Debunking Trump's Tariffs Part 3

Reciprocity

I have previously posted on two justifications for the massive Trump tariff increases: Moving Manufacturing to the US and national security. This post will focus on a final justification “a lack of reciprocity in our bilateral trade relationships, disparate tariff rates and non-tariff barriers, and U.S. trading partners’ economic policies that suppress domestic wages and consumption, as indicated by large and persistent annual U.S. goods trade deficits.”

As explained below, there is indeed a lack of reciprocity in many of our bilateral trading relationships, but they don’t justify the massive—and economically incoherent—tariffs proposed by Trump.

As an initial matter, regardless of the merit of the policy concern, almost all economists and trade experts agree that the way the Trump Administration actually determined its “reciprocal” tariffs is, well, simply bonkers and illogical. The calculation was simple. As the BBC summarized: “take the trade deficit for the US in goods with a particular country, divide that by the total goods imports from that country and then divide that number by two.”

There are myriad problems with this formula. First, it completely ignores service imports and exports. Given that the U.S. benefits from a huge trade surplus in services (and largely in high margin businesses like financial services), the formula distorts the actual trade imbalance. This is important—while Canada has a trade surplus in goods with the U.S., the U.S. actually enjoys a trade surplus when you include services.

Second, a particular nation’s trade surplus with the United States typically has little to do with that country’s trade policies. This is particularly the case with small poor countries. These countries often have a trade surplus with the United States because they are too poor to buy much of the high end products the U.S. exports. The Washington Post gives the example of tiny Lesotho, that might suffer a huge 50% tariff because of its trade imbalance with the U.S. Why the trade imbalance? Lesotho has a significant clothing and textile industry for many major U.S. brands, but is too small and poor to import much from the U.S. Another example, is Madagascar, which produces 80% of the world’s vanilla. It is facing a 47% tariff because of the large vanilla exports to the US. The imbalance in both case has nothing to do with trade restrictions.

This is true of our trade imbalances with even large industrial countries. For example, our goods trade imbalance with Canada is driven largely by our import of oil from Canada. A full 61% of our imported oil comes from Canada. Why do we import so much oil from Canada? As Ed Conway explains our refineries were designed for heavy oil found in Canada rather than the lighter oil now being produced in the United States.

So even if think we need to adjust the tariffs to account for unequal tariff and non-tariff trade barriers, the tariffs originally proposed by Trump simply didn’t make sense.

So is there an imbalance in either tariff or non-tariff restrictions that merits attention? The short answer is yes, but the unfairness does not justify the massive Trump tariffs, and there are larger U.S. economic interests at stake that will be put at risk.

Let’s look at tariffs first.

As you can see, the U.S. average tariff rate for the US is about the same as our major trading partners. In looking at this chart, it is important to note that it is the weighted average, which means it takes into account not only the actual tariffs, but on the product mix imported into each country. What appears to be a disparity may simply reflect the different goods imported by each country, rather than the underlying tariffs. A higher weighted average may mean only that the country imports more items that have higher tariff rates, and not unfairness in the rates themselves.

Accordingly, given that these are weighted averages, the take-away from this chart is that US tariff rates are roughly equal to Japan, EU, Canada, China and the UK, but are much lower than tariffs in countries like India and Brazil. Still, there are many examples of unequal tariffs once you drill down to specific products. Until the Trump Tariffs, the EU tariff on cars was twice that of the U.S. India, for example has a staggering 101% tariff on cars, which is much higher than the U.S.

Non-tariff restrictions can be even more specific. These include health and sanitation restrictions, inspection requirements, labeling requirements, and outright prohibitions on the importation of certain goods. While some restrictions might be motivated by protectionism, others reflect different policy judgments on regulatory matters. The E.U. for example, has extensive regulations on genetically modified food (whether imported or not), which has large impact on U.S. agricultural imports.

So what is going on with these various tariff and non-tariff restrictions? The answer is pretty straight-forward. In a word, politics. Most of our trading partners are Democracies and, like all democracies, politically powerful groups can affect trade policy. Rice farmers in Japan have been successful in advocating for restrictions on rice imports to Japan. Farmers in may E.U. countries have been successful in imposing limits on imports of many food items.

And the U.S. is not immune for these political pressures. The U.S. sugar industry is notoriously successful in getting Congress to impose restrictions on sugar imports to the U.S. The Jones Act shields the U.S. shipbuilding industry from any foreign competition. And thanks to lobbying decades ago (by industries that have largely disappeared in the U.S.), there are quite high tariffs on many footwear and textile products compared to other products. (A canvas shoe, for example, faces a whopping 68.5% tariff.)

Because trade barriers are the result of domestic politics, getting other countries to change their restrictive policies can be very challenging. Even a high tariff on the E.U. is unlikely to open up agricultural markets if it means farmers will hold demonstrations that will shut down France—as they did last Fall in response to a fairly modest South American trade deal.

Given these realities, U.S. trade policy has focused on measures that are hugely important to the U.S. economy, while still politically feasible. Given the importance of service exports, the U.S. has been very successful in ensuring that U.S. financial service and professional service providers have access to important U.S. markets. Our banks, investment firms, engineering firms and even law firms can be found across the globe as a result. In addition, given the importance of Intellectual property to the U.S. economy, there has also been a focus—with great success—in ensuring the protection of patents and other intellectual property rights. This has been particularly important to high margin industries such as luxury goods, software, high technology and pharmaceutical companies.

So will the threat of the Trump tariffs open up foreign markets to U.S. companies? Perhaps, but count me skeptical. I suspect that there may be modest adjustments in some tariffs, but ones that might have occurred anyway. The EU, for example, has long been hinting that they would be willing to reduce tariffs on U.S. cars. And some of the poorest countries may be willing to make huge concessions of tariff rates to avoid devastating pain, but concessions that will result in little new trade opportunities for U.S. companies—because these countries are, after all, poor. And, we already seeing some countries proposing increased purchases of U.S oil and gas—largely because these imports won’t impact any domestic industries—that might have occurred due to market conditions anyway.

I doubt, however, that we will see significant changes—such as the opening of EU agricultural markets—for the very simple reason that making these concessions are politically impossible. And there is a downside to the aggressive Trump posture: our hard fought gains on IP and services could be at risk if the Trump Administration is unsuccessful in its negotiations.

So how should we address the trade imbalances in tariffs and non-tariff barriers? We learn from history. Its a slog, but the year-in and year-out discussions with our trade partners over the years has resulted in meaningful opening of service markets and increased protection if our IP rights. They have also made some progress with high tariff countries such as India. Incrementalism seems to work.