It’s T for tariffs, cuz they’re taxes, too

As the Trump administration unveils tariffs on China for various offenses and on steel and aluminum producers (except for the six or seven most important exporters to the U.S.) amid both cheers and worries about trade wars, it seems like a good time to review some of the basics of the global trade system that has been developed since World War II.

Old School.

In 1776, while there was some little disturbance going on in the colonies, Scots moral philosopher and economist Adam Smith published The Wealth of Nations, establishing the theoretical (and moral) foundations of capitalism. Smith argued that markets, not government direction, led to the most efficient and most moral outcomes both within a nation and in trade between nations. His classic example is the very proficient maker of pins and the equally skilled maker of hats. The pin man could make one or more hats to meet his needs and the hat man could make his own pins, but it is far more efficient and cheaper for the pin man to make a lot of pins and sell his extras to the hat man and others pining for pins and for the hat man to crank out those chapeaus and sell them to the pin man and other folks with cold heads. Result is more pins and more hats get produced and consumers get cheaper but higher quality products. For Adam Smith, it didn’t matter if the pin guy and the hat guy lived in the same country or not. If the pin guy can ship his pins across country or overseas and still sell them more cheaply than other producers, then everyone is better off, except the local pin maker who can’t compete with the foreign pin maker. Adam would advise him to up his game or find a different trade. Alternatively, the local pin maker could appeal to his government to tax those foreign imported pins to make his home grown pins a better deal.

By the middle of the 19^th Century, the major European countries had adopted Smith’s ideas to some extent for their national economies. But they were very protective of trade with their colonies. They were also very inclined to listen to their own business people and tax foreign goods to protect home grown products.

The high (or maybe low) water mark for the use of tariffs as a strategy for protecting domestic industries was reached in 1930 when the U.S. Congress enacted the Smoot-Hawley bill that tried to counter the effects of the Great Depression by dramatically reducing imports from other countries. When the major European economies enacted similar stiff tariffs on American goods, everyone ended up worse off. 1) The tariffs reduced foreign demand which meant manufacturers had excess production and no market so they cut wages or laid off workers, which made already weak economies even weaker. 2) The tariffs led to higher prices on goods that countries had to import because they did not produce them themselves and that also made weak economies weaker. The Smoot-Hawley tariffs did not cause the global Great Depression but they made it much worse than it would have been.

New School

The creation of a capitalist global market based on free trade was a critical component of the Breton Woods agreements that led to the creation of the institutions and organizations that promote cooperation and mange conflict in the modern world. The first step was the General Agreement on Trade and Tariffs (GATT) which sponsored a series of international conferences aimed at voluntary agreements on reducing or eliminating tariffs. While GATT conferences were generally successful at reducing tariffs across much of the world, it became clear that some countries were coming up with clever tactics for achieving the goal of making foreign imports more expensive without formally imposing tariffs.

Is It …?

There are three major tactics that some countries* have adopted to boost their exports or reduce their imports: dumping, subsidies, and Non-Tariff Barriers (NTBs). They all share two properties: they are not a direct measure, like a tariff that shows up on an invoice or price tag, and they are all ambiguous.

*No country believes that it is pulling a fast one with sneaky ways to discriminate against foreigners, but every country is sure that everybody else is doing it.

Dumping is the practice of selling something abroad for less than it costs in the home market. This can help an exporter out compete local producers. But determining when a product is cheaper abroad than at home is not as simple as comparing price tags. Figuring out the exchange rate between currencies is part of the puzzle, the presence or absence of different kinds of sales taxes comes into play, and often the exported product is somewhat different than the domestic version.

Subsidies can be direct, such as tax breaks or low interest loans; or indirect, such as benefits for workers, or help in arranging business deals. Many governments have an industrial policy under which some industries, particularly those that are likely to do much more business abroad than at home, are selected as potential winners and backed by direct and indirect government action. But governments subsidize all kinds of business in myriad ways and teasing out those cases where government subsidies are directly intended to tip the balance of trade can be maddening. For over two decades AIRBUS and Boeing, premier rivals in the international aircraft industry, battled over who was being unfairly subsidized. AIRBUS is owned by a consortium of European countries who provide tax breaks and incentives and worker training, which Boeing saw as unfair subsidies. Boeing gets tax breaks from several states, government insured loans for its defense businesses, and assistance from the U.S. State Department’s consular service abroad, all of which struck AIRBUS as a higher level of subsidy than it was getting. After repeated battles at the World Trade Organization that ended inconclusively, the two giants decided it was more cost effective to just call it a draw and stop investing so much in legal wrangling.

NTBs are anything a country does that seems to discriminate against foreign imports … at least in the eyes of the foreign business. But a reasonable requirement that applies to both foreign and domestic goods and reflects different health and safety laws or local customs isn’t a barrier to trade … is it? Japan, like the United States and everyone else, has a law requiring product labels to include where they came from. In the U.S. the label can be small and inconspicuous, like the little sticker on your banana or the tag on the back of your blouse. In Japan, especially for agricultural products, the country of origin label must be large and prominent. OK, but that very trivial fact has led to U.S. claims that it’s an NTB. Rice grown in California’s central valley and exported to Japan is genetically identical to rice plants grown in Japan. Nonetheless many Japanese say they can taste the difference. (I used this example in class one semester when there were three exchange students from Japan sitting the back row and they all nodded, “YES”) In part because Japanese rice growers are subsidized so heavily by the government to keep prices high, rice from California sells for less per kilo than Japanese grown rice. When the rice shop puts a large and prominent “grown in USA” sign on a bin of lower priced rice, it is effectively advertising that this cheap stuff is inferior. Part of the local culture, or a non-tariff barrier to trade?

European rules for determining that a soy bean is not a Genetically Modified Organism (and Europeans are far more skeptical of GMOs than Americans) are a lot more stringent that U.S. rules: You have to not only prove that the bean wasn’t grown from GMO seed, but that it could not have been pollinated by a GMO plant, or mixed with GMO beans during harvest or processing. European farms tend to be much smaller and less efficient than the large agribusiness operations in the Midwest that have made soy beans one of the big three American crops and are a major export commodity. Are the rules about GMOs, which in practice apply almost exclusively to American imports, reasonable health regulation or an underhanded way to keep U.S. farmers from flooding Europe with cheap soy beans?

WTO?

When it was clear that GATT and pledges to reduce tariffs had gone about as far as it could, the major economic powers, led by the U.S., developed the World Trade Organization. Through a series of major international conferences, the members of the WTO have adopted an elaborate set of rules governing barriers to trade, levels of subsidies, and anti-dumping provisions, as well protections for intellectual property rights. Equally important, the WTO has a dispute resolution mechanism. Members of the WTO are obliged to submit disputes to arbitration by an impartial panel of experts. Once the process is complete, members are obliged to live with the findings.

A major weakness of the WTO system, that it shares with most other international organizations, is that enforcement of decisions and judgments is left to national self help. If you win your case against another country, you are entitled to institute tariffs or other measures proportionate to the damage you have suffered. Most of the time that is quite enough and the losing side will change their policies. And sometimes it is not and the winner is left with little more than a moral victory.

USA Today

The United States has been the global leader in developing international organizations, rules and procedures to create a more orderly and cooperative world. The announcement of unilateral tariffs on steel and aluminum and later tariffs on Chinese exports marks another sharp break with some seventy years of progress away from international anarchy.

Contrary to the impression one might have gotten from White House pronouncements, it is not the case that nothing had been or was being done to counter violations of international trading rules, particularly in the case of China. When China joined the WTO in 2001 it was with some very specific stipulations about changes in economic and trade policies that must be made. Since then China has been the target of a number of complaints to the WTO and has lost most of those cases. I think it is fair to say that China still plays fast and loose with many of the rules and is less than scrupulous regarding other peoples’ intellectual property, but their behavior has markedly improved. In fact the United States is not alone in objecting to Chinese behavior in the global steel market and piracy of intellectual property. Even as the President announced the steel and aluminum tariffs the United States Trade Representative was meeting with his European Union counterparts to continue to develop a coordinated approach to convincing China to clean up its act.

The international system is much more organized and and international cooperation is much greater than it has ever been. Conflict gets our attention and can have immediate consequences. Cooperation leading to slow, incremental change is easy to overlook and its results can be taken for granted.

The greatest danger in disrupting the existing imperfect world order is that the result will be far worse. Aas Joni Mitchell sang, “don’t it always seem to go, you don’t know what you’ve got ‘till its gone”