Why complete elimination of trade tariffs may never occur.
By Hafeez Esmail, Main Management
The Heritage Foundation, in their report titled “The Benefits of Free Trade: A Guide for Policymakers”, notes – “Societies that enact free trade policies create their own economic dynamism–fostering a wellspring of freedom, opportunity, and prosperity that benefits every citizen.” They also underscore that free trade “offers consumers the most choices and the best opportunities to improve their standard of living.”
It is a concept that America has consistently favored over the past century, with few exceptions. Moreover, as measured by the market capitalization of equities, it’s a philosophy that has served the American economy very well, particularly since World War II.
Although US society, as well as nations around the world, unquestionably draw significant benefit from global trade, the wealth isn’t equally shared by all. As other nations are able to produce goods either more efficiently or for a lower cost than stateside, a number of US jobs in that industry are eliminated. Ultimately this has resulted in rising inequality between unskilled and skilled workers as the former have continued to lose ground. The Economist notes in their “What is the future of free trade?” article that “technological progress, rather than global trade, has had the bigger impact on workers”.
However, a number of industries threatened by free trade have successfully lobbied to be shielded via protective tariffs and, in some cases, significant government subsidies. Almost every country has their protected industries, some of which are termed sacred cows based on the reticence of government to curtail their sheltered status.
Earlier this year much was made of the tariffs shielding the Canadian Dairy Industry – quite literally sacred cows! A heavily regulated system restricts production levels to ensure sustainable pricing, and simultaneously imposes significant tariff barriers on imports. It has been likened to Soviet style communism and such a characterization does not seem unfair. Nonetheless, given the importance of farmers to life in central Canada, this is unlikely to change anytime soon.
Canada is not unique in protecting politically sensitive businesses – it happens around the world. To be fair, the US sugar industry may be a similar offender. Per the chart below, the American Enterprise Institute highlights that “By forcing Americans to pay an average of 43.4 cents per pound in 2012 for inefficiently produced domestic beet sugar instead of 26.5 cents per pound for more efficiently produced world sugar, US sugar policy forced Americans to pay a “premium” of almost 17 cents per pound for the roughly 17 billion pounds of American sugar”. That’s a premium of about $3b per annum that American consumers paid in in artificially inflated sugar costs. Certainly, some nations are bigger offenders than others, but none are immune.
Most accept the Heritage Foundation premise that “Free trade policies have created a level of competition in today’s open market that engenders continual innovation and leads to better products”. However, because of significant political pressure from specific industries, although it’s a positive to move towards lower trade tariffs, truly free trade may never occur.
As a result, trade policy is rarely black or white and tends to be more nuanced. Take for example the 10% tariff on sedans made in America and exported to Europe. It’s certainly true that it dwarfs the 2.5% tax that are imposed on sedans imported from Europe. However less talked about is the 25% tariff imposed on trucks and SUVs imported from Europe into the US. If no tariffs are the goal for European and American auto imports to one another, that would mean all of the aforementioned trade barriers should go away.
This past April Ford announced that it will reduce the number of sedans it produces to just two – the Focus and the Mustang. The key reason is sedans have far lower margins than trucks and SUVs. “We’re going to feed the healthy parts of our business,” CEO Jim Hackett stated, “and deal decisively with the parts that destroy value.” GM and Fiat Chrysler appear likely to adopt a similar focus on higher margin trucks and SUVs.
With all auto tariffs removed with Europe, might US Carmakers sell more sedans in Europe? Possibly, but it seems likely that US assembled Honda and Toyotas exported from America may be primary beneficiaries. On the other hand, is it likely that US automakers experience margin pressure to the more profitable Trucks and SUV portion of their business if tariffs on European built SUVs are lifted? It seems inevitable that any increased sedan sales would be dramatically offset by increased BMW, Audi and Mercedes SUV imports from Europe that may even come with lower price tags.
The Heritage Foundation claim that “Free trade enables more goods and services to reach American consumers at lower prices, thereby substantially increasing their standard of living” seems well founded. However, all nations will continue to ring fence industries that they consider strategically or politically important. Accordingly, getting to global trade that is completely free of tariffs is a wonderful goal, but may never be fully attained.
While threatened tariff wars may make headlines and provoke outrage, the reality is getting closer to free trade is often a complicated process. And the outcomes won’t be universal wins for all US industries and may actually impose further body blows to an already embattled American manufacturing sector.
Hafeez Esmail is the Chief Compliance Officer at Main Management, a participant in the ETF Strategist Channel.
A pioneer in managing all-ETF portfolios, Main Management LLC is committed to delivering liquid, transparent and cost-effective investment solutions. By combining asset allocation insights with smart implementation vehicles, Main Management offers a unique approach that translates into distinct advantages for our clients, including diversification, cost efficiency, tax awareness and transparency. http://www.mainmgt.com