Trump Protectionism Wont Work

Donald Trump has recently been promoting his protectionist policy in the importation of steel and aluminum. Specifically, a tariff rate of 25% on imports of steel will be applied and 10% on aluminum, excluding Mexico and Canada for now.

Trump has justified this measure because “the steel and aluminum industry in the United States has been devastated by aggressive foreign commercial practices” and has also described the industry as “vital” to American national security.

This policy is undertaken under a logic of “national security”, rather than purely economic, based on a little-used commercial law of 1962. In April 2017, the Commerce Department initiated an investigation into whether imports of steel and aluminum “undermine national security” and concluded, early in 2018, that they did, which opened the door for Trump to apply tariffs.

There have been many reactions in different countries, criticizing this decision. Canada called the tariffs “absolutely unacceptable,” while senior EU officials said they are developing plans to combat this decision. Some European companies mentioned that they were putting American investments on hold as a response.

Why does Protectionism Not Work?

When we are faced with a national scenario in which an internal industry lacks the capacity to compete against the country’s external industry, the State decides to penalize the external industry through a tax policy, called tariff policy.

As a result, there is an increase in external prices compared to domestic prices, so that, in comparison, domestic industry significantly improves its competitive position vis-à-vis consumers.

These measures are applauded by the left because when sanctioning the external companies, apparently, it is possible to benefit the internal industry and, the companies and their respective business profits.

The great benefit of this policy is to privilege a specific industry, simply by placing itself in the national sphere. However, it has great harm for consumers.

Imagine that we are with Product A that has been manufactured internally and whose price is $20 and on the other hand, we have Product B, with the same characteristics as Product A, at a price of $15, but it has been manufactured externally. In this case, imagine the State decides to impose a tariff policy, so finally, the final price of Product B is $23, that is, higher than Product A **. In this environment, what would be the consequences of this decision? **

With the tariff policy, the main one harmed is the consumer as it experiences price inflation as the best market alternative in the market is damaged. In this case, the best alternative was Product B, for a price of $15. However, after the tariff policy, its best alternative is Product A, for $20, which means a greater mobilization of its resources to acquire the same good.

Given that Product B is no longer the best option for consumers, there is a destruction of competitive employment, linked to Product A, that is, a job that had a greater facility or ability to offer a product to the market, at a cost of comparatively minor production. In other words, the efficient producer loses.

It is interesting to assess the dynamic effects when applying this type of measure. The price difference between both products implies an opportunity cost. With the protectionist policy, the consumer must mobilize a greater amount of resources to acquire exactly the same. This price differential would have meant savings, which could have been used to demand other consumer or capital goods to provide greater welfare.

If there is a technological improvement that allows for a lower cost, protectionist policies will seek to damage these technological advances. In fact, in full technological revolution, many states seek to protect certain sectors before the emergence of the so-called collaborative economy that has improved consumer alternatives.

In conclusion, protectionist policies not only harm consumers and competitive employment in the short term, but also impede the process of creative destruction that allows us to free up resources to exploit new sectors or new ways of knowledge, not yet developed, which implies a position contrary to the progress and improvement of societies.

Trump and the consequences of its protectionism

In this case, Trump’s protectionist measures are focused on aluminum and steel, seeking to benefit the national steel and aluminum industry since, for example, the use of the steel industry has fallen since the 650,000 workers in 1950 to about 140,000 today, with many of the factories closed.

Following Trump’s decision, the big steel and aluminum producers applauded the tariffs. The American Iron and Steel Institute thanked Trump for “tackling the steel crisis,” and the second-largest US aluminum producer, Century Aluminum, said the measures could boost domestic investment of its products.

In fact, in the stock market, US companies linked to steel and aluminum experienced increases. AK Steel, the market leader in the United States of electrical steels, sheets of stainless chrome and stainless sheets with aluminum coating rose 9.5% after the news.

Among the biggest losers in the news were auto manufacturers, which account for just over half of the demand for steel in the United States. This makes the automotive industry the second largest consumer of aluminum and steel, after construction.

Some of the closest allies in the United States would be the most affected. The largest exporter of steel to the United States is Canada. Germany, Japan and South Korea are also among the top ten exporters, and China is only the tenth largest.

Another consequence is the risk of a protectionist escalation or commercial war. China is already reviewing whether to restrict US wheat and soybean imports in response to previous tariffs, and could expand that policy to other major US imports, including technology, aircraft and intellectual property.

With all this, those who will suffer will be consumers through inflation. The tariff policy will lead to domestic steel and aluminum whose prices are higher than imports.

The risk of a protectionist escalation is the least desirable outcome in a global economy. It is understood that the most logical thing is that the most efficient and specialized producers are those who must remain in the market and the most inefficient are those who have been expelled. In a protectionist escalation, we would see increases in the general inflation levels when carrying out the productive processes that suppose a greater cost.

Increasing protectionism and deglobalization isolate economies, separating the global economy into its constituent parts. In such a world, there will be no capacity to send and distribute the excess demand and supply from one economy to another through the world system, so that inflation will no longer be distributed globally.

Some countries would tend to higher inflation, while others will face moderate inflation and even deflation, especially countries that export raw materials in the emerging world, and specifically in Latin America, which houses great wealth in raw materials.

If there is a success that is attributable to inflation, it has allowed millions of people to be lifted out of poverty, especially in China and India. Thanks to this process of global trade, for the first time in history, we saw how in 2015, extreme poverty fell below 10%. So a protectionist anti-globalization escalation would put at risk the positive evolution of this trend that accelerated from the seventies.

Protectionism is not a new measure

Several previous presidents imposed tariffs or other trade barriers to protect the US industry from cheap foreign imports. Presidents Lyndon B. Johnson, Richard M. Nixon, Jimmy Carter and Ronald Reagan all applied quotas – import limits – or minimum prices on steel. Economic studies have concluded that these measures did little to stop the decline of the industry.

More recently, the administrations of George W. Bush and Barack Obama applied both tariffs to steel. Bush imposed broad tariffs of up to 30% on steel imports in 2002.

They were supposed to last three years, but they retired soon, after the World Trade Organization (WTO) ruled against it and it was an ineffective policy for the construction boom that the United States was living in those years.

Trump’s use of a national security law to implement tariffs is extremely unusual, although Reagan used the same law for more limited purposes. While normal commercial actions are public, Trump’s process was opaque. The law also gives the president full discretion on how and for how long it will apply the tariffs, unlike other commercial actions, which are based on economic conditions and are subject to periodic review.

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