Thursday, March 8, 2018

Trade Retaliation and the Trump Steel and Aluminum Tariffs

The Trump Administration's recent announcement that it was imposing new tariffs of 25 percent on imported steel and 10 percent on imported aluminum have sent shivers through the global economy.  Let's look at some background on the issue and how it may play out over the longer term.  For the purposes of this posting, I am assuming that the Trump Administration will proceed with its original plan to impose tariffs on both Canada and Mexico.

First, the imposition of the new tariffs was undertaken following an investigation by the U.S. Department of Commerce under Section 232 of the Trade Expansion Act of 1962.  Under section 232, the Secretary of Commerce is charged with conducting:

"...comprehensive investigations to determine the effects of imports of any article on the national security of the United States."

These investigations include consideration of:

1.) domestic production needed for projected national defense requirements;

2.) domestic industry’s capacity to meet those requirements;

3.) related human and material resources;

4.) the importation of goods in terms of their quantities and use;

5.) the close relation of national economic welfare to U.S. national security;

6.) loss of skills or investment, substantial unemployment and decrease in government revenue; 

7.) the impact of foreign competition on specific domestic industries and the impact of displacement of any domestic products by excessive imports.

Since 1980, the Commerce Department has conducted only fourteen Section 232 investigations and only 28 investigations since the law was put into place in 1962.  Actual import restrictions under this law were last imposed during the Reagan Administration in 1986; in that case, it involved the importation of machine tools from Japan, Taiwan, West Germany and Switzerland as shown here:

In the case of the most recent announcement under Section 232, the investigations into steel and aluminum imports covered about 2 percent of total goods imported into the United States in 2017, covering $29 billion worth of steel imports and $17 billion worth of aluminum imports.  The new tariffs would aim to cut steel imports by 37 percent and aluminum imports by 13 percent.  While on the surface the Trump Administration would appear to be targeting steel and aluminum exports from China, in fact, by value, only 6 percent of America's imported steel and aluminum is sourced from China.  Here is a graphic which shows U.S. steel imports by product and source nation:

The biggest problem with international trade is that it is always a two-way street.  When one nation imposes tariffs on another nation's products, the targeted nation may choose to retaliate.  For example, in retaliation for the Trump Administrations tariffs and quotas on U.S. imports of solar panels and washing machines which primarily targeted China (as well as South Korea), Beijing has announced that it is investigating whether $1.1 billion worth of sorghum (2017 import statistics) that was exported to China from the United States was either dumped or subsidized.   While this may be a relatively small issue for the U.S. economy, it is a very important issue for the American farm sector since China is the top buyer of U.S. produced sorghum.

With that in mind, let's look at an analysis by Chad Brown at the Peterson Institute for International Economics (PIIE) which provides us with a sense of how trade retaliation could take place in this particular case.  Under World Trade Organization (WTO) rules, countries would be permitted to retaliate against the United States if there is a legal finding that the domestic security rationale under Section 232 has no basis in fact.  The compensation/retaliation allowed under WTO rules has generally been set at the value of the exporting nation's lost trade value.

Here is a graphic showing the value of steel and aluminum imports into the United States by source nation:

Top exporting nations of both products include:

Canada - $12 billion

European Union - $7.3 billion

Russia - $3.0 billion

South Korea - $2.9 billion

Mexico and China - $2.8 billion each

The author assumes that there is a linear relationship between each product's tariff rate and the volume of reduced imports, in other words, a 25 percent tariff on steel would result in a 38.5 percent reduction in steel imports and a 10 percent tariff on aluminum would result in a 17.3 percent reduction in aluminum imports.  

Let's look at how the United States would be punished for this trade policy under WTO rules.  As I noted above, the allowed level of compensation/retaliation granted to the affected nations is equal to the value of that nation's lost trade value.  This graphic shows the estimated lost exports and retaliation limits if the Trump tariffs are imposed:

As you can see, under WTO rules, Canada would be grated $3.2 billion per year, the European Union would be granted $2.6 billion per year, South Korea would be granted $1.1 billion per year and Mexico would be granted $1.0 billion per year.  China would be granted a relatively small $689 million per year since it is a relatively small supplier of both products.  Total compensation/retaliation would be $14.2 billion annually for all nations that supply the United States with steel and aluminum.

The author notes that, in general, nations affected by trade disputes generally implement WTO retaliation by imposing 100 percent tariffs on goods that are imported from the defendant, in this case, the United States.  This ultimately means that U.S.-produced goods are more expensive in the affected nations reducing their consumption by local consumers  in the case of the steel and aluminum tariffs, the European Union has announced that it will target $3.5 billion worth of U.S. imported goods including Harley Davidson motorcycles, Levi Strauss jeans, bourbon whiskey and impose a 25 percent tariff on goods like steel bars and orange juice.  Here is what European Commission Vice President Valdis Dombrovskis had to say about the Trump tariffs:

While the Trump "Make America Great Again" is an interesting talking point that grabbed American voters' attention during the 2016 election, in the world of global trade, no nation is an island unto itself.  Any moves by Washington to protect U.S. industries through the use of tariffs will certainly be met by retaliation that will likely result in a zero net gain for the U.S. economy as a whole and U.S. workers in particular.

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