Making Sense of the Current Trade Conflicts

Through a combination of free trade agreements and globalization during the 20th century, firms and consumers could obtain nearly any good or service they desired, without worrying about cost-prohibitive taxes or tariffs on international commerce. That assumption became a little shakier on March 8, 2018, when President Trump issued Proclamations 9704 and 9705, which instituted a 25 percent tariff on steel and aluminum imported into the U.S. With some notable exceptions (Mexico, Canada, and Australia), the tariff hits our geopolitical allies and enemies alike, and they have all retaliated in their own ways. More recently, the Trump Administration removed trade preferences for India, and that country too has hit back with its own trade barriers against the U.S.

For Tuck associate professor Emily Blanchard, these are heady times. As a trade economist who closely studies how foreign investment and global value chains are changing the role of trade agreements in the 21st century, her expertise is especially relevant today as businesses and individuals struggle to make sense of the escalating trade wars instigated by the U.S. That, in part, motivated Blanchard to write “Trade Wars in the Global Value Chain Era,” an accessible primer on the reasons why the current trade conflicts are especially dangerous, given the fragmentation of the global supply chain. The piece is a chapter in the free Vox e-book, Trade War: The Clash of Economic Systems Endangering Global Prosperity, which is available to download here.

Below, Blanchard answers some questions about the recent trade actions and highlights some of the most important points from her piece.

Why has the Trump Administration started these trade wars?

Candidly, it’s not clear. The administration has offered a series of justifications for various trade actions, some of which make more sense than others. Most conspicuously, the president has said repeatedly that new tariffs are in part to address trade imbalances, to get rid of the current account deficit. But that’s just silly. The current account deficit is determined by the difference between national saving and national investment—so unless tariffs cause us to save more or invest less, they’re not going to make a dent. (And think about it—investing less and saving more both reduce economic activity. History shows us that recessions are a great way to reduce the current account deficit, but I don’t think that’s what the president is hoping for.) So while tariffs aren’t going to eliminate the trade deficit, they are upsetting our trading partners. And as trade tensions and battles escalate, we may see higher tariffs on our exports of goods—and especially services—that are the mainstay of U.S. businesses. Worse, since U.S. exports are concentrated in thriving industries, the trade war is jeopardizing U.S.-based companies with high profits and high wages.  

What can we glean from the president’s statements, regarding motivations for new tariffs?

An alternative justification for the tariffs is that they’re actually designed to give the U.S. greater leverage in trade negotiations. This makes more sense, but it’s still an expensive and risky strategy with so many U.S. businesses and workers on the line. In some cases this may work— for example, by threatening tariffs, some trading partners like Brazil and South Korea offered to “voluntarily” reduce sales of steel to the U.S. (To be clear, this raises costs to U.S. consumers and the many U.S. manufacturing firms that use steel as an input to production. But if the goal is only to increase prices of steel in the U.S. for the benefit of U.S. steel producers: mission accomplished.) But this is also getting out of hand. For instance, when the president threatened to slap across-the-board tariffs on Mexico because he wanted Mexico to keep Central American asylum seekers from entering the U.S., the threat upended the norms and rules of the system of global trade cooperation that the U.S. has built and led for the past 70-plus years. The president has been weaponizing trade in a way that may have long-lasting consequences for global governance.  

Is the president justified in any of his concerns about trade?

Well sure, and it’s important to give the president credit for diagnosing some legitimate problems. For example, China is expropriating (implicitly and explicitly), intellectual property of U.S. and foreign firms. That’s a violation of the norms of international commerce, if not the explicit rules. He’s not the first to recognize and try to address the issue, but he’s really called it out. (The Obama and Bush administrations also had deliberate strategies to try to change China’s behavior, not least via the Trans-Pacific Partnership, which the Trump administration scuttled in 2017.)

He’s also implied that, since the end of WWII, the U.S. has been a global leader through global governance initiatives and the Marshall Plan, and deliberately left a lot of gains on the table for other countries to share in. The U.S. strategy was to build a liberal world order based on rules, norms, open markets, and a set of American values. Now Trump’s actions seem to be saying, We’re bigger, so we should get all the benefits. More cookies for us: less for the world. America First. So if we had written an agreement where everyone was winning, maybe we should be winning more. While I think his premise is correct—the U.S. did stop short of pushing its trading partners to the wall in each and every negotiation—I’m concerned about the implications of this new tack, for the world, and for us. I worry that the president doesn’t appreciate the mutual gains from our existing trade agreements. He often argues that other countries will be worse off if we don’t have these agreements, but that the U.S. will be better off. He’s thinking of trade as a zero-sum game, as if it’s a real estate transaction. And it’s just not. What would be correct to say is: without this agreement we’ll both lose. Other countries may lose more—especially if they are small—but there is no doubt that we’ll lose too.

What are the fundamental points of your chapter on trade wars in the global value chain era?

The first thing to know is that the way we make things in the world is different today than it was in the time of Adam Smith, David Ricardo, or even when the GATT (General Agreement on Tariffs and Trade) was signed in 1947. The president seems to be thinking with that very mercantilist mindset, which is decidedly unhelpful, if not dangerous. The fact of the matter is there’s really no such thing as an “All-American” firm that hires only American workers, uses only American machinery and capital and inputs, has only American investors and then sells its products as exports to the world. At the same time, our imports are not coming from fully foreign entities. A lot of what we import was made by U.S. firms, funded by U.S. investors, using inputs and ideas from U.S. workers and then assembled abroad. Putting tariffs on “foreign” goods means implicitly taxing all of the U.S. capital, labor, ingenuity, and industry that go into making products around the world. This complex reality means trade wars today are profoundly expensive in three ways:

1. The Nature of Tariffs
   
   First, because tariffs are applied to the gross value traded, not the net value added at the last step of the production chain, a tariff is added on the gross value of something every time it crosses a border. With globally fragmented production, where you have products crossing borders many times and adding bits of value at each stage in the production chain, those tariffs accumulate. Suppose a product crosses a border 10 times during the course of production. That means a tariff is paid on each component of the product up to 10 times! Research shows us that consumers end up bearing the lion’s share of these tariffs in the form of higher prices. The last estimate I saw is that U.S. consumers as a result of tariff actions since 2018 are paying around $500 more per household, per year. That’s huge.
    
2. Firms will respond to higher costs and risks
   
   If tariff costs are magnified with global production fragmentation, firms will respond accordingly. Maybe they won’t produce by having goods cross borders 17 times. Maybe they’ll decide to make their products right next to consumers in the U.S. and hire American workers to do it. That’s one possibility, and the one the president seems to be hoping for, but it’s not the only possibility. Firms are going to do the math, and if they think these tariffs are going to continue, they’re going to start consolidating their value chains somewhere, but not necessarily here. Maybe it will be closest to the natural resource, or wherever the workers are the cheapest.
   
   Or maybe they’ll double down on the safest places to do business. And this is among the top risks for the U.S., because one of the biggest costs of these tariffs is also the hardest to measure: the increase in uncertainty. If firms don’t know what the rules of the game are going to be, they can’t manage the risks of investment, innovation in new designs, reaching new consumers, and finding production efficiencies. The more erratic our economic policy becomes, the more a multinational firm might start to second guess its investment in a U.S. division. Globally-engaged firms might choose to avoid the risk of the U.S. political whims. The fear is that America-first could backfire, since firms can change their behavior in ways that are not easy to predict.
    
3. Tariff costs and benefits will be shared in complex ways
   
   With production fragmentation, who ultimately bears the cost of the tariffs is more complex and more diffuse. The cost of U.S. tariffs can come back on the U.S. in unexpected ways. The cost on consumers is real. Recent estimates suggest U.S. consumers are bearing the vast majority of the costs of the recent tariffs. For something like washing machines, recent estimates suggest that U.S. consumers are bearing 100 percent of the tariff cost. So Chinese exporters are doing just as well as before, and U.S. consumers are paying higher taxes. Part of what this is saying is that the world is big: if Chinese exporters can’t sell to the U.S., the vast majority of the world’s population is not in the U.S., so they can sell somewhere else.
   
   Who shares in the cost burden of the tariff overseas is more complicated because of the supply chain. Suppose the U.S. puts a tariff on shoes from Vietnam. A lot of those shoes are sold by Nike. So people who own Nike stock are paying some of that cost. Suppose you make the rubber sole in South Korea; you’re paying part of the cost. And there’s a benefit we can forget. The benefit of the tariff is for U.S. import competing firms, like steel manufacturers. But not all of the benefit stays in U.S. hands. A lot of U.S. domestic car production is done by foreign firms using foreign capital and investment, and foreign supply chains. So you take the Subaru Outback, which is completely assembled in the U.S, with an engine made in Japan. So the tariff is really good for Japanese engine producers supplying Subaru. We don’t keep 100 percent of the tariff protection; a lot of it is going outside the country.

For more insights, read Emily Blanchard’s “Trade Wars in the Global Value Chain Era.”