Ten Ways a Trade War Could Impact the Economy and Other Dubious Economic Choices by World Leaders
The incoming US President looks to join an elite club of iconoclastic world leaders intent on rewriting economic orthodoxy. He is promising to turn conventional thinking about trade policy on its head by placing blanket import tariffs on goods arriving from our largest trading partners in pursuit of both economic and, here’s the twist, geopolitical gains. For those not in the know, a tariff is a charge, generally targeted, that national governments levy on imported goods to protect domestic industry from “unfair competition.”
Tariffs have been a common tool of trade policy for centuries to address specific trade issues, but the breadth of what is being promised today hasn’t been seen in the US since the catchily monikered “Smoot-Hawley Tariff Act” of 1930. Passed after the stock market crash and economic crisis of 1929 it was intended to protect American farmers from foreign competition and was (spoiler alert) famously unsuccessful, leading to a cascading global trade war that dragged the American domestic economy even further down, and played its part in putting the Great into the Great Depression of the 1930s. But if you cannot do something similar and expect a different outcome then you are clearly fake news.
But before we detail how tariffs impact the economy, let’s shout out to several other modern visionary political leaders who have challenged economic orthodoxy, for the US President is in interesting company here. Turkish President Tayyip Erdogan recently upended conventional logic around interest rates, operating on the belief that high interest rates serve to stoke inflation and not curb it, as orthodox economists contend. Thus, he ordered significant interest rate cuts by the Turkish Central Bank in response to high inflation, the result of which was (spoiler alert) even higher inflation, compounded by significant currency devaluation. The policy was ultimately reversed, but he still gets part marks for trying to make an impact as an economic theorist.
Perhaps the most dynamic current member of the club of iconoclasts is Argentinian President and “anarcho-capitalist economist” Javier Milei who took charge of the chronically chaotic Argentinian economy one year ago. While not rewriting orthodoxy per se, he deserves his place here for his remarkable zeal in its application, behaving like the IMF on amphetamines (International Monetary Fund – renowned for forcing harsh cuts in government spending on countries requesting economic bailouts). Promising to break the back of triple-digit and climbing inflation, he has taken a chainsaw (mostly metaphorical) to a bloated public sector, slashed consumer subsidies, and moved government accounts into surplus for the first time in many years. Currently, only partway through his experiment, he appears to have successfully curbed inflation and stabilized the currency without losing popularity despite the severity of the cuts (perhaps showing what a mess the country was in). It now remains to be seen if he can pull off the, potentially even more difficult, back-half of his miracle by digging the country out of the resulting recession, spiking unemployment, and steep rise in poverty rates that his ultra-tough love approach has provoked.
Special mention should be made of the fleeting Prime Minister of Britain, Liz Truss, who tried to join the club of economic innovators by upending the existing precarious relationship between government service obligations, revenue, and debt. She intended to administer a “growth shock” to the economy by instituting significant tax cuts without offsetting decreases in spending and without identifying how the gap between obligations and revenues would be bridged - all while sidestepping traditional institutional safeguards against such “reckless” behavior. The result was (spoiler alert) that the debt markets reacted extremely negatively, government borrowing costs surged, the currency plunged, the Bank of England had to intervene in the bond market, and the Prime Minister found herself out of a job. All within the life span of a head of lettuce (inside joke for Economist readers).
But enough celebrating the dubious choices of world leaders and back to tomorrow’s trade war, and ten ways tariffs on imported goods impact the (domestic) economy:
1. Tariffs provide immediate revenue to the government, although this declines as imports decline.
2. Tariffs increase the price and decrease the supply of imported goods to consumers and industry, putting upward pressure on inflation.
3. Tariffs can benefit domestic industries and jobs in the short term by sheltering them from foreign competition.
4. Tariffs push consumers toward these sheltered domestic substitutes, in sectors where they exist, as they become more price competitive and foreign products become more expensive and scarcer.
5. Tariffs can also push up the cost of these domestic substitutes to the extent that they face the increased costs and decreased availability of imported inputs, putting upward pressure on inflation and downward pressure on economic growth.
6. Tariffs provide sheltered domestic substitutes with greater scope to increase prices in the absence of foreign competition, putting upward pressure on inflation.
7. Tariffs work to shrink the overall size of the economy as tariffs by one country generally lead to retaliatory tariffs by others, decreasing exports and overall world trade.
8. Tariffs work to shrink the overall size of the economy by limiting consumption due to increased costs all around.
9. Tariffs work to reduce innovation in the economy as sheltered industries face reduced competitive pressures that spur innovation.
10. Tariffs negatively impact consumers through cost-of-living increases, contributing to a wealth transfer from consumers to the government and sheltered industries.
Note: Tariff impacts on consumers may be mitigated indirectly and unequally to the extent the government returns tariff revenues to consumers via domestic tax cuts, with benefits depending on the amount and targeting of the cuts, and with the overall ability to cut taxes constrained by slower economic growth limiting the available tax base.
Welcome America to the club of unorthodox economic innovators, where no idea is too daft, and no action too audacious. Only time will tell how this new protectionist turn will end should it come to pass as advertised, but if history is any guide (spoiler alert)…