The Tiff About Tariffs

A Brief History on U.S. Tariffs

When our country was still in its infancy, tariffs provided much needed federal revenue and protection for our developing industries. The British, among other more established countries, had much more efficient production means, and therefore could produce goods and ship them to us for far less than we could produce at home. In order for our country to gain stability and independence, it was imperative those young industries be protected by a tariff system.

And it worked!

By 1880, our industrial and agricultural businesses and their workers had become the most efficient in the world. Similar to the technology boom we have all lived through, from 1867 to 1900 U.S. steel production increased more than 500 times, from 22,000 tons to 11.4 million tons. No other country in the world had more industrial capacity, more market demand, and the required complex delivery systems to get goods to market.

They were no longer at risk from low cost imports. Indeed, it was the British who now saw their country flooded with imports. But the high tariffs continued to be demanded by the American business owners and their workers. Because as they became more efficient, that tariff helped keep prices for their goods high – resulting in fat profits and higher wages. Not much of which was reinvested to improve quality or efficiency of production.

It is at that moment, the high tariff system became an ideological relic without economic rationale.

Why Tariffs on Steel and Aluminum Now?

American industries continued to thrive until around 1970’s, when other countries became serious competition. Japan is one of note, as they built their own steel production plans with the latest tools and technology after WWII. Steel was central to the economic development and recovery of Japan. They could produce the best steel and aluminum for the cheapest price in the world.

Today, the U.S. produces just 5% of total global output. Our domestic production has not met our demand for many years. In fact, imported steel has grown by almost 220% since 2009. We now only produce about two-thirds of what we consume, and that share is shrinking.

At the risk of simplifying the complex demise of steel production in the U.S., the lack of profit reinvestment into innovation and modernization of U.S. steel plants had finally brought their doom.

Steel is a Matter of National Security

There has long been talk about the need for strong steel and aluminum production in the U.S. as a matter of national security. In war times, weapons production is vital to protect our country. During WWII, as our allied nations were enduring nighttime bombing and battles galore, the U.S., protected by her natural borders, was able to keep pumping out steel and aluminum to build trucks, bombers, guns and more. These supplies were given by the millions to our friends in Europe and Russia whose production capabilities were crippled by wartime violence.

So, what would happen today should war come upon us? Well, it’s likely our own industry won’t be able to produce all that is needed – hasn’t been able to for quite some time, actually. In fact, we are the world’s largest steel importer.

We get most of our steel from Canada (16%), Brazil (13%), and South Korea (10%), as well as Mexico and Russia (9% each). One would presume our friendly neighbors to the north and south would come to our aid in need. That is, of course, if they are allies in whatever conflict may arise.

Since we import more than 88% of Canada’s total steel production, 68% of Mexico’s total production, and 40% of Brazil’s total production, any import tariffs we levy on them would have devastating impacts on their industries. They really would have no other choice than to retaliate against us.

It would seem we can all agree that steel and aluminum production is vital to national security in war times, so it does not seem to make sense to initiate a trade war with our major trade partners. Especially now when U.S. relations with other less-friendly countries are increasingly strained.

China Steel Threat

China is the world’s largest producer of steel by a huge margin. China makes about half of the world’s total output, but we don’t import much from them. China’s explosive economic growth over the last several years has been driven by domestic demand. However, China does export a little steel – about 8.8% of total production – mainly to South Korea and Vietnam.

Here’s the deal with Chinese steel: Most of the producers of steel and aluminum are either owned or controlled by the Chinese government. That means they are probably highly subsidized, and thus can provide the least expensive steel and aluminum product in the world.

As their economy slows down, so will their domestic demand for steel. If production doesn’t slow as well, we would see a glut in the global markets of supply. And prices will fall. Private producers will suffer (and have been already), while the Chinese government will continue to subsidize their own production facilities to keep them at the ready. They quite literally can sell their steel at any price – even prices below the cost of production. Therefore, Chinese steel has an unfair advantage in the world markets.

(The World Trade Organization has rules that neutralize the negative effects of these subsidies, called “countervailing duties”, as well as rules that equalize the negative effects of dumping product, called “antidumping duties”. Right now, the U.S has 149 such trade remedies in effect, with largest number (24) against China.)

So, that makes me wonder: Has China figured out the answer to their own national security? Should steel and aluminum manufacturing be part of our government as an element of national security without profit motive? Or do we keep production with private for-profit enterprise?

Private Enterprise: The American Way

Since Trump’s announcement on March 1, 2018, many steel and aluminum company CEOs have appeared on media outlets supporting the new tariffs. Every single one of them spoke about how new tariffs will enable them to invest in technology and equipment to make their production more competitive in global markets. Their stocks have soared.

At the risk of throwing shade on the industry, that sounds like fake news to me. This is the industry that once reigned supreme in America, whose natural geography and resources were ideal. This was the industry that capitalized on the forced labor of convicts in the south during the early part of the 20thcentury. This is the industry that created fantastic wealth for those founders, including Andrew Carnegie, JP Morgan, and Charles M. Schwab, thanks in part to a tariff system that morphed from protection to profiteerism. This is the industry that failed to reinvest and keep up with changing market dynamics.

Can we really trust that this time will be different? And are tariffs going to “do the trick”?

The tough part is, in order for these current CEOs to prove me wrong, the tariffs would have to be put into effect, and those CEOs would have to actually invest in their companies. Meanwhile, a trade war is more than likely to ensue, shooting up prices on a huge array of goods for all of us, and potentially hundreds of thousands of folks will lose their jobs.

Trump can enact these tariffs without congressional approval under an obscure legal provision that permits the president and treasury secretary (Mnuchin) to levy tariffs as needed for national security. The provision in the law was probably contemplated to mean in times of war, but hey, whatever. For all we know, war is raging at the White House.

Despite the recent resignation of Gary Cohn, here’s hoping the prevailing wisdom of open trade has some staying power. I am not convinced that tariffs alone will be enough to shore up our fading steel and aluminum industry. Perhaps some consideration should be given to the Chinese way of thinking – perhaps this industry is “too important to fail”?

And all that being said, even if the love affair the markets have had with Trump may be over, our economy does remain on solid footing at the moment. We will, however, be seeing more volatility for a while.