But How Do It Know?

Remember the old joke where the steel worker was sitting on a ledge having his lunch and says to his co-worker, “The thermos is the greatest invention ever”, and his co-worker asks him why, to which he replies, “Because it can keep things hot or it can keep things cold”.  Of course, his co-worker asks why that is so amazing and the steel worker says, “But how do it know?”  Sometimes when the news reports on trade wars or new trade agreements, or tariffs being levied, one can feel a little like that steel worker.  It’s important, yes, we get that, but how exactly, and do these things that are on a global scale affect us here on the ground?

Back to Basics

A few months ago we talked about the origin of the income tax in the United States.  The first thing to understand about trade is the tariff.  A tariff is like a tax in that it can be a percentage of the price of a good, or a flat rate per unit, or a per shipment tax.  Except where a tax is meant to generate revenue for a municipality in order to cover costs, a tariff is meant to be punitive, or rather corrective.

Tariffs are often levied against a particular commodity in order to protect its  industry.  Take steel, as an example.  Up until the early 1970’s the U.S. was the largest producer of iron and steel in the world.  But, of course, other industrialized countries were producing steel and eventually began to export their steel to the U.S.  Well, why on earth wouldn’t we just buy the U.S. steel since it’s right here?  It comes down to price.  If you are the procurement department of a motorcycle manufacturer and you can suddenly buy the same raw material for less, why wouldn’t you?

Then it becomes a snowball effect – foreign steel costs less than U.S. steel – buyers of steel buy the steel that costs them less – so buyers eventual profits increase.  But what happens to the U.S. steel industry when fewer companies are buying?  You got it, layoffs.  Government then steps in to put a tariff on that foreign steel so that it costs the same or more than U.S. steel, thus “protecting” the U.S. steel manufacturing industry. 

Why Let Them In

Shouldn’t we just protect ourselves and not allow those foreign countries to sell us their steel in the first place?  Well, in theory this may sound like a good idea, but in reality we are a democracy who has a free market, meaning the government can’t really stop companies from buying goods from whomever is willing to sell them.  So, on principal, we can’t protect ourselves in that way.  But we can attempt to level the playing field.

Level the Playing Field

But as level as we can make it inequities will creep in, such as the trade inequity we currently have with China.  The U.S. and China are the two largest economies in the world so competition is inevitable.  But when the inequity starts to tip in one direction then one party loses too big.  For instance, China currently sends us way more goods than we send them.  But Americans have enjoyed years of low prices on all sorts of goods manufactured in China from dog food to toys to TVs.  When you are looking at two equally beautiful 72” screens you are probably not going to check the label for origin, you are more likely to check the price tag.  All things being equal you buy the one that is $100 less in most cases, right?

As much as we like purchasing stuff for a bargain, we do need to have jobs in order to keep buying, and the trade inequity can impact jobs if the balance tips too much.  Let’s go back to our steel example.  Many of us are old enough to remember the massive layoffs of the 1980’s.  In the steel industry as more cheap steel came from other countries then less U.S. steel was purchased.  As less U.S. steel was purchased, less workers were needed to produce that steel, and layoffs inevitably followed. 

Tit-for-Tat

Ideally, trade goes back and forth with both sides benefiting somewhat equally.  But neither benefits if the other falls completely apart.  Think of a Monopoly game.  When everyone has about the same number of properties the game can keep going on and on, with each charging the others rent.  If one person suddenly gains a foothold and holds most of the properties then eventually everyone else will be crushed under the weight of paying out too much rent and not receiving any in return.  Then the game comes to a grinding halt.

So, what is the effect of the tariffs on us?  If a tit-for-tat raising of tariffs between countries goes on and on, economists predict that companies will begin to pass along the additional costs of tariffs to purchasers of their products – prices rise, trade begins to slow, and workers lose jobs.  So, while that TV may still be cheaper, maybe now only by $80 instead of $100, you may not be able to buy because maybe your hours just got cut, or you lost your job altogether.  Although the effects of trade disputes and tariffs may not seem to concern us  quickly and directly they can have impact.  Consider avocados.  In an earlier spat with Mexico, the administration threatened to close the U.S./Mexico border.  Economists in the know suggested that it would take America five days to completely run out of avocados if that were to happen.  Imagine the number of restaurants and stores affected by that trade dispute!  Most trade disputes are not as drastic and swift as that possibility was, but imagine the effect of a trade dispute or “war” as it is sometimes called, being a sort of slow-motion avocado trade – eventually something will be too expensive to buy or run out, someone won’t be able to sell, and someone will