The simple tariff being discussed in D.C. might spell the end for global trade and security as we know it.
The Trump administration has requested that Congress focus on two major policies during the next few months. One is Obamacare, as excising Barack Obama’s legacy remains a core issue for Trump’s diehard supporters. The second is tax policy reform, specifically corporate tax reform. Trump has indicated that he wants the process to be more or less revenue-neutral, but he also wants the corporate tax rate to shift from today’s 35 percent (among the world’s highest) to 20 percent (among the world’s lowest). While undoubtedly such a cut would massively expand corporate activity and thus tax receipts, such a lower rate would still require replacement income to come from a new source.
From what I’ve heard from DC of late, it seems that Democrats and Republicans alike (not to mention the Trump team) are zeroing in on a common approach — a tariff system.
Administrating a tariff system can be somewhat tricky. The easiest way to manage one is to simply slap on a “border” tax and tax absolutely everything a set percentage as it comes across. The problem with this, however, is that if you have any manufacturing supply chains that cross the border more than once — like, say, everything Ford and Chevy do — things can get taxed multiple times. Such a turnover tax drastically increases the cost — and diminishes the competitiveness — of goods and smashes any supply chains the U.S. has that rely upon the NAFTA partners. That would — at a minimum — trigger an economic depression in places like Michigan and Texas.
A less disruptive option is to implement some sort of content-origin rule, so only the percentage of value of the product that isn’t American gets taxed, and that only once. This requires a more involved detection and labelling system and requires a degree of trust with your close trading partners, but within the NAFTA system something more or less like this already exists. You’d just need to layer in a new bureaucracy atop what’s already there.
This method has some interesting advantages.
In addition to very strongly encouraging American firms to keep their businesses within the U.S., this sort of tariff system is also fairly modular. Since you are already collecting product origin data you can adjust the tariff country-by-country and product-by-product, for example having tariff levels that favor trade with Honduras but disfavor trade with South Africa. Tariffs and trade access very quickly become a tool of state power. As the U.S. has the world’s largest consumer market, that’s no small factor. The biggest losers from such systems would be countries and industries whose supply chains are almost wholly non-North American in nature. China Inc’s gangly East Asian industries would wither, as would Germany’s fully Central European ones. From the Trump White House’s point of view, these are probably viewed more as features than bugs.
There are, however, two far-from-insignificant problems. First, such a system is flat out illegal under the rules of the World Trade Organization. The whole concept of tariffs are one that the U.S. has been browbeating out of the international system since 1944 as part of the move to globalized free trade. Going the tariff route by definition means either facing a fleet of international lawsuits (which the U.S. would almost certainly lose), or simply walking out of the WTO completely. The ability of the U.S. to export to anyone that it didn’t have a side deal with would almost certainly collapse.
The second major problem is that anything that has such a crushing effect on globalized trade will gut the export-led industries of every country that happens to have an export-led economy. Roughly two-thirds of the world’s population almost certainly would face economic depression.
The United States would definitely feel the pain of this, but it would be manageable. Only 8 percent of U.S. GDP is from merchandise exports, and one-third of that is to Canada and Mexico. Only the United States has a demography that’s full of consuming 20- and 30-somethings, and so only the U.S. has the necessary end-market that makes export-led economies around the world work. If Washington and Mexico City and Ottawa can find a way to forge a non-WTO way forward (three guesses what my next topic will be), then the U.S. would likely only suffer a mild recession.
For everyone outside of North America, however, the near-future would hold economic disaster.
The U.S. may be the least involved country in international trade from a trading perspective, but it is the most involved country from a trade-management perspective. Without unfettered access to America’s consumer market, the global market shrinks by about one-third. Without the only global navy providing freedom of access and freedom of the seas, maritime trade — the way four-fifths of global trade moves — is endangered if not outright impossible. That isn’t just a problem for computers and furniture, but for iron ore and, oh yeah, oil too. Like it or not, the U.S. is the indispensable country for the global order in its current form.
Remove the U.S. and we don’t get a new global order, we get disorder because there is no country or coalition of countries that can replace the United States in financial, consumptive or military terms. The world’s rising powers — most notably China — see trade as a plank of security policy that is most definitely a zero-sum game. Any attempt by them to impose their own global (or even regional) preferences would quickly lead to conflict with other powers that would lose out under Chinese management. In China’s case that’s a lengthy list that would involve everyone from Japan to Taiwan to Indonesia to India to Saudi Arabia to the United Kingdom.
The reason the U.S.-based system works is that U.S. has global reach but no global needs. It has been willing to sublimate its economic needs in order to build and preserve a global system. China is the opposite. It has global needs but no global reach. It wouldn’t be willing to sublimate anything for its economic goals, and so no one has any interest in deferring to Beijing.
This tax shift under discussion in Washington very well might be how the whole global structure comes crashing down.