Understanding Trump’s tariffs

What are their plausible reasons, what is their significance and what is the cultural shift that these tariffs bring?

Noisy collapse of a common market

Import duties or tariffs are a legitimate instrument of the States in the intervention of economic or financial imbalances. In one form or another, they are practiced by all states (even if some, including the US, have chosen to put zero taxes relative to some trading partners).

The European Union was established and operates primarily as a common market, with zero taxes on intra-Community trade. Extra-Community imports are taxed by each EU member with their own quotas and depending on the category of goods or services. On the same model, the United States was a common market with Mexico and Canada. The North American Free Trade Agreement (NAFTA) was initiated by Republicans, through Ronald Reagan, in 1988. Subsequently, it was expanded in 1994 (the Bush administration) and 2020 (the Trump administration, in the first term). The North American market became the third largest common market in the world, after ASEAN (today, RCEP) and the EU, all with sensibly equal figures.

The sudden introduction of 25 percent tariffs on imports from Canada and Mexico, for almost all product categories, makes Trump’s second term begin by collapsing this common market initiated and conducted by Republicans for decades.

Before NAFTA

The Trump administration’s gesture does not mean a return to the situation before the NAFTA deal. His impact is much deeper.

In its history, the U.S. has consistently had high tariffs on importing from the two neighboring countries. Before NAFTA, imports were charged differently by categories of goods and had values between 20 and 50% for imports from Mexico (but lower for some product categories) and between 10 and 40% for imports from Canada. Import duties were applied differently to protect specific economic zones.

Meanwhile, given NAFTA’s common market, the economies of the three countries have become interdependent, especially for products that have many subassemblies. The most common example is that of the automotive industry. Vehicles that have as their final label “made in the USA” comprise parts and subassemblies made both in Canada and Mexico, and they actually travel, during the assemblage, between these three states. Similarly, in other industries, presuming sustainability of the common market, companies have developed vertical or horizontal chains that include all three countries.

Not only in this situation, but also in many others, the structure of international trade has changed radically compared to the pre-NAFTA period. Given the recent diversification, finished goods today have only a contribution of less than a third to global trade. As a weight, they are outweighed by intermediate services and goods, followed by final services. The new, indistinct tariffs would therefore be interspersed in production chains, not just in the markets, at the risk of a original U.S. product, but elsewhere completed, to be returned with import duties.

At first glance, the impact of undifferentiated tariffs of 25% deeply disturbs production networks, including for the American industry.

In contrast, Canada announced that it would impose symmetric tariffs (not as undifferentiated, but on thousands of products). Mexico will probably do the same. The result will be an imbalance and instability in the markets and in commercial activity. But also higher and faster revenues to the state budget.

Beyond North America

The first wave of tariffs affects North American trade, but also China. The 10 percent tariffs against the Asian state, imposed in Trump’s first term, are now doubled. Like Canada, China has announced it will respond similarly.

Also with an indistinct share of 25% would be taxed and imports from the European Union.

Some analysts believe that these tariffs are imposed only for real negotiations to be held for quotas and specific product categories, and this could even happen in the second part of the year. In this case, the negotiation technique is not seen in international relations in the last century, where the practice is for negotiations to be conducted ahead of hard reversible actions.

Why tariffs?

During the Carter administration, the U.S. has a trade deficit that grows year-on-year. On an international scale, proportionally, it is not a deficit not seen before, but in gross figure it is impressive: a trillion dollars a year and continues to grow. In parallel, public debt and foreign debt have increased to levels that would be astonishing if other developed countries (Japan, Great Britain, Italy, etc.) were not in similar situations.

For a long time, the dollarization of the world economy has made the foreign debt of the United States quite bearable. China, Russia and oil exporting countries, which had huge collections of dollars resulting from their international trade, felt as incorrect many decisions of the US federal reserve that forced the dollar to manipulate the “burden of foreign debt.” In the European Union, the launch of the euro was a first signal for a global de-edolization rate. The abandonment of the dollar as a benchmark in world trade has shrouded even more in the years after Russia invaded Ukraine. To deal with international sanctions, Russia, China, but also India are trying a dedolarization of the BRIC. If this were to happen quickly, the effect would be problematic for the United States.

However, a closer analysis shows that the deficit of the balance is a symptom and not a cause. And import tariffs, especially if they are not sectorally differentiated, cannot target the real problems of the American economy. The foreign debt is high because the public debt is high. On the other hand, the economic competitiveness on industrial production is quite low, on the one hand due to demographic problems (the economic deactivation of the baby-boom generation, reaching the retirement age), and on the other hand the high wages in the American economy.

Thus, if the purpose of these tariffs is really to bring back branches of industrial production to the U.S., it will still be very difficult for this to happen. The workforce available, if we don’t take into account (illegal) immigration, is among the smallest in the world and will be declining. In contrast, average wages in the United States are a third higher than in Canada, 400% higher than in Mexico and 350 percent higher than in China. The task of creating jobs through tariffs is not at all simple.

Customs as a line of doctrinal fault

The major causes of the negative balance are therefore structural. They are related to demographic trends and the overall level of the economy. However, in customs (in the price of products to be subject to customs duties) many products and services end up with distorted prices. It is not all over the world that the same political and economic doctrines are valid, and because of this the price has many components.

In terms of economic history, customs taxation is the oldest form of economic protectionism. But many other forms have generalized in the meantime. Some of them have directly protectionist goals, others do not. Even though the U.S. practices some of these forms, their size and impact are significantly smaller than in other countries. On the one hand, the U.S. domestic market is more open to self-regulation than centralized regulations, making it more competitive, but also applying other standards, sometimes incompatible with those of other states. On the other hand, the economic stimulus is much lower, in the name of the same economic freedom.

Specifically, two major phenomena affect the ability of the United States to compete in international trade with greater success. The first is frequent statist intervention from other economic spaces. In the U.S., there is no such thing or does not exist on the same scale.

Forms of State aid

Thus, for example, direct subsidies granted to industrial production by some states – China is clear example – makes products cheaper than production in export. Such policies, quite similar to dumping, make Chinese products and companies gain market share by bankrupt products and companies from other states. The order of the day is the production of Chinese electric vehicles that reach European and American ports with prices that could ruin the development of local producers. By spotting market-induced distortions, the EU has imposed its own tariffs, between 17 and 35 per cent on various vehicle brands, depending on the subsidy they receive from the Chinese state. (Not all brands are Chinese. Tesla is also on this list because its production in China is the beneficiary of such subsidies).

The case of direct subsidies is very clear. But in many other situations state aid is not so obvious. Tax exemption for some producers or some branches is in this category. In itself, the practice is legitimate and allows states to precisely stimulate some economic sectors. However, when they are exporters, products and services have added competitiveness that local producers cannot afford.

An even grayer shade is that of reduced taxes. The same advantages of competitiveness are obtained, even if not on the same scale. For the State in which the import is made (and which has not taken the decision to grant tax incentives), distortions induced in their own market may be major.

Excessive regulation or non-regulation

In other cases, import tariffs are justified by differences in socio-economic standard. Lack of regulation or overregulation creates, each of them, its own spectrum of problems, but which translates into less loyal forms of competition.

The United States is in the middle between the European Union, which tends to regulate the economic activities very strictly, and countries in the Far East, which tend not to respect even the most general international principles.

Thus, the European food market is blocked for the United States by the EU decision taken many years ago not to allow genetically modified products. In the U.S. they are allowed. Almost completely, American agricultural and agri-food products cannot thus enter Europe. More recent regulations, which are related to the EU’s internal policy and vision, are taking many other American companies, products and services off this market. The European Union’s environmental policy (justified by the real need to avoid a climate collapse) sets standards that many American companies are not willing to comply with. As a result, their access to the European market is greatly diminished or impossible.

None of these situations are influenced by U.S. tariffs on imports. However, reciprocity was a prerequisite for the development of agreements on the free movement of goods and services. Even if concretely the European Union’s standards do not put import barriers, they operate as such and create an asymmetry in the trade relations between the two entities. Europeans have higher prices (as a result of compliance with EU standards), but they have the freedom to access the US market, while the reciprocal is not valid. In this case, in the American view, the imposition of tariffs on EU countries would be a way to rebalance the system.

On the other hand, in many countries of the East the lack of minimal standards create serious distortions. A long string of reports revealed that in Vietnam, Indonesia and other countries businesses use poorly-paid child labor or treat their workers in ways that can be assimilated to slavery. Even in China are documented cases in which companies force their workers to work without a break, 7 days out of 7, in the long run, and often more than eight hours a day. Situations of this type create the problem of collaboration with entities that do not respect human rights. At the same time, it also creates unfair competitive advantages because the workforce ends up having an insignificant contribution in the final price of the products.

The correct answer to situations of this kind would be the involvement of international organizations in a closer monitoring of forced labor and child exploitation. But the simple answer would be the imposition of tariffs by which, in the end, the competitive advantage obtained through such practices would be canceled.

What is the real impact of imports into the US economy?

A detailed analysis of the impact of imports into the U.S. economy was conducted by the Federal Reserve in San Francisco. However high the gross figure is, on the scale of the U.S. economy imports account for less than 11% of consumption. But even that figure hides a paradox.

Many of the products imported into the United States are products of American companies. Primary or actual production is thus carried out in Mexico or Canada or China and these products are subsequently imported. As a result, the production price represents (today) only a small part of the consumer price. Thus, according to the same source, the price of the imported product doubles in the USA by the commercial addition and through the shipping and storage costs. Moreover, even before the products pass the U.S. customs, much of their value is accounted for in the U.S. accounts.

A concrete example given by several economists is that of sports shoes (with American brand) that have a price for sale $100 in stores in the US: Of these, only 25 dollars end up in the factory in Asia where they were produced. Another $50 is marketing expenses (transport, storage, sale) across the U.S., and the remaining $25 represents transportation (3-4%) and the American brand’s royalty for design, advertising and profit.

Globally, 43% of the value of imports return to the U.S. as royalties for investment, intellectual rights and other mechanisms. For products in China, 56% of the import price returns to the U.S. through these channels. (The worst is the United States in relation to the EU, from where only 18% of the amounts return to the US; but even in this case the actual balance is favorable to them.)

But not all this money is returning to the US. The U.S. trade deficit (as well as the European Union) would be significantly lower if both entities limited the possibility for large companies to send their money into tax havens. In particular, the profit made by “overseas” investments is more prone to excessive “fiscal optimizations”. Compared to domestic products, which can be tracked throughout the entire commercial flow, the value of imported products is more difficult to trace, given the many economic jurisdictions through which these financial flows pass.

The End of the GATT Age

In recent years, the world economy has gone through major crises: Covid, the supply chain crisis, the complex crisis triggered by the Russian invasion of Ukraine. Perhaps the effect of U.S. tariffs will not outpace any of them in terms of impact. After so many shocks, it is expected that the production chains, on the one hand, and the savings as a whole would have acquired the dose of resilience that would allow them to cope. The only definite effect is an inflationary spurt.

With a positive impact or not, whether or not, Trump’s tariffs illustrate, at least to the same extent as their economic relevance, the change of a cultural model, of a paradigm in international relations.

History has also seen double-digit tariffs, but not in recent history, not intempestivent and not in bulk. The correct and judicious use of tariffs was regulated by the GATT agreement, initiated by the US and the UK and which is the basis of the World Trade Organization (WTO) today. The role of the world leader of the United States after World War II also resulted in its effort to permanently reduce taxes and barriers in international trade. In today’s practice, most countries have for most of the products single-digit tariffs, carefully negotiated and not imposed unilaterally.

Thus, the Trump administration’s decisions affect not only NAFTA (which has become a “state of stability and prosperity”), but the entire system that underpins the regulations of world trade. It remains to be seen whether such unpredictable decisions will become permanent and whether they will become a tool of intimidation in international politics. President Trump is still credited as a negotiator, and current decisions are viewed as a way to get his trumps in future negotiations.

However, the disengagement of the United States towards international organizations (which it has often created and imposed) is already a phenomenon, and it is found not only in the area of international exchanges, but also in that of human rights or environmental protection. Also, the US participations in the World Health Organization and even in NATO are questioned, and this is due to Russia’s actions that have emptied the content of the UN’s main task – to prevent and deter military aggression. Thus, these days, the entire international system of international agreements and organizations is strongly affected by the actions of several major powers, and its preservation and reconsolidation is a challenge for both next and long-term days and weeks.

Romanian version