President Donald Trump's decision to impose sweeping tariffs of 25 percent on steel and 10 percent on aluminum is just the most recent in a series of actions that threaten global trade.
If imposed, the tariffs will raise costs for U.S. consumers and businesses and the country could end up in a full-blown trade war with other major economies. But even if Trump drops the tariffs, carves out exemptions for specific countries, or indefinitely delays implementation, the effects on the economy could be negative and persistent.
The stock market tumbled on Wednesday over fears of retaliation from China after a report said President Trump is considering another $60 billion in tariffs on Chinese goods.
This is because a trade cold war — a period with greater risk of high U.S. tariffs, foreign retaliation and the weakening of existing trade agreements — can diminish investment, erode business confidence, and leave America vulnerable to greater disruption in a crisis.
This worries me because I have spent the last 10 years researching how trade agreements reduce policy uncertainty, promote trade, and leave consumers better off.
To be fair, Trump is attempting to address manufacturing job losses, a real problem for those affected, but he's using blustery rhetoric and the wrong tools for the job. The gains from trade liberalization are distributed broadly to nearly everyone in the form of lower prices everything from TVs to toys. But the losses are concentrated with those on the few who lose their jobs in affected sectors of the economy.
Commerce Secretary Wilbur Ross argues that tariffs will add just a few cents more to the price of a can of soup and 1 percent to the price of a car. He's ignoring the scale of increased costs and potential job losses or wage pressure in industries that produce hundreds of millions of cans and millions of cars per year.
In effect, he and the president are endorsing distributed losses to everyone and concentrated gains for steel and aluminum. A strong economic argument supporting this trade off hasn't been made and the long run damage to U.S. credibility and ensuing reduction in economic activity will be hard to reverse.
The real damage may not be evident until the next economic crisis. In joint work with my colleagues Nuno Limão at the University of Maryland and Jeronimo Carballo at University of Colorado, we looked at how economic and policy uncertainty interacted during the Great Recession to amplify the collapse in U.S. exports.
We found that agreements, such as the North American Free Trade Agreement, provide a more predictable trade policy regime during a crisis, precisely when calls for protectionism might be loudest. Where an agreement was in place, it cut the cumulative reduction in U.S. exports by about one third, primarily because businesses continued to export rather than exit foreign markets altogether.
Trump is slowly, but surely, eroding the value of these agreements and threatening the stability of the world trade system. Not all tariffs are bad and nearly every U.S. president has imposed tariffs of some sort. But past tariffs were targeted and went through the rules and dispute systems put in place to prevent a reprisal of 1930s era protectionism. Trump's steel and aluminum tariffs threaten to be much worse.
The reasons are numerous. First, most traditional manufacturing industries in the U.S. use imported steel and aluminum so any reasonable profit and loss forecasting should factor in a probable cost increase.
Second, there is the risk that U.S. trade partners will retaliate against other sectors of the U.S. economy. Sorghum farmers in the Midwest may suddenly find the Chinese market is closed to their exports.
Finally, the U.S. usually exempts the countries that have free trade agreements with the U.S. from unilateral tariffs. This is more than just a courtesy. Our partners in free trade agreements make numerous concessions and commitments.
So far, Trump has only offered a temporary exemption to Canada and Mexico, and he's made it conditional on NAFTA renegotiation and other objectives like a border wall. These tactics undermine the effectiveness of trade agreements.
By abandoning international cooperation and threatening to do economic damage to enemies and allies, Trump has started a trade cold war. Its duration is uncertain, the eventual winners, if any, are unclear, and the economic consequences could be overwhelmingly negative.
Commentary by Kyle Handley, assistant professor of business economics and public policy at the University of Michigan Ross School of Business.
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