The Case For And Against Tariffs

Adam Smith, the famous Scottish economist of the 1700’s, is considered the father of modern economics. His main contributions were his theories of the specialization of labor, promotion of the profit motive and minimal government intervention in the economy. He believed that the specialization of labor would result in lower costs, the profit motive would incentivize efficiency, and the economy would benefit from limited government involvement by its connection to robust markets. His conclusion was that unconstrained markets would enhance the lives of individuals and society. Thanks largely to the impact of United States trade policies over the past 80 years that embraced Smith’s concepts, the result has been the explosion of global trade and the commensurate expansion of growth and affluence throughout the world.

President Trump’s affinity for tariffs is not new – it can be traced back to statements he made in the 1980s. He has argued that nations have been ripping us off for years and that tariffs would level the playing field. According to President Trump, this unfair trade advantage that has created a trade deficit has caused a significant decline in domestic manufacturing. He is convinced that not only will tariffs increase domestic manufacturing and create new jobs, it will enhance national security by manufacturing critical goods vital for our defense. He also contends that the revenue raised by tariffs will reduce our federal deficit and offset the lower taxes that would result from the proposed tax law currently being legislated in Congress.

There are numerous counter arguments against the imposition of tariffs. The President has asserted that companies rather than the American consumer will absorb the additional costs resulting from tariffs. There is no evidence that this is the case as US companies such as Walmart have already selectively raised prices. While some companies with high profit margins may be able to withstand price increases, other firms with smaller margins have no choice but to raise prices to avoid going out of business. Rising inflation, reduced consumer spending and a recession are likely outcomes. While increasing domestic manufacturing seems like a lofty goal, the fact is that only 8% of the American labor force work in manufacturing and, as Larry Summers has pointed out, half or 4% work in finance and marketing. Furthermore, because of the 3-5 year time frame and expense necessary to build a plant, manufacturers are unlikely to respond favorably to a muddled outlook of the economic future before making such a commitment. Finally, since most of the high paying jobs in the US are in the service industry, there is an open question of who would be willing to work in lower paying manufacturing jobs.

Trade deficits should not be regarded as a competition between nations but rather viewed in the context of net benefits to each. The lower cost of goods manufactured in a country and exported to another provides consumers with more purchasing power. It allows countries with more advanced and expensive products to concentrate on those they specialize.

This trade off benefits both countries. Furthermore, trade surpluses by other countries are often cycled back to the United States in the form of investments. In fact, these investments often narrow the gap between the domestic shortage of savings/investments and represent a significant facilitator for our continued economic growth.

The financial impact on the United States from a slow down in global trade could be profound. The recent turmoil in the financial markets could be a precursor of events to come. Foreign demand for United States government debt will decrease resulting in higher interest rates and exacerbate our federal deficit. Even worse, the status of the United States dollar as the reserve currency of the world could be threatened as nations abandon the dollar for other currencies, perhaps even crypto.

As I prepare this newsletter, only the United Kingdom has reached a deal with the United States while others apparently are in the works. However, this agreement is misleading since we actually have a trade surplus with the United Kingdom. While some economists such as Peter Navarro are wildly optimistic about the positive impact of tariffs, most are not and the prosperous economic future forecast from tariffs as advanced by the Trump administration is problematic at best.

Sincerely,

Clifford L. Caplan, CFP^®, AIF^®