Tariffs: a recipe for a supply-side chaos and higher inflation

Peter Warburton - 28 June 2018

Donald Trump is not the first US president in recent times to seek to appease a tiny constituency of workers with punitive import tariffs. The presumption of the aggressor in a trade battle is that the potential for welfare gains greatly exceeds the potential for welfare losses. Yet, the reflective studies of both the Bush steel tariffs in 2002 and the Obama car and truck tyre tariffs in 2009 do not bear out this optimism. The reason that aggressors typically back down is that the economic welfare losses become obvious, painful and cumulative, rather than as a reaction to a slap on the wrists from the World Trade Organisation.

Worse, these disputes leave a bad aftertaste that sours relationships for years. Rescinding a punitive tariff does not restore the status quo ante. In the same way that the liberating multilateral trade rounds of the 1960s, 1970s and 1980s built trust and fostered new trading relationships, the erection of new barriers to trade inflicts reputational damage for the country concerned that extends far beyond the narrow sector context.

Peak starry-eyed optimism about the world trade order may well have been around 2007, when long, thin supply chains stretched around the globe and auto manufacturers tendered for the supply of parts on a lowest cost basis, almost regardless of country origin. The global financial crisis put a stop to that fantasy, as credit conditions tightened and supply chains ruptured. While there appears to be more of a compromise between cost, reliability and robustness in post-crisis supply arrangements, the replacement of vertical integration (big firms owning or controlling their supply chains) by horizontal integration (rival firms dependent on the same vector of suppliers) is highly significant for the impact of tariff increases.

The option of switching from a tariff-impeded foreign source of supply to a domestic producer is in most cases a non-option.  There is no domestic producer with the capability to substitute, like for like, quality for quality, size for size what is currently purchased abroad. The supposed welfare gain from raising the tariff barrier turns out to be a massive own goal, raising the input costs for a broad swathe of domestic industries and the retail prices for consumers with little offsetting benefit to the protected industry.  The 2012 Petersen Institute study of the impact of the tyre tariffs found that “the additional money consumers were spending on tyres meant that they weren’t spending on other retail items”, subtracting the equivalent of 3 times the number of retail jobs as the number of manufacturing jobs that were saved. The inflation impacts are clear from figure 1.

On the most favourable reading of the outlook, president Trump will relent within 12 months and his punitive tariffs will be withdrawn. However, even on this scenario, there is to be expected an ongoing welfare loss that all nations must share.  Quel dommage.

Figure 1

Sources: Gallup, Trevor Williams Consultancy

Figure 2

Data source: Thomson Reuters Datastream

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