Man of steel

The leader of the free world, who prefers to communicate his outbursts on Twitter, once again sent shockwaves trough the networks of global politics. At the beginning of March Trump used his presidential power to impose protectionist tariffs on steel and aluminum imports. Brazil and the European Union already announced plans to counter the President’s move, meanwhile Russia is still outlining a response according to their official communication. China and Canada also voiced their disagreement. Europe’s stance on this matter is particularly interesting. As a direct motive is absent since the EU’s steel and aluminum exports to the US are marginal, it appears that the Union rather acts as a champion of free trade solely based on its political and economic agenda.

Misunderstood issues

It is not the first time that Trump’s opinion turns out to be false. Since the presidential campaign he tried to win the public’s support by voicing made up issues, and blur the lines between opinion and facts. He was already proven wrong in ecological, economic, and social questions such as immigration. Even though he likes to accuse China with creating the hoax of climate change, it is a measurable problem. The trade deficit with Germany is not a result of currency manipulation, since Germans have no independent monetary policy. The primary reason for disappearance of industrial jobs is not outsourcing, but the unstoppable and inevitable nature of technological change. Most of the illegal immigrants arrive to the airports, and forget to leave after their visas expire. A wall would do little good to counter this problem. Finally, most of Norwegians actually have a really good time in Norway, and they don’t consider moving to the US.

The President’s attitude towards tariffs is based on similar personal opinion formed by bad information. The real problem is not merely dumping, but the increasing competition on the world stage and the lack of development in the American industrial sector. As an industry learns to produce more efficiently it is only natural if they try to meet the demand of foreign markets and expend.

The process started in the early 90’s with the political wave of democratization in the Eastern-bloc and Brazil. Some former Soviet states and China did not reach the de facto democratization stage, however, their economies certainly made a move towards free markets by abolishing price fixings and opening to international trade. These trends brought almost a billion of new labor onto the world market. The access to cheap labor started to absorb Western capital. In the meantime, the former, mostly socialist governments which could only survive so long on the back of Western loans got into a debt spiral. Capital absorption crowded out debt supply, increasing the interest rates, pushing economies into even deeper recession and starting a deleveraging cycle. These recessions made Eastern labor even cheaper and more attractive, creating a vicious circle. The second part of the decade produced several debt crises in Russia and the Far-East.

Previously the economies of Pacific-Asia tried to support their industries by introducing import subsidiaries to support domestic demand, fixed exchange rates for easier accountability, and sometimes even capital account constraints to smoothen the flows. These systems of institutions created persistent inequality in foreign accounts, which became unsustainable once the engine of growth slowed and currency deprecations became inevitable. At this point policymakers found it more fit to introduce Keynesian measures, arguing that now that production is established, the real scarce resource is domestic and foreign demand. By devaluing their currencies and open capital markets the balance could be resorted and new policies could be implemented.

But why do we need to go back so far in time? In the second half of the twentieth century the American industry stood without any competition. On the one hand, Western-Europe – it’s previous competitor – was too busy with restoration works, which, by the way, required American industrial products, creating further boost of demand. On the other hand, the heavy industry oriented Eastern-bloc isolated itself from the capitalist markets. Developing markets were occupied with import subsidies, as we have established. The post-war era created all the optimal conditions and tailwinds for the American industry. This era quickly soured by the depicted opening of Eastern economies, and collapse of socialist regimes.

Both the private and public sector reacted to these changes during the beginning of the new millennia. As we can see from the data, the trend of productivity and output moving together broke down in American industrial sector by the end of the twentieth century. The new industry approach focused on increased productivity and less-labor intensive practices. On the political side, the Bush-administration introduced protectionist tariffs in March of 2002. The only issue with these policy responses is that they were inadequate to reverse global trends, moreover, they even set the industry back according to certain studies.

The real world

The reality is somewhat different from Trump’s views. First of all, there is the issue of trade deficits and inequalities in the balances. It is correct that these differences in the balances exist, however, equilibrium cannot be reached by implementing protectionist measures. Even though it is possible to temporarily make certain imported goods more expensive, in the long-run this measure becomes counter-productive. By penalizing importing compared to domestically sourced materials creates a shortage of US dollars on the world market, meanwhile also reduces the demand for the currencies of trading partners. The result is a new equilibrium with stronger USD, which penalizes American exports and makes other, non-tariffed goods cheaper for the American consumers. All in all, the blocked ‘leakage” on industrial metals’ market creates new ones in parallel supply chains.

Secondly, introducing tariffs on foreign goods often means similar response on behalf of the trading partners, further eroding the competitiveness of the US exports. The Trump-administration forgets about the concept of comparative advantages. The US has trade surplus with a group of countries, and/or on a lot of markets, such as agriculture, non-car vehicles, or clothing. However, we can’t speak about a fully developed amnesia after all. The NAFTA member Mexico and Canada have already been excluded from the tariffs, meanwhile the ‘fair-trading partner’ Australia also got the President’s pardon.

Thirdly, we have to deal with one of the most overlooked factors in economics: consumer and supplier surpluses. Meanwhile it is fairly straightforward to measure the surplus of suppliers in the form of profit figures, on the demand side the difference between willingness to pay and the market price is a hidden element. On the one hand, cheaper imported metals can widen the margin for machinery exporters, for instance. On the other hand, consumers have access to cheaper durable goods, creating consumer surplus and increasing purchasing power for a broad group of the society. In case of more expensively sourced materials both surpluses can melt.

Finally let’s look at the microeconomic side of the argument. After taxing the cheaper import materials, the US industry must face higher average procurement costs. In case they can raise their prices the quantity sold must fall, in the opposite case they earn lower margins after the same number of goods. Naturally, a mixture of different magnitudes of the two effects is imaginable as well. Within the domestic industry it would hurt one of the most important producers. As raising living costs squeeze out low paying/low value-added jobs from the market an industry has no choice but to flee forward. High-tech manufacturers often require higher fixed asset ratios, hence higher financing needs. Moreover, due to the specialized, low volume nature of the production lines the average unit costs also often exceed their low-tech peers. Increasing the procurement prices will hurt the exact segment which could mean the salvation of the sector in the longer-run, meanwhile, low-cost manufacturers who have little to do in a developed economy can survive.

The outlook for the industry is actually far from ideal. The creator of the slogan ‘America first’ probably can’t be persuaded by reasonings such as: increasing dollar rates will choke international finance and growth, or that protectionism and closed-door policies are biggest enemies of specialization and development. Higher domestic prices, squeezed out high-tech manufacturers, and less competitive export due to a stronger dollar are all on the list of domestic issues. If no credit can be given to ‘fake news’ and ‘liberal media’, the President should just ask his Russian peer what to the economy when cheaper foreign alternatives disappeared from the shelves.