Economic Theory

Steel tariffs raise input costs and misallocate resources

Next time someone advocates a new government policy, here’s a simple test to tell whether they are serious or selling snake oil: are they willing to acknowledge the trade-offs inherent in their proposal?

That might seem a banal – and low – hurdle to pass. But it has a remarkable ability to separate wheat from chaff.

Any idea that changes incentives or re-allocates resources is going to come with costs as well as benefits. So when we are told that there is either all upside or all downside from a proposal, be suspicious.

It is highly unlikely that regulations to reduce carbon emissions are simultaneously good for the environment and for economic growth, with no downside.

It is highly improbable that there are zero possible economic benefits from Brexit – as the referendum Treasury analysis insisted – or no potential risks.

Whenever we spend more taxpayer funds on something, families have less money to spend on themselves and their own needs – and this has consequences too, all too often neglected.

This week, President Trump’s Trade Council director, Peter Navarro, would have failed the test.

In an article defending the President’s decision to not renew exemptions on steel and aluminium tariffs for the EU, Canada and Mexico, Navarro extolled how existing protectionism had encouraged a new aluminium mill in Kentucky and restarted steel-making facilities in Illinois.

Remarkably, he concluded that this was the first step in making US manufacturing great again.

That sound you can hear is the nineteenth century French economist Frederic Bastiat spinning in his grave.

“There is only one difference between a bad economist and a good one,” Bastiat mused. “The bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

What Navarro neglected to mention were the two key downsides from the protectionist policy: higher costs for US steel consumers, and other US exporting industries being hit by tariff retaliation.

Yes, it would be churlish not to admit that protecting domestic steel and aluminium industries might lead to more investment (at least in the short-term) in those industries.

But a manufacturing boom? Steel and aluminium are key intermediate goods in the production process of other manufacturers. It’s difficult to see how raising the price of steel, for example, will help the 300m customers and 6.5m workers in industries which consume it, rather than produce it.

The impact is likely to be higher product prices for consumers of these goods, or shrinking businesses.

For reference, there are only around 140,000 US workers in steel production. If this is populism, the word has lost all meaning.

Already, US steel prices have diverged dramatically from prices seen elsewhere – and that was before these exemptions expired.

The effects are beginning to be felt, with companies losing contracts to foreign suppliers as they pass these cost increases on in the form of higher prices. Others have cancelled plans to expand or are considering relocating manufacturing plants to Europe or Canada.

Even if the tariffs themselves do not bite too hard for a particular business, the uncertainty inherent in current US policy may deter some from making investments.

I’ve warned before on these pages that European leaders should not escalate tensions with the US by retaliating with more tariffs. After all, the insight that tariffs are primarily paid by your own consumers applies to the EU too. But Mexico, Canada and the EU look set to do just that. And while their own consumers will suffer, there will be concentrated impacts on certain US industries too, with agriculture likely to be hit particularly hard.

Funnily enough, again, Navarro failed to mention that effect.

As my Cato colleague Simon Lester tweeted, Navarro’s article reveals that there are some die-hard protectionists at the very top of the Trump administration – as if that was not obvious already. How else can one explain the spurious use of national security grounds to protect against steel imports from military allies?

If that justification wasn’t shaky enough, the new discussion of using the same rationale to impose tariffs on imported cars should dispel the myth that this is a targeted deviation from free trade, as opposed to a broader ideological crusade.

The Navarro-ites clearly want to use trade policy to explicitly help particular heavy-manufacturing industries. But this protection, and the concentrated benefits it bestows, comes with larger yet more diffused costs across the US economy, as input costs soar and resources are allocated to less efficient use.

To ignore these costs, wittingly or unwittingly, is to make a cardinal sin of economic analysis.


This article was originally published by City AM.

Ryan Bourne occupies the R. Evan Scharf Chair for the Public Understanding of Economics at Cato. He has written on a number of economic issues, including: fiscal policy, inequality, minimum wages and rent control. Before joining Cato, Bourne was Head of Public Policy at the Institute of Economic Affairs and Head of Economic Research at the Centre for Policy Studies (both in the UK).