Trump and tariffs: an explanation

A trade tariff is a tax or duty placed on imported goods, for example applying a 25% tax on specific imported goods. A non-trade tariff is any measure, other than a trade tariff, that acts as a barrier to international trade, for example applying stringent checks, additional licencing or simply quota limits.

The main purpose of a trade tariff is to reduce demand for foreign goods and therefore rebalance any trade deficit between two countries. The US trade deficit to Mexico increased by 70% to $170bn, a deficit to Canada of $45bn and China is anything up to $400bn. Trump is not happy with this inequality and has been threatening sweeping changes.

Trump’s use of tariffs
 

Trump in his first presidency used tariffs as a deterrent, a threat to other nation states that if they don’t modify their approach in foreign affairs, then there would be repercussions. This blunt tool worked too, improving the US trading terms with selected countries. Trump 2.0 has been very vocal on wanting to correct the trade deficit the US has with its neighbours, Canada and Mexico and its largest trading partner, China. The new President has threatened to introduce 25% tariffs on goods from Canada & Mexico and 10% on China. Therefore, increasing the cost of imported goods from these countries by the respective tax rate. A separate tariff has also been threatened for Oil & Gas imports from Canada, attracting a 10% tariff. The US currently imports 75% of its petroleum and crude oil, with Canada being the dominant supplier at around half of the total oil imports.

The EU is the next target on Trump’s radar.  
 

Problem with tariffs
 

The challenge is that when one country applies a tariff, there is often a corresponding tariff placed by the effected country. This is what we have seen with Canada and Mexico both quick to respond with their own potential tariffs on selected US goods. But a ‘trade war’ doesn’t benefit anybody. The global stock markets initially dropped sensing reduced profitability of companies. It becomes a battle of wills, who will blink first. Trump’s ideology is that the US is the world’s largest consumer nation and its buying power will harm other nations more than the US, plus he will actively encourage its population to ‘buy American’.

Within 24 hours, Mexico rowed back on its tariff threats and agreed to send 10,000 soldiers to the border to help with illegal migration into the USA. Is that great negotiation by Trump or Mexico falling for a bluff. Either way, Trump has improved his border issues and looks like a decisive President in the eyes of his Republican voters. And shortly thereafter, Canada capitulated, announcing a 30 day pause to tariffs and implementation of a $1.3bn border plan to reinforce protections to limit illegal smuggling.
 

Inflationary pressures of tariffs
 

A quick political fix on immigration is one thing, but undoubtedly there will be tariffs for some countries or members of supranational organisations, like the EU. The quirk of tariffs is that it isn’t the foreign country that pays the tariff, it is the importing company that pays it, i.e. a US company who then passes on the cost through increased pricing to the consumer. The Budget Lab at Yale University has estimated that if demand remains the same then the average household in the US will be $1,170 worse off. Not quite Making America Great Again. It should be clarified that most products do have price elasticity, meaning that demand drops if price increases, although this varies by product or service.

Trump has certainly won round one of trade wars, his next objective will be to persuade a shift in consumer habits to buying US products and improving trade deficits with key partner nations which may just nudge the US towards Making America ‘Marginally Better’ Again!