Monday, March 30, 2009
Everyone loses in trade wars
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Miles McCoy
McCoy is a student at the Washington and Lee University School of Law in Lexington.
The recession is frightening. People lose their jobs daily. The news never seems any better. And the multibillion-dollar bailout program intended to stop the bleeding is not yet effective. Considering these factors, it is perfectly sensible to conclude that something must be done to save American jobs -- and the problem is trade. But trade is not the problem.
To illustrate the point, let us consider the application of a tariff on a good entering the U.S. and the effects of this tariff on the economy.
Mexico is importing widgets into the United States at $80 per widget. The domestic industry, because of labor cost constraints, produces widgets at $100 per widget. Under the demands of the population, Congress places a $20 added value tariff on widgets. Now all widgets in the U.S. market are $100 (in our two-country world, at least). What did this do?
First, effects of a tariff are usually shared between the consumer and the producer. However, in the simple example above, the Mexican producer can pass the entire cost of the tariff along to the consumer. Essentially, the tariff acts as a tax on widgets paid by the consumers.
Second, consumers pay more for widgets. Whether a consumer is an end-user or a manufacturer is the end-user, widgets cost more. In the case of a manufacturer, the increase of the cost for widgets will increase the cost of the supplies necessary to produce their good, which means a ripple effect of increased widget and end-good prices
Here is the effect on wages that is largely unconsidered. If a consumer has to pay more for widgets, one of two things occurs: They buy fewer widgets or they have less income to buy other goods. If I buy a widget at $80, I have more money left over to buy other goods, like computer software or tobacco. However, if I buy a widget for $100, I buy less of those other goods because I have less money. This decreases the demand for those other products.
As the demand for those other products decreases, so does the need to employ all the people who produce those products. Thus, the protection of the widget industry can cause job losses in other industries.
Also notice that the price of widgets increased. People will buy fewer widgets. The decrease in demand for widgets will decrease the necessary work force. The people the tariff is trying to save will still lose their jobs, just fewer of them.
Let's recap. A protective tariff is essentially a tax on the consumer of the good. This tax raises prices on the good itself and on any products that need the good in production. And, the tariff will not protect the domestic jobs. It will spread the job losses around.
Finally, this scenario only included the domestic market effects. Remember the tobacco and software mentioned above. They will have tariffs placed on them by other countries. That will cause job losses in domestic industries because we started a trade war over widgets.
Trade is good for everyone, because stopping trade is bad for everyone. It will cause more job losses and higher prices. So, is the widget worth the war?
