With the possibility of a trade agreement with China and/or additional trade barriers looming, it is worthwhile to revisit the issue of tariffs. There is so much simplistic information about how tariffs work that unless we start with some common knowledge, it is impossible to have a rational discussion about the issue.
First, what is a tariff? It is a tax on imported goods and as such raises the cost of those products. It is typically implemented to protect a domestic producer, equalize a subsidy that foreign companies may receive, or punish a foreign country for actions it has taken.
What is critical is recognizing who pays the tariff. The foreign producer is not responsible for the tariff. The importer pays the tariff once the good reaches the United States. After the tariff is paid and the goods are released to be sold in the country, the tariff cost is distributed.
Consider the tariffs on Chinese products. The U.S. cost of the imported product now reflects both the production costs and the tariff. The importer, distributor, retailer, and/or consumer battle to shift the tariff expense onto each other. The market power of each ultimately determines who pays.
Consequently, the tariff raises the cost to consumers and/or lowers earnings of businesses. That is why a tariff is viewed as nothing more than a tax on domestic firms and households.
So, who actually wound up paying the tariff tax?
A recent study by the New York Fed, Princeton University, and Columbia University found "that the U.S. tariffs were almost completely passed through into U.S. domestic prices, so that the entire incidence of the tariffs fell on domestic consumers and importers up to now, with no impact so far on the prices received by foreign exporters.”
In 2018, household income losses were estimated conservatively to be in excess of $8 billion and massive amounts of time and resources were spent finding ways to circumvent the tariff expense.
Yes, the tariffs are reducing household spending power, but the administration argued they were needed to narrow the trade gaps with some nations, especially China.
So, how did we do? So far, not very well.
In 2018, the U.S. trade deficit with China surged by nearly 12 percent. With the European Union, the deficit increased 11.6 percent; with Mexico, it expanded 14.6 percent; and with Canada by 12.6 percent. So much for narrowing the trade deficits with our major trading partners.
Also, the administration argued this isn’t just about narrowing the trade gaps; it is also about righting wrongs. It might be on to something here.
The theft of intellectual property (IP) is rampant in China. It is recognized that if you do business in China, you are in great danger of having your most precious asset, IP, stolen.
Should tariffs be employed to address the loss of IP? I am not sure.
Despite the risk to IP, for decades, U.S. companies flocked to China. It could be argued they viewed the potential IP loss as just another cost of doing business.
Recently, I gave a talk to a group of investment professionals and raised that issue. I asked: If firms knew the loss of IP was possible or even likely, why did they do business in China?
The explanations were disconcerting. First, there was the simple cost/benefit calculation that the lower wage expenses derived from operating in China would more than offset any potential IP losses. Second was the belief the Chinese market was so large that earnings there would dwarf the potential IP threat. And finally, there was the confidence, at least initially but possibly still now, that the Chinese would not be able to steal their most valued secrets.
Companies that operate in or do business with China do so willingly and with full knowledge of the risk to their IP. Who is to blame, then, if they lose assets they knowingly put at risk?
The Chinese also took a gamble. If U.S. companies didn’t operate in or stopped working with China, where would the Chinese economy now be? Not where it is. The Chinese took the risk that the U.S. companies would come despite the IP risks and they won big.
The organized theft of IP should not happen. But tariff wars that hurt the many are not the answer to protecting individual businesses’ IP.
Tariffs raise consumer costs, lower corporate earnings, do little to reduce trade deficits, and so far, have yet to make it safer for businesses to operate in China.
Still think tariffs are a good idea?