Eswar Prasad is a professor of trade policy at Cornell University and a senior fellow at the Brookings Institution.
President Trump's decision to impose tariffs of25 percenton steel imports and10 percenton aluminum imports, followed by hisplanto hit China with $60 billion in tariffs,appearstoaugura trade war. Worries about the stability of the international trading system have roiled financial markets and led to loud recriminations fromCongress, economists andforeign leaders. As with many economic policies, tariffs cancreatewinners, losers and lots of misconceptions.
MYTH NO. 1
Tariffs will help reduce the U.S. trade deficit.
President Trump seems to believe that taxing imports of certain goods, which would raise their prices and reduce demand, will bring down the trade deficit. Hetweetedthat the North American Free Trade Agreement (NAFTA) "has been a bad deal for U.S.A." because of our "large trade deficits." The AFL-CIOsupportsthis view. And it's true that the U.S. trade deficit, which represents the excess of imports over exports, was$566 billionlast year (or nearly 3 percent of annual gross domestic product). Blocking imports seems like a simple way of fixing the deficit.
It's not. Retaliatory trade barriers put up by other countries wouldhurtU.S. exports and offset reduced imports, meaning the trade deficit wouldn't vanish. What's more, lower exports would mean less employment — a possible unintended consequence of Trump's policy.
Trade deficits are ultimately aresultof macroeconomic policies that influence how much a country produces and consumes. When a nation consumes and invests more than its annual output, it has to run a trade deficit. A temporary deficit is not a bad thing if it reflects good investment opportunities or strong income growth that leads people to spend more money. But a trade deficit fueled by large government budget deficits can be harmful.
Reducing government borrowing and helping U.S. firmsboosttheir productivity (meaning they could better compete abroad) would do a lot more to shrink the trade deficit than anything else. Getting other countries to drop their trade barriers would certainly help, but doing this through bilateral and multilateral agreements is likely to be more successful than simply raising tariffs.
MYTH NO. 2
The United States would win a trade war.
A trade war is an escalation of tit-for-tat trade restrictions imposed by two or more countries on one another's exports. Trump hasarguedthat trade wars are "good, and easy to win," especially since the United Statesimportsa lot more from many of its trading partners than it exports to them. Some analysts, such as Robert E. Scott of the left-leaning Economic Policy Institute,arguethat other countries won't even dare engage in a trade war with America. This past week, Treasury Secretary Steven Mnuchin asserted that "the United States is the largest trading market," implying that it has more leverage than other countries.
But shutting down trade with any country would lead tocollateral damage. A trade war wounds all combatants: It rattles business and consumer confidence, restrains exports, and hurts growth. Many U.S. businesses rely on low trade barriers to create international supply chains that reduce costs and increase efficiency. These could come apart amid the new tariffs. The last time the United States imposed sweeping tariffs, in the 1930s, the effect was to prolong andworsenthe Great Depression. Winning a trade war by destroying both imports and exports would be a Pyrrhic victory.
MYTH NO. 3
Tariffs are powerful negotiating tools.
Tariffs are oftenseenas sticks that increase leverage in trade negotiations with other countries. The message is: If you don't give us favorable terms, we'll hurt your industries. Conservative economists such asLarry Kudlow, who was named Trump's top economic adviser this month, andArthur Laffer, both of whom have derided tariffs in the past, make this argument. Trump's threats seem to have softened China's position in talks with the United States; Beijing hassignaledthat it may open more of its markets to American goods and better protect the intellectual property of U.S. companies.
This is a dangerous game, since even the threat of such action opens the door for other countries to consider unilaterally protecting their own industries through similar measures. Former U.S. trade representative Michael Fromannotesthat other capitals could block imports of U.S. agricultural products on the grounds of food security, thereby improving their negotiating positions. The European Union hasthreatenedtariffs on American bourbon, peanut butter, cranberries and orange juice. The mere uncertainty fomented by Trump hurts U.S. businesses thatrelyon intricate international supply chains.
All countries, even long-standing trading partners and allies, now have reason toreevaluatetheir economic relationships with the United States, which looks like an untrustworthy partner. After Trump pulled out of the Trans-Pacific Partnership, the other 11 countries in that arrangementmoved onwithout Washington; they'll benefit from easier access to one another's markets for their exports at a moment when we're the ones saying we need to export more.
MYTH NO. 4
Tariffs are an unfair, illegal strike against trading partners.
Foreign officials, such as European Union Trade Commissioner Cecilia Malmstrom, have labeled Trump's tariffsunfairand aviolationof World Trade Organization rules. A Chinese officialblastedthe proposed tariffs against China as a "wrong practice" and groundless.
The WTO permits tariffs under certain conditions, including when a country faces unfair competition from trading partners; other nations have tariffs on many products, often athigher levelsthan ours. China has skirted WTO rules and not met itscommitmentsto open up its domestic markets, so the WTO hasokayedprevious tariffs against it. The body evenallowstrade sanctions based on national security considerations in exceptional circumstances, such as war or some "other emergency in international relations."
The problem is that Trump'stweetssuggest that his tariffs are really focused on economic objectives, not national security. This pretext opens the door for other countries tousesimilar grounds to impose retaliatory sanctions, undermining the rules of the global trading system.
MYTH NO. 5
The tariffs will not help the steel and aluminum sectors.
Some economiststhinktariffs are so terrible that nothing good can come of them. "Targeting bilateral trade deficits makes no sense and can be counterproductive," Washington Post contributor Jared Bernstein wrote on his personal blog this month. Even some aluminum industry leaders haveexpressedreservations about whether the tariffs will help their businesses. In a headline, the Aluminum Association called "Across-the-Board Tariffs A Missed Opportunity on Industry Trade Challenges."
In fact, they will help. By limiting imports, whichaccountedfor about one-third of steel demand and nearly 90 percent of primary aluminum demand in the United States last year, the tariffs will lead to higher prices in the United States for both metals. This will be great for steel and aluminum company profits. Indeed, stock prices of companies in these industriesjumpedwhen the tariffs were announced as investors anticipated higher profits in the coming years. Unfortunately, this won't do much for employment in these industries, which are becoming highlyautomated. Moreover, higher prices will be passed on to consumers who buy metal things, such as cars, machinery and construction materials. This will hurtemploymentin thosesectorsand could reduce the demand for steel and aluminum.