Why Economists Hate Tariffs: Part TwoSubmitted by Headwater Investment Consulting on August 3rd, 2018
By Kevin Chambers
In Part One of Why Economists Hate Tariffs, we explained how the economic theory of comparative advantage skews an economist's opinion of tariffs simply because tariffs make international trade more expensive for all countries. Today, let's explore why economists believe that tariffs have a larger impact on international trade in today's global economy.
Why Tariffs Matter More Now?
So now that we understand why economists hate tariffs, why do they think tariffs are even worse today? The short answer is because our world is more globalized. The Ricardo model is good in a textbook, or the 1800s, but we live in a complex global world with lots of competition between countries. Tariffs are more effective when they are targeted. That is why the Trump administration has targeted specific industries, Steel and Aluminum, and also specific countries, China and Europe. Except our world is not like Ricardo’s model. It isn’t binary. It’s not US vs. China in a bubble. One of the China’s biggest imports from the US is soybeans. We grow a lot of soybeans and China uses a lot of them. China’s retaliatory tariffs would make soybeans grown in the US more expensive.
In the Ricardian model, China would try to replace the imports from the US by growing their own. However, instead of growing them, China is going to shop around the rest of the world for cheap soybeans. China may buy Brazilian soybeans or Russian, or Indian. Yes, they might be a little more expensive, but China can still get the benefits of global trade, just with other countries than the US. China will still be better off, plus they will be making another country better off as well by building up the soybean industry in another country. Chinese importers will make relationships new suppliers. Meanwhile, the US growers will lose their connections and their business.
This dynamic makes tariffs even more expensive for countries. In the original model, the opportunity cost of not trading is just cost. Hours used to produce goods. It’s simple. If the countries want to trade, they just ramp up production in one industry and decrease in another. But now, as trade shifts around the world, industries might not be able to recover if tariffs are ever reduced. US soybean farmers might not be able to re-enter the global market at a later date. Or at least, it will be more difficult.
The goods that worry economists most are called intermediate goods. These are the goods that are bought and sold as an input for other goods. China is mostly buying soybeans to feed livestock. The soybeans are an input into China’s production of pork, beef, and chicken. The buying and selling of these products are done by businesses. A soybean is a soybean. Thus, price is very important to them. To a large extent, quality is not a big determining factor. They do not care where they come from, just how much they cost.
Anil Kashyap, an economist at the Chicago Booth and a member of the Booth panel, points to some research that shows: “natural disasters have revealed how tightly integrated a lot of the supplies changes are and how vulnerable to apparently small disruptions.” Supply chains are not set in stone. When there is uncertainty and a disruption, be it a tsunami or a tariff, companies find new suppliers of intermediate goods. Research has shown that even small disruptions can send supply chains of companies off the rails. Large tariffs on intermediate goods would be a big disruption, one that even additional farm subsidies might not be able to fix.
Economists like to use a phrase when describing their models: ceteris paribus. It means, all other things being equal. Economic models are just that. Models. They are economic theories that work best when markets work perfectly with all other things being equal. The real world is complicated. Economist are united against tariffs. Especially the tariffs proposed by the US, China, and Europe in the current climate. No one can really predict what will actually happen. Businesses and governments are made up of people. Sometimes people don’t act rationally like economic models expect them to respond. No matter the uncertainty of the outcome, when a group of academic agrees completely, it might be worth listening.