The Trump tariff and the dumb market

Imagine five American firms, each of which lays off New York workers.

Firms 1, 2, and 3 close their New York widget factories.

  • Firm 1 builds a new widget factory in Mexico.
  • Firm 2 builds a new widget factory in South Carolina.
  • Firm 3 does not set up a new factory anywhere. Instead, it buys widgets from a separate company which built a widget factory in Mexico and imported them into the U.S. This separate company never had a U.S. factory.
  • Firm 4 closes its New York call center and lays off all its employees. The firm opens a new call center in the Philippines.
  • Firm 5 keeps its New York widget factory open but replaces half its employees with robots.

In all five cases New York workers lose their jobs. Firms 1 and 4 move New York jobs to foreign countries while Firm 2 moves New York jobs to South Carolina.

President-elect Trump’s proposed new 35 percent tariff would apply to Firm 1, and specifically to goods imported into the U.S. from the new Mexican factory that replaced Firm 1’s now closed New York factory.

It appears his policy would not apply to Firms 2-5. Based largely on his recent interview on Fox News Sunday with Chris Wallace, here is my best read of Mr. Trump’s intent.

  • The policy clearly does not apply to Firm 2, which “moves jobs” within the U.S.
  • He said the policy would apply to a company that “wants to move to Mexico or another country.” Firm 3 isn’t moving anything. Firm 3 shuts down a U.S. factory, while a separate firm makes the replacement goods and imports them.
  • Firm 4 is outsourcing services, not goods. (I think) his policy would apply only to manufactured goods.
  • The tariff also doesn’t apply to Firm 5, since while jobs are lost, no jobs are moving.

Over the next few months Team Trump will have to address the following four questions about his proposed tariff.

Question 1: Will it work? Will the threat of an import tariff prevent the case of Firm 1? In the short run, yes. A punitive tariff can be set high enough that it outweighs the cost advantages of cheaper foreign labor and a less burdensome foreign regulatory environment. The tariff would in effect trap domestic manufacturing capacity and prevent it from moving outside the U.S., and that’s the intent.

At some point, however, another firm without existing U.S. manufacturing workers can set up a factory in Mexico and start making similar goods at lower cost than Firm 1’s trapped U.S. manufacturing capacity. Those goods would not face the import tariff since this separate firm didn’t move jobs out of the U.S. Firm 1 will struggle to compete with these less expensive imports and may eventually shut down its New York factory despite the policy designed to help those workers. In the long run Firm 3 can probably beat Firm 1.

Question 2: Is the Firm 1 case the result of unfair trade? Chris Wallace described Firm 1 as making a free market decision. The president-elect replied “No, that’s the dumb market… I’m a big free trader, but it has to be fair.” Mr. Trump seems to be conflating two things:

  1. a foreign government’s trade policy or a negotiated trade agreement (“bad trade deal”) that disadvantages U.S. producers relative to foreign producers; and
  2. a competitive market advantage to producing goods overseas unrelated to trade policy: things like cheaper labor or resource inputs, or lower tax and regulatory burdens.

The president-elect and his advisors now need to explain why, in the absence of the first, the second is not a free market, why they think it’s unfair trade. If there is something in NAFTA that tilts the playing field away from the U.S. and toward Mexico, I’ve never heard Team Trump explain it. In the case of Mexico, Mr. Trump’s “dumb market” is also a free market, just one in which he doesn’t like the outcome of competition.

Question 3: What share of laid off manufacturing workers see their jobs outsourced to foreign countries? New Yorkers in all five of the above cases are laid off. How many of them are in the first case relative to the others? To answer this you’d need to measure automation vs. outsourcing, domestic vs. foreign outsourcing, and services vs. manufacturing, as well as make a guess about how many firms would choose the Firm 3 path when confronted by a tariff that applies only to Firm 1.

If laid off Firm 1 New Yorkers are only a small portion of all laid off New Yorkers in Firms 1-5, by itself that doesn’t mean you shouldn’t try to help those in Firm 1. It does mean you’ll need to explain why you’re trying to help some laid off workers and not others. That brings us to the political and communications challenge…

Question 4: Is the policy fair and will it be perceived as fair? What do you tell the laid off workers of Firms 2-5 when they ask why you’re not helping them as well? The affected workers, their families, and the local economy, probably care less why New York jobs disappeared than how many did. Team Trump could argue their policy is narrowly tailored to solve only a specific problem, that of manufacturing jobs outsourced overseas because of unfair trade policies or bad trade deals. The laid off New Yorkers probably don’t care whether their jobs were shipped to Mexico, shipped to South Carolina, or taken by robots. If Team Trump can’t answer question 2 convincingly and explain why Firm 1’s workers were harmed by unfair trade policies or agreements, rather than by the harsh realities of the free market on a level playing field, then their justification for helping some workers but not others could fail. And if Firm 1’s laid off New Yorkers are only a small portion of those laid off in all five firms, then Team Trump will face an even greater political and communications challenge.

Rather than an import tariff that may not work in the long run, is unfair to other laid off workers, and undermines free market competition, I’d like to see President-elect Trump dedicate his energy to pushing the other policies he referenced on Sunday: those that make it less costly for firms to employ American workers by lowering tax and regulatory burdens. Make America a great place to invest, expand, and create new jobs. A flexible and rapidly growing U.S. economy is also the best way to help Americans who lose their jobs (for any reason) find new ones quickly.

 

By | 2017-11-04T20:44:07+00:00 Tuesday, 13 December 2016|