Trade Tariffs

There has been widespread discussion about tariffs in recent weeks thanks to President Trump announcing a 25% tariff on imported steel and 10% on aluminium. Tariffs have been in place for years and there is great debate about whether they work or not. With the current news cycle, everyone seems to be upset except the President who is walking through the chaos quite happily. His own party is worried about jobs, foreign Governments are worried about jobs and there are as many people who support the tariffs as there are who object to them.

The President has already been putting tariffs on a wide range of products so these new ones shouldn’t have been a surprise, however two of the three top importers of steel are affected: Canada and South Korea. The North American Free Trade Agreement that Canada is a signatory too is also under threat so I’m sure they are less than pleased. For South Korea, they are unhappy because it comes at a time when the US should be standing behind them to deal with their northern neighbours.

Let’s deconstruct the idea of tariffs and the importation of goods with a slant on the car industry. There are several reasons why a company such as a car manufacturer would import a product such as steel or aluminium:

1. The demand for the product outstrips the local supply.
2. The local supply is of a lower quality than the foreign sourced product.
3. Economically it is cheaper to buy the product from a foreign vendor (including shipping and import duties).
4. A combination of some or all of the above!

If the demand outstrips local supply then the car manufacturers will still need to import product from overseas and for steel, the unit price will rise by 25% to cover the tariffs. It is unlikely that the steel producer would absorb this cost. So for every purchase, the US Government gets its coffers topped up.

There have been reports that the mothballed steel plants in the US would need significant investment to restart and wouldn’t provide the increase in jobs suggested by the White House. This is because to compete with the imports, the steel companies would have to automate more, thus not requiring as many workers. Those same reports suggest that some of the plants would take several years to get back up to speed.

The New York Times reported that some local steel companies have already increased their unit prices to be under the imports including the tariff applied. So what happens in this instance? The costs for the manufacturers rises and as such the retail price of each car will have to rise. None of the Big 3 in the US can afford to trim their profit too much.

If the car manufacturers are buying foreign steel because it is of a higher quality, then they need to make a big decision. Do they switch to a lower quality local steel (assuming supply can meet demand) and risk the overall quality of their product slipping which in turn could reduce sales and therefore revenue and profits.

If the reason to buy imported steel was purely economical, then it may be that the 25% rise makes the foreign steel more expensive. Again assuming that local supply can cope with demand, all might be OK, however knowing that the majority of steel imported comes from Canada, South Korea and Brazil with several other countries filling the gap, it is clear that the local supply is not big enough.

The car manufacturers need steel and they need a continuous flow through their stamping plants. They cannot afford to disrupt production. The Big 3 may well find it cheaper to move production to Mexico, China or another country and factor in a possible import tariff on their products. That is a simple economic decision and one that Ford took last year when they quietly moved production of a vehicle from Mexico to China – they didn’t add any production capacity in the US where the vehicle is actually sold.

The world is dependant on materials like steel or aluminium and as such I don’t think these tariffs will have an immediate impact on the steel producers across the globe. They will continue to do what they do every day – monitor the market and their competitors to improve their costs and pricing. The miners might get hit with a demand for lower pricing however if they stand their ground, the costs should remain at a constant rate. What will hurt the steel producers will be a slow down in sales of the finished products.

So who will be hurt by these tariffs? The big losers will be the American consumers who will see price rises on many products as all manufacturers pass on the extra costs. This could be tempered as buyers consider what to buy – or whether they buy at all. It is likely that inflation will rise which will put stress on the economy. If the consumers stop consuming, then local jobs will go which will be exacerbated by a likely trade war that might result in consumers the world over slow down their buying.

With a slow down in sales will come a reduction in revenue from sales taxes and even income taxes which the tariffs may not be able to cover. When that happens, Donald Trump will blame everyone else for the problems that he started with his Secretary of Commerce, Wilbur Ross, a billionaire heavily invested in the steel industry!

I’m not a person who demands free trade because that is an impossible situation with far too many differences in economies across the world. However, I do think that each country has to seriously consider what it is good at and stop trying to protect failing industries at taxpayers expense. That in itself is a hard job!

Let’s see how 2018 plays out – with a lot of head scratching, bashing and banging no doubt!