And the broader adverse effects of a U.S. trade war with Canada and Mexico would not be trivial.
And the broader adverse effects of a U.S. trade war with Canada and Mexico would not be trivial.
D onald Trump promised tariffs, and he delivered, imposing by executive fiat tariffs of 25 percent on imports from Canada (10 percent on Canadian energy) and Mexico and 10 percent on imports from China. His justifications are “the major threat of illegal aliens and deadly drugs killing our Citizens, including fentanyl,” and our “major trade deficits with those countries.” According to the president, “the tariffs are going to make us very rich and very strong.” Note the inherent inconsistency: Tariffs imposed by other nations presumably would make them “very rich and very strong” as well. A trade war makes everyone a winner!
Unsurprisingly, the Canadian and Mexican governments threatened immediate retaliation in ways that would prove painful for Republican congressional districts and states. It is no surprise, then, that Trump agreed to suspend the tariffs on Canadian and Mexican exports to the U.S. for a month while negotiations proceed.
Because tariffs are taxes, and because an increase in taxes is a source of economic pain, it is obvious that Trump, having made a big splash, has come to recognize the enormous downsides of a trade war. Why else would the announcement of the tariffs have been made on a Saturday? And why else would Trump concede only a few hours later that there will be “some pain” but “it will all be worth the price that must be paid”?
About that pain: It is unlikely that Trump understands it fully, as it would extend far beyond the costs to be inflicted on the U.S. economy by U.S. tariffs and the certain retaliation from our trading partners. Trade wars are no source of riches or strength, and to the extent that one net effect would be an artificial strengthening of the dollar, other U.S. export sectors — machinery, chemicals, energy, agriculture, etc. — would suffer. More generally, there would result in a broad array of effects across the U.S. economy, complex and unpredictable but, on net, strongly negative because, again, tariffs are a tax.
But what is fascinating about Trump’s original announcement is the lower tariff on Canadian energy exports to the U.S. Someone must have informed Trump that his policy would result in higher prices for gasoline and other refined petroleum products — never a political winner — with particularly adverse effects in the Midwest.
Refineries are designed to process specific grades of crude oils. When they refine other grades of oil, they do so with less efficiency — the value of the mix of refined products yielded. Because refineries in the Midwest are designed to process heavy, sour (high-sulfur) Canadian crudes, and because Canadian crude exports to the Midwest are almost 70 percent of total U.S. imports of Canadian crude, Trump’s tariff on Canadian crude oil would have stronger effects on gasoline prices in the Midwest, although the adverse effects would be felt nationwide.
Some U.S. refiners might substitute crude oil produced elsewhere (e.g., the Middle East) in place of some Canadian crude, but is that really what Trump would consider a net economic improvement? The net effect would be a sharp increase in, say, gasoline prices in the Midwest; some estimates range from 30 to 70 cents per gallon. Nor would other U.S. regions be exempt: Mexican crude oil would be subject to the full 25 percent tariff, and, in any event, market forces would equalize U.S. gasoline prices across regions, net of transportation costs, differing regulatory requirements, and other second-order factors.
More generally, because tariffs are taxes, Trump’s stated policy would impose massive costs on the U.S. economy. The Peterson Institute for International Economics estimates that “Trump’s bigger tariff proposals would cost the typical American household over $2,600 a year.” Notice also that, as a percentage of after-tax income, these additional household costs would be highly regressive: For the five income quintiles and the top 1 percent of earners, the respective economic losses would be 6.3 percent, 5.3 percent, 4.1 percent, 3.4 percent, 2.9 percent, and 1.4 percent.
Does Trump actually believe that a more autarkic approach would make the U.S. better off? At least rhetorically, he does indeed: “We don’t need them to make our cars, we make a lot of them, we don’t need their lumber because we have our own forests. . . . We don’t need their oil and gas, we have more than anybody.” Do relative incremental costs not matter? Trump’s view that a bilateral trade deficit of, say, $200 billion means that we are “losing” $200 billion is preposterous. Are imported goods, services, and inputs worthless to the U.S.? With the same logic, are the groceries I buy at the local grocery store — I sell nothing to it — also worthless?
If Trump wants to do something about the tragedy of drug addiction and the deaths caused by fentanyl, he must change the American demand for drugs. As that has proven an exceptionally difficult objective, he has turned to our neighbors, demanding that they cut off the drug flow — an effort that would also come a cropper; consider, for example, how difficult it is to keep drugs out of American prisons.
Back to tariffs on Canadian crude oil. The lower tariff rate threatened by Trump suggests strongly that he recognizes the downsides. But should his proposed tariffs be implemented, there would result large, artificial resource shifts across sectors driven not by market forces but instead by government fiat, imposing substantial aggregate economic costs. Let us hope that Trump is looking for a way out of the corner into which he has painted himself. Let us hope as well that he has learned something.