losing the war on trade

Politics aside, President Obama’s heavy tariff on Chinese tires was a bad move. Although tariffs temporarily increase domestic sales and production, establishing trade restrictions cuts jobs. Obama’s decision to enforce a high tariff was an effort to curb the flow of Chinese tires into the U.S. as tire imports from China have tripled over the past five years. The Steelworkers Union claims that this increase has led to the loss of 5000 jobs in the tire industry in the United States. Yet the tariff could cause a trade battle that would hurt employment more than help it.

A tariff is a tax on an imported good. In this particular case it raised the price of tires imported from China by an additional 35% the first year, on top of the 4% tariff on all tires that is already in place. The new tariff takes effect starting September 26 and will last three years, declining by 5 percent each year. A tariff is intended to discourage the purchase of foreign goods, boosting demand for domestic goods and therefore domestic production. And indeed it does. Firms can sell at a higher price, so less-effective domestic producers can stay in the market. This increases domestic production allowing American firms in the tire industry to prosper.

However, with this new tariff there are winners like the tire industry—but there are also losers. A tariff raises the price of tires because consumers can no longer choose between internationally competitive, purchasing tires at the world price. Thus, prices increase, and those who cannot afford the increase will be “squeezed out” of the market, and so American consumers lose. This is called a dead-weight loss, or a loss of surplus that could have been avoided. However, it doesn’t just end with those who no longer buy tires. Higher prices mean consumers do not get as much satisfaction out of their purchase, so even Americans who still buy tires suffer under the trade restriction.

Not only do domestic consumers lose but domestic producers as well. China retaliated a few days after to the tire tariff by announcing an investigation of alleged dumping by the United States of auto parts and chicken parts. Dumping is when a country sells a good to another country at a price lower than the domestic price. A cut back of those exports would decrease domestic production in those industries. In addition to the direct impact from retaliation there is also an indirect impact on production: as our demand for imports declines our demand for net exports rise. This affects the exchange rate, driving it up. This makes the goods the U.S. produces more expensive relative to foreign goods, so our exports fall, causing domestic demand to decrease.

Ironically enough, the cost of saving employment is unemployment. It runs deeper than that, though, because tariffs support inefficient at the expense of more efficient ones. In other words, Obama is making it more costly for our consumers to protect an industry that is more costly to run. In fact, simple geometry shows that the amount gained by the consumers in free trade exceeds the amount producers gain under the tariff to the point where we could compensate workers who lose and still be better off than under a tariff. This is due to the absence of dead-weight losses under free trade, which maximizes welfare.

The worst part is, if China retaliates by imposing a trade restriction rather than hurt it would help them. Because they have a fixed exchange rate they would not suffer the loss of exports from a higher exchange rate, but their exports would increase. Although the United States cannot afford to engage in a trade war, China can. We must end it before it escalates.

If curbing unemployment is really the goal then President Obama missed the mark. Instead of preventing the loss of thousands of jobs he has forced unemployment with trade restrictions. In addition, the tariff is forcing consumers to support inefficient firms with higher prices, reducing the benefit they get from the purchase and squeezing some consumers out of the market entirely. The economic losses from this tariff fall exceed the economic gains. However we must not forget that in a time of economic uncertainty, free trade will expand both production and consumption, boosting our economy more than any stimulus could.