Over the last two weeks, President Trump has said the House Republicans’ Destination Based Cashflow Tax (DBCT) is “too complicated”. He’s right about the complexity (see Part I), and it would yield countless unintended consequences, both known and unknown. In separating the corporate tax reform and trade policy discussions, the President has reduced the probability that the DBCT plan becomes law, which is by itself a good thing, but in advocating for tariffs as a means to American mercantilism, the shift away from DBCT is not a shift away from protectionism. On the contrary, his position is starker, and when compared to the circuitous and arcane effects of the DBCT, the simplicity of Big Border Taxes makes them much easier to retaliate against. From the perspective of a dispassionate investor, perhaps the most important excerpt from Trump’s inaugural address was this: “We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs. Protection will lead to great prosperity and strength.”
It’s appropriate at this time, I think, to contemplate the impact on the economy of the President following through on his consistent commitment to protect American jobs through tariffs – the real “Big Border Tax.”
Consider what would occur if the US taxed Chinese imports structurally, in a broad application of a blanket tariff. Perhaps this is obvious, but US imports from China include relatively few luxury goods, and instead are broad swaths of affordable consumer products, as well as manufacturing machinery and materials such as “rare” earth metals (at dirt cheap prices).[1] Under a broad tariff, everything from smartphones to apparel, from sneakers to speakers would cost more – probably quite a bit more. The increased costs would be born not by the affluent consumers in the US, but uniformly by almost everyone. The beneficiaries will be partly everyone (as taxpayers, to the extent tariffs raise significant revenue from foreign companies), and partly those workers who produce domestic substitutes for formerly cheap imports. A systematic surge in inflation for broad baskets of consumer goods (think 10, 20, 30%) by itself is clearly not good for growth. However, if those price hikes in turn go toward funding government expenditure and/or broad support for high wage (high productivity) jobs, you could envision how the US might enter a virtuous cycle where the economy grows organically on its own. These are theoretically appealing traits of mercantilism. Whether the economy enters that virtuous cycle is of critical importance: it would determine the difference between stagflation (inflation with meager growth) and durable growth. There are significant barriers to the positive outcome….
First there is the question of response from US trading partners. Retaliatory tariffs on US exports would be nearly certain, as well as perhaps creative taxation on the commerce of US corporations operating abroad. Though the US has consistently run a trade deficit for much of the past 40 years (an advantage in trade negotiations), US businesses generate significant revenue and earnings abroad. Apple is a prime example. This is no secret of course, but in 2015, the S&P 500 companies generated 44% of total sales outside of the United States.[2] At this point, the US corporate structure depends on foreign growth and foreign consumption for its current valuation. Undoing this, and moving toward economic nationalism is fraught with tremendous challenges. Of course, most policymakers wouldn’t condemn or oppose US corporations’ international business success – it’s good for the health and strength of the country. However, the issue is that America’s ability to do business abroad (and export from the US) depends on foreign governments allowing it to occur free from discriminatory taxation, which in turn, requires all governments to acquiesce to the benefits of free(r) trade. This is globalization. The US and global economies are pretty far down this road, so even though mercantilism advocated as far back as Henry Clay and Alexander Hamilton sounds compelling, earlier starting points were much different. In the modern global economy, the adjustment would be painful.
The President’s assertions that global trade is not free now, with barriers to US interests in place already, are true. Some protections are codified in law and others are basically cheating. For example, China recently exempted domestically-produced aircraft from their 17% VAT, while imported planes still incurred the tax. This discriminatory practice was successfully challenged by the US Trade Representative at the WTO, and the Chinese policy was reversed during 2016.[3] The details are extremely important though in assessing what’s fair, and what’s not. Analyzing those details is part of the WTO’s purpose. Ironically, during the Obama administration, the US filed more WTO challenges than any other country, and basically won all of them.[4] I would also note that in terms of sheer number of protectionist policies, the US has already enacted the most of any country observed by GlobalTradeAlert.org in the period from January 2008 to the present.[5] To the extent President Trump’s actual policy approach will be targeted, and not as simple as a blanket Big Border Tax, then it may succeed in swinging the fairness pendulum toward the US, without killing cross-border commerce.
Another related dynamic at play is the trend toward automation as the default “America First” solution to lack of labor competitiveness. To the extent border protections and the bully pulpit are successful in attracting and retaining manufacturing operations within the US, much of the work will be automated, requiring fewer jobs per unit of output. After the auspicious deal to save the Carrier plant in Indiana, United Technologies CEO Greg Hayes revealed to Jim Cramer that the company would invest $16mm “in that factory in Indianapolis to automate to drive the cost down so that we can continue to be competitive. Now is it as cheap as moving to Mexico with lower cost of labor? No…. But what that ultimately means is there will be fewer jobs.”[6]
It’s hard to imagine this trend toward automation in domestic production reversing, and re-shoring in response to tariffs should intensify that trend as the breakeven wage goes up. Manufacturing is not the only industry impacted by the evolution of automation – specialist firms are now facilitating the wholesale delegation to AI of many traditional high-skill support and business services. According to a recent Wall Street Journal article, “this phenomenon is known as ‘no-shoring.’ The idea is that digitizing back-office tasks brings them back to the country in which a company operates, but without bringing back any jobs.”[7]
So what to make of all of this? Big Border Taxes, though appealing in a vacuum, by themselves are unlikely to be the solution for lost jobs and productivity of big chunks of the American workforce. When foreign wages remain a fraction of the American equivalent —Mexican manufacturing workers for Carrier earn 80% less according to Greg Hayes (!)—the size of the tariffs necessary to equilibrate that competitiveness gap is too large. The domestic inflationary impulse would be significant, the retaliatory harm to existing American interests abroad would be intense, and even at low tariff levels, automation trends will accelerate.
Emphasis on the importance of American interests, and using the Big Border Tax as leverage in structural trade negotiations with targeted applications, can however be part of the solution. As automation increases, re-shoring produces fewer jobs but the new ones tend to be highly productive, which is certainly better than nothing. Combining the America First momentum with fiscal stimulus and structural reforms which focus intensely on lifting productivity is the way forward. The President has continued to stress the importance of the Big Border Tax in his policy discussions though, so the probability he presses ahead with it is rising.
[1] In a perverse twist, the US successfully challenged Chinese export quotas on rare earth metals at the WTO (filed 2012, resolved 2014) in order to increase international access to these materials from Chinese suppliers at prices below American production costs (the lone American producer, Molycorp, filed bankruptcy in 2015).
https://www.wto.org/english/tratop_e/dispu_e/cases_e/ds431_e.htm
[2] https://us.spindices.com/documents/research/research-sp-500-2015-global-sales.pdf
[4] https://ustr.gov/sites/default/files/2016_FACTSHEET_trade_enforcement_record.pdf
[5] http://www.globaltradealert.org/node/2257
[6] The entire text of this interview is fascinating in the context of the globalization discussion. Most of it describes their Pratt & Whitney engines, which will power several models of Airbus aircraft. Retaliatory trade restrictions would not be good for UTX.
[7] http://www.wsj.com/articles/technology-vs-the-middle-class-1485107698