In a tariff war, everybody loses: economist Joel Naroff

The first shots in the latest trade war were fired this week, but even if they were blanks, the long-term implications of imposing tariffs on close allies and major U.S. trade partners will be felt for a long time.

A tariff war has almost broken out

President Donald Trump announced that 25% tariffs would be added to imports from Canada and Mexico, while 10% tariffs would be levied on China. These are our three largest trading partners with imports totaling over $1.2 trillion. That is over 40% of all imports.

Almost immediately, “agreements” were made with Mexico and Canada that postponed the imposition of the tariffs for 30 days. In return, each country agreed to take some token action on the movement of people and fentanyl across their borders. Precisely what they will do and when they will do it is not clear, but it was enough that President Trump pulled back.

As for China, the smaller tariff increases were met with modest but carefully targeted Chinese increases in their tariffs on products imported from the U.S. Those tariffs remain in place, at least as this piece is being written.

Linking tariffs and drugs makes no sense

While it is hard to know the true reason for the 30-day pauses, the sharp Monday opening drop in equity markets undoubtedly played a role. In addition, comments by business groups — which supported the attack on fentanyl smuggling but also argued that tariffs were not the solution — undoubtedly played a major part.

The business community’s response, questioning the linkage of drug trafficking to tariffs, hit the nail on the head: Tariffs are fundamentally economic weapons that do little to directly target the drug problem.

Why would the White House upend the international trade structure by going after our closest trading partners? Maybe because this has little to do with fentanyl and immigration and everything to do with the America First approach the administration is taking.

Drugs are the excuse for tariffs

Linking the tariffs to drugs, however, is a convenient head fake that allows the U.S. to get around international trade agreements, including one signed by President Trump during his first administration.

The USMCA, a trade agreement between the U.S., Mexico, and Canada, went into effect July 1, 2020. This was an update of the North American Free Trade Agreement, better known as NAFTA. As part of this agreement, tariff increases were barred with the exception of “essential security interests.”

So how did this administration get around that? It issued an executive order with the following statement: “The extraordinary threat posed by illegal aliens and drugs, including deadly fentanyl, constitutes a national emergency under the International Emergency Economic Powers Act (IEEPA).”

By linking drugs and immigration to international trade, tariffs became a tool. That raises the question: Does the use of the blunt force of tariffs make sense to address those problems? And if so, at what price?

Tariffs cost consumers

That the costs of tariffs are almost entirely born by the importing nation is generally accepted by economists and the business community.

For example, when the tariffs were announced, a Canadian energy supplier to New England immediately posted they were passing the tariff cost on to its customers. It was estimated that could raise the price of gasoline by 25 cents. And that was on a reduced 10% tariff that the oil industry wrangled out of the administration.

Expect the tariffs on Chinese goods, if they do go into effect, to be passed through to U.S. consumers in a similar manner.

Tariffs don’t address the drug or immigration problems

The point is, there is a disconnect between the drug and immigration problem and tariffs as the solution. Tariffs may force some nations to bend a knee (to use a White House phrase) to the U.S. but they don’t get at the root cause of the problems.

Drugs have been an issue for decades if not centuries. In the last 50 years, the U.S. has fought wars on marijuana, cocaine, oxycodone, and now fentanyl, among others.

And let’s not forget the 18th Amendment, which banned alcohol. That was really effective, wasn’t it?

We have faced surges of immigrants whenever problems abroad, be that wars, famine, or despotism, force people to seek out the United States as place where they can be safe and make a living.

We have tried to build walls, and have others pay for it (never happened).

The idea of claiming that Canada is playing a major role in the illegal importation of drugs is bizarre, given that it is estimated that about 0.2% arrives from our northern neighbor.

And of course, tariffs do nothing to reduce the demand for illegal drugs. Markets are efficient: When demand for a product is strong enough, it will be supplied, one way or another.

The reality is that the drug and immigrant argument for tariffs is misleading and hides the true reason: The administration is basing its economic policy on making foreign goods more expensive here and in doing so, incenting companies to produce here. They just cannot admit that.

Why tariffs are bad — or are they?

Economists have this quaint notion that free trade benefits everyone — and we have models that prove it.

But that only holds on a level playing field. As I pointed out during the first Trump administration, most countries, including the U.S., use tariffs to protect favored industries. That warps the economic models — if some countries cheat, everyone else loses the benefits.

The issue is how to deal with the cheating. That is where trade agreements come into play. They are supposed to level the playing field, not bludgeon trade partners.

Ultimately, tariffs and trade wars cause everyone to lose. They force firms to relocate to minimize political risk, not maximize economic efficiency. They threaten supply chains that were built to create secure sources of inputs and manufactured goods. Tariffs raise prices.

What they don’t do is solve drug and immigration problems.