Here we are, over a week later. The world has not stopped revolving. The sun has continued to rise in the East. No one has paved the streets with gold. In fact, not much has changed in my day to day life since Election Day. I didn’t suspect that it would.
However, I have gotten a fair number of questions about the ex-President-elect’s proposed tariffs. While no one knows the details of Trump’s plans, perhaps even himself, everyone assumes he is going to use tariffs as an economic and political cudgel. After years of the powers that be preaching the benefits of free trade, folks are understandably a mixture of curious, cautious and anxious.
How will they impact the economy moving forward?
First things first. Trade has always been beneficial for the dissemination of goods, by definition, services and ideas. It is no mistake the European Renaissance happened after the Crusades, as opposed to prior. It is also no mistake Japan’s economic growth exploded after it ended its self-imposed isolation. Nor do you have to look much further than places like Singapore or Hong Kong to find modern examples of countries/territories which have become fabulously wealthy by trading, largely.
All told, trade is virtuous, and anything which facilitates trade is desirable. At least that is the thought process.
In a purely competitive, laissez faire global economy, free trade would be the ideal. Counties would produce those items for which it has a ‘comparative advantage’ relative to their trading partners, and import those for which they don’t. Eventually, trade imbalances and purchasing power disparities would minimize. At least that is the way it works in theory.
We will never know, because a purely competitive, laissez fair global economy is a pipe dream even to the most optimistic of us. It will never happen, because humankind prone to protect its selfish interests. This has always been the case in the past, and likely will always be the case in future.
Therefore, I can sensibly argue tariffs are an impediment to trade, clearly. Anything which restricts the free flow of capital, goods and services to their highest best use is detrimental to economic growth. As such, tariffs are an impediment to overall societal wealth.
There you have it. I have said it, and I am not going to take it back.
You see, domestic manufacturers outsource their production capacity to take advantage of the local markets and to drive down unit labor costs. This often leads to American companies exporting their goods back into the United States. In truth, our massive trade deficit is largely due to Americans buying the foreign-made goods of American companies.
But will slapping tariffs on foreign goods actually improve the U.S. economy? Reduce our trade deficit? Increase jobs? Grow the blue-collar middle-class? All of those wondrous things and more.
The quick answer is probably not, that is if you look at tariffs solely from an economic viewpoint.
For instance, let’s assume Company A can produce widgets in the United States and get them to market at a cost of $10/unit. However, it can reduce its all-in cost of $6/unit by producing in Mexico. Now, let’s further assume the clearing price for the item in question is $15.
What should it do? Well, since shareholders tend to like profits, the company should move production to Mexico and export back into the United States. Voila. Instead of making $4/unit, it will make $9.
Seeing this and bristling at shuttered factories, the powers that be decide to enact a $4/unit tariff in order to eliminate the cost-advantage that producing in Mexico has over the United States. The thought process is that this will protect American jobs, and people tend to like that sort of thing.
But will it? The answer is a little more fuzzy than you might think.
The reason being the company is now foregoing $4/unit in profit by not producing in Mexico. Remember, business owners, shareholders, like more profit instead of less. As a result, they will do what’s necessary to drive down unit costs at their domestic facilities. Ordinarily, this will include some combination of initiatives like hiring more productive workers, increased spending on technology, relocating production to a lower-cost, right to work state, and a host of others.
It certainly doesn’t mean keeping the same workers at the same wages and maintaining the status quo in terms of processes. No way. As such, marginal workers get pink slips in either scenario. Move production to Mexico, they lose their job. Keep production in the United States, again, they lose their job….probably to a machine or a simple change in procedure.
But what about those American companies already producing elsewhere? Will these threatened tariffs be enough to “onshore” jobs? The answer is also not quite as clear as you might think.
IF the size of the tariff is greater than the differential in production costs, a U.S. company may decide to move production back to the United States. Remember, they are also selling into the market where they are producing, which might even be more profitable than the US. However, only those companies which currently have domestic manufacturing facilities will likely do so.
The reason being? Cost. It actually might be less expensive to simply “pay” the tariff, as opposed to building a new, presumably up-to-date, EPA compliant factory from the ground up. Have you ever wondered why those things don’t just pop up every day?
So, tariffs? Historically a hindrance to trade and it is unclear how many jobs they will actually save, since technology has always been a bigger killer of jobs than foreign countries.
With that being said, there is certainly a case to be made for enacting tariffs as a way to dramatically shrink the supply chain for the defense industry.
Period. While the Pentagon has been hard at work reducing its direct dependency on Chinese suppliers, with some success, it would be ideal to “onshore” as much as possible in the unlikely event of a global cataclysm.
IF that is the reason being given for punitive tariffs on certain industries, that might make logistical sense, if not necessarily economic sense. However, we will need to do a lot more than slap some tariffs on a few countries in Asia to rebuild our severely atrophied shipbuilding industry.
Of course, these 1200 words only scratch the surface of this argument. However, if nothing else, hopefully I have imparted that they likely won’t cause the job growth the ex-President-elect promises. However, they also won’t kill the consumer the way others have speculated. As with all extremes, the truth is almost always somewhere in the middle.
Another truth is this: no matter who wins any election from today until Doomsday, the sun will come up in the East in the morning.
Have a great weekend.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.