U.S. Import Tariffs: Why the Cost Will Be High

The Trump administration’s decision last week to impose tariffs on imports of steel and aluminum from Canada, Mexico and the European Union will have costly ramifications, according to experts in international finance, trade and economics.

The tariffs – 25% on steel and 10% on aluminum – will jeopardize U.S. ties with longstanding allies and raise prices of goods that use steel and aluminum, thus hurting demand, investment in factories and jobs on both sides of the equation, they warned. Retaliatory tariffs are inevitable, and the matter could face drawn-out challenges at the World Trade Organization, they said.

According to Ann Harrison, Wharton professor of management and business economics and public policy, the tariff move is “shocking,” both because few expected Trump to follow through on his threats to do so, and because it involved the closest allies of the U.S. “They are just outraged and very upset,” she said of Canada, Mexico and the EU. “This move violates international law, and [these allies] see it as a rejection of longstanding relationships.”

Canada will most likely retaliate with its own tariffs on its imports of U.S. products while it pursues negotiations to find a mutually acceptable solution, said Patrick Leblond, a senior fellow at the Centre for International  Governance Innovation in Ontario, Canada. Leblond is also an associate professor and chair on business and public policy at the University of Ottawa’s Graduate School of Public and International Affairs.

Leblond noted that Canadian Prime Minister Justin Trudeau has the strong support of Canadians to push back against the U.S. tariffs. “Canadians are ready to … bite the bullet for as long as it will be necessary,” he said. They would also look for how the tariffs play out on U.S. products exported to Canada against the backdrop of the mid-term U.S. Congress elections in November 2018.

“This move violates international law, and [U.S. allies] see it as a rejection of longstanding relationships.”–Ann Harrison

“The Trump administration keeps asking for things that it knows are impossible, once it seems to think it has a victim on the hook,” said Mary E. Lovely, professor of economics at Syracuse University’s Maxwell School of Citizenship and Public Affairs and a nonresident senior fellow at the Peterson Institute for International Economics. “Our allies are increasingly waking up to that and beginning to have some solidarity in knowing they’re all being treated in a way that is contrary to international law, and which is politically not viable within their own countries. So it doesn’t look like they have many options other than to resist.”

Harrison, Leblond and Lovely discussed the impacts of the tariffs on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

A Trade War Looms

The EU has already challenged the Trump tariffs at the WTO, but it could take a long time for a resolution, said Harrison. Some countries like Mexico have chosen to act without that longer process “because they’re just so infuriated by these actions,” she added. Other countries have described the U.S. move as a “safeguard action” — trade parlance for attempts to protect its industries for domestic reasons — she noted. “It adds tremendous pressure and begins to diminish the rules-based global trading system that the U.S. has established over the last 60 years.”

The matter is likely to weigh heavily at the G-7 meeting this coming weekend in Quebec, Canada, with a sharp divide between the U.S. on one side, and the other six members outraged over the Trump tariffs. The Trump administration had originally announced the tariffs in March, covering several other countries, but suspended them to make way for negotiations on how best to reduce perceived national security threats to the U.S. The administration has since reached agreements with South Korea, Australia, Argentina and Brazil on steel; and with Australia and Argentina on aluminum. It failed to reach similar agreements with Canada, Mexico and the EU, leading to the re-imposition of the import tariffs, effective June 1.

Leblond said Trudeau was hopeful of some kind of a deal before the latest tariff action, but called off a planned visit to Washington, D.C., when he learned that the U.S. would insist on its demand for a “sunset clause” in the renegotiations of NAFTA (North American Free Trade Agreement) that are underway concurrently. Under the proposed sunset clause, the three members of NAFTA — Canada, Mexico and the U.S. — must renew the 23-year-old agreement after five years, or else it would lapse. Trudeau also rejected the U.S. justification of the tariffs on national security grounds. “The idea that we are somehow a national security threat to the United States is quite frankly insulting and unacceptable,” he said at a press meet last weekend.

Lovely noted that the U.S. has always had issues with the EU, such as its demand that the latter lower tariffs on automobiles. She said that with its latest action, the U.S. is following a pattern of “asking for things which are quite extraordinary within the context of the World Trade Organization and how trade liberalization has always happened.”

By antagonizing its allies and trading partners, the U.S. is also undermining the chances of forging a common front to deal with China, Leblond said. He expected the leaders of other countries attending the G-7 summit to impress upon Trump the need to preserve that potential of a common front, but was not hopeful that those entreaties would work. “I’m not sure they will be very successful because this is how Trump tends to negotiate: He hits first and then says, ‘Well, if you want me to stop hitting you, you better accept all these other things that I would like to get from you.’ The other leaders will say, ‘That’s not going to work, and so you choose what you want to do.”

Upping the Ante?

Trump has repeatedly said that the U.S. has been “ripped off by other countries” for years on trade, and has held those countries responsible for America’s trade deficit woes. According to Harrison, “The U.S. has been playing a game of trying to open other countries’ markets for its goods for generations and generations.” She saw the tariffs as more of a negotiating stance on Trump’s part. “He’s really kind of upping the ante and playing a game where he’s saying we feel violated.” She also pointed out that Trump’s claim on trade deficits is misplaced. “[The trade deficit] has nothing to do with exports on the part of other countries. It’s more about the fact that our country borrows more than it essentially makes and it needs to support that in some way.”

Section 232 “affords maximum discretion to the President; it’s a tool that he can pull off the shelf and use rather quickly.” –Mary Lovely

The tariffs will end up hurting everybody, according to Harrison. “The best way to understand this is to think about a bully in the playground,” she said. The bully thinks he’s the strongest person on the playground and makes demands from his friends, but it turns out that he has somehow misjudged his allies and in fact is living in a different world than 30 or 40 years ago, she added. “They’re going to fight back. And you end up in what’s known as a prisoner’s dilemma where everybody fights everybody and everyone is left off much worse off than they were before.” The EU may be one place where Trump could actually get what he wants because it is fragmented with different interests between its members, especially with the Brexit negotiations, she added.

Consumers, Jobs, Investments

Harrison predicted that the tariffs and the retaliatory actions by other countries would lead to higher prices of products that use steel, such as automobiles. “Even if companies redirect their supply chains from other parts of the world in order to avoid the tariffs, it will still mean higher prices in terms of transportation, for instance,” Leblond added.

The resulting higher prices will mean lower volumes as consumers will either buy cheaper cars or delay buying cars, Leblond said. The uncertainty and the higher costs will in turn compel companies to put off investments, or invest in other growth markets like China, he warned. All said, it would impact job creation and wealth creation.

Automakers have estimated that the tariffs would add about 1% to the cost of cars, and they may pass on anywhere between two-thirds or all of it to customers, said Lovely. “If it’s a $5,000 tax, it would funnel through right to the [customer’s] wallet,” she said.

At risk are also the jobs of steelworkers both in the U.S. and in the countries at the receiving end of the import tariffs, as one recent study claimed. Lovely said the auto industry, for example, is so well integrated across the U.S., Canada and Mexico that “we don’t even know how to separate American and Canadian content.” Caught in the crossfire are the unions that represents steelworkers on both sides, and they have argued against tariffs on Canada, she added.

The overall pain may be lessened because the U.S. economy is on an upswing now, Lovely pointed out. “However, we already see a [so-called] Goldilocks labor market, because while unemployment is very low, wages haven’t really picked up the way that we would like to see. This could threaten that.”

The tariffs will also hurt Trump’s voter base. “Trump is ostensibly doing all this for the people, but the people whose interests are most likely to be affected are against these tariffs,” said Harrison, referring to the steelworkers unions. “Part of the reason they’re opposing it is because their brothers in Canada in the same union are also going to be hurt.”

Harrison also dismissed the idea that tariffs could improve the well-being of Americans who are not well off. “The average [annual] wage of the lower 50% of the population is something like $18,000, which is scary, but tariffs are not the way to solve that problem,” she said. “The steelworkers themselves are telling us that.”

The Question of National Security

Lovely said Trump has used national security as the pretext for the tariffs under Section 232 of the Trade Expansion Act of 1962. “It affords maximum discretion to the President; it’s a tool that he can pull off the shelf and use rather quickly.”

“We’re hoping that that the retaliation response from the Canadians and the Mexicans will be enough to put enough pressure on the Trump administration to back down….”–Patrick Leblond

Harrison pointed to two impacts of the Trump tariffs. “First of all, it really denigrates international law in the sense that we all know that it’s not being used for national security,” she said. If other countries take this to the WTO, and it rules against the U.S., “it weakens that body,” she noted. “The second cost, of course, is that it alienates our allies. Therefore it actually weakens national security for us to make this claim, because it puts a big wedge between us and our closest allies who have stood by our side in a variety of different situations, and we could meet again in the near future.”

Hopes of a Rollback

The Canadian government has begun a month-long public consultation process where it would receive inputs from industry and others on how best to deal with the tariffs. If the Trump administration does not roll back the tariffs by then, Canada could impose retaliatory tariffs on imports from the U.S., Leblond said. If Trump follows through on his threat to impose tariffs specifically on automobiles and other products, that would escalate the current situation, he warned.

However, Leblond was hopeful of a rollback by Trump. “We’re hoping that that the retaliation response from the Canadians and the Mexicans will be enough to put pressure on the Trump administration to back down and get back to negotiating in good faith, and try to get a new NAFTA deal that would be good for everyone,” he said.

In the meantime, Canada would engage with its partners in the U.S. at multiple levels — Congress, state legislatures, governors, city-level leaders and the business community, Leblond said. In that exercise, Canada would essentially try to bring as much pressure as possible on the Trump administration to abandon its tariff move, he said. “[The hope is] we can put an end to this. Everyone is hurting with this. No one benefits.”