Trade War? What Trade War?

If you’ve been following the news recently, you’ve probably run across a headline or two about the impending trade wars with China and other countries.  It seems like wherever you digest your news, from the left-leaning sources like The Huffington Post to right-leaning sources like Fox News, the media has unilaterally lambasted the strategy.  I’ve seen the headline “economic suicide” thrown around more than once.

The fear here is that if we impose tariffs on imported goods from other countries, those countries will retaliate by increasing their own tariffs on our imports.  The immediate negative effect to us, the average consumer, is that the prices of things we like to buy could increase.  A good example of this is all the recent press on the expected rise in the price of imported autos here in the U.S.  (See New Camry?  We’ve Got Trade War Bills to Pay). 

The less direct impact (to us, the average consumer, at least) is that higher tariffs could impede global trade and harm our economy in the longer term.  We start taxing imports of steel, aluminum, and other goods, our trading partners respond in kind, and all of a sudden we’re not swapping “stuff” back and forth as seamlessly.  According to David Riccardo’s law of comparative advantage, this would be bad for both us and our trading partners.

 

A Different Take on Trade Wars

I’d like to offer a slightly different opinion than what we’re currently seeing in the media.  I had the privilege of attending & speaking at a conference on Evidence Based Investing a few weeks back in southern California.  Among other big-name speakers (of which I am definitely NOT), Vanguard’s Chief Global Economist Joseph Davis delivered his take on the state of the U.S. and global economies.  He was also asked directly whether he thought the escalating trade wars would be a catalyst that derailed our economy.

Joe’s response was straightforward: no. 

His rationale was that at their current levels, the tariff rates are really a drop in the bucket of our country’s aggregate global trade.  While there is fear that we could volley back and forth with our trading partners, alternating tariff escalations, he believes there’s only a 20%-30% that this activity actually ends up harming the economy.

 

Some Context

It’s pretty clear at this point, based on the media coverage and general public backlash, that much of the country favors free & global trade.  But to put all this perspective, the U.S. has some of the lowest aggregate tariff rates in the world.  According to the Pew Research Center and The World Bank, the average tariff applied across all U.S. products was 1.61% in 2016.  That compares to a similar 1.6% in the 28-nation EU, 3.54% in China, and 4.36% in Mexico.  Less developed economies in Africa and South America are significantly higher.

On top of that, our tariff rates are about as low as they’ve ever been before.  The trend since World War II has been toward freer trade via consistently lower tariffs.  But that wasn’t the case at all in our country’s first 150 years.  When tariff statistics began in 1821 (again according to the Pew Research Center), 95.5% of all U.S. goods had tariffs, constituting 43-45% of their total value.

That’s a tremendously high tax rate.  Thanks in part to Riccardo’s theory of comparative advantage, we’ve gotten away from this protectionist standpoint after realizing that we'll all be better off if we focus on producing what we're good at, and trading it for stuff that other countries are good at.  As a result, tariffs in general have trended consistently downward from those levels since.

 

What Does It All Mean?

To be clear, I’m no fan of tariffs and am a strong proponent of free international trade.  While I do think our current trend of increasing tariffs across the board is dangerous, the context here is very important. 

Trump’s rhetoric around “we’re getting killed in trade” seems pretty silly on its face, but this is what he’s referring to: we impose far lower taxes on other countries’ good than they impose on ours. 

Will tariff hikes end up harming our economy?  Probably not unless they continue going back and forth with our trading partners. 

At the very least, I hope that doesn’t happen before my next purchase of a foreign car!

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