justification is the subsidy is vital to ensuring a domestic capability that would otherwise be located overseas because of cost, but it is a subsidy nonetheless. Make no mistake, however—a tariff is no less a subsidy than a grant. A tariff allows a domestic producer of a product to sell at a higher price and thus a higher margin. This effectively subsidizes the private company. The difference is that the tariff subsidy is paid for by consumers, not the government, with a resulting distortion to the market that will hurt U.S. competitiveness. A direct subsidy can be more targeted to the capability needed. It can also ensure accountability so the subsidy is given if promises are kept.

So does national security justify the tariffs? Not by a long shot. We largely have the domestic capability we have better tools to increase capability than tariffs.