Free Trade 101: What Does a Trade War Really Mean?

On March 1, 2018, President Trump announced tariffs on all steel and aluminum imports into the U.S. Six days later, the European Union announced retaliatory tariffs on imports of American goods, like jeans, bourbon, and Harley Davidsons. On April 3, President Trump announced tariffs on Chinese mechanical appliances, which will affect over $45 billion worth of imports; China responded by imposing tariffs on American auto and aircraft goods, which will affect another $50 billion of goods. On May 23, the Trump administration announced it was looking into whether imports of German cars like Mercedes are a security threat: this is an excuse to impose even more tariffs on auto parts, affecting over $200 billion worth of goods.

We have three separate cases of tariffs, each enacted quickly by the President and were responded to in kind by other countries around the world. But, you might be wondering, what exactly are tariffs? What does a trade war mean? And how the hell do German Mercedes affect national security?

There's a lot to unpack here, so let's start at the beginning. Free trade simply refers to the import and export of goods among countries without any kind of barrier imposed on the goods. Such barriers include tariffs (aka, taxes) and levies that determine how much of a good from another country can enter a domestic market and whether the exporter needs to pay a tax for selling goods abroad. Countries have historically enacted these barriers so that domestic industries face less competition from abroad. Exporters that sell a good in another country have historically paid a fee for doing business in that country, usually in the form of a tariff. This cost is paid during shipping and then passed onto the consumer in the form of higher prices. So, essentially, tariffs = more expensive products. If a good produced abroad is more expensive than a similar good produced domestically, the consumer is inclined to buy the domestic version. In fact, the consumer is almost always inclined to buy the cheaper of two of the same good for normal, everyday things. Therefore, in order to protect domestic industries, governments have often favored barriers to trade. This has broad implications on the development (and stagnation) of local industries and employment levels.

Higher barriers to trade impede the flow of goods that travel throughout the world. Barriers increase the cost of doing business in other countries and typically discourage producers in one country to sell in other countries. This is better for domestic industries. If companies don’t need to worry about competition from another country, then they feel less pressure. If lumber producers in the U.S. don't need to worry about producers from Canada that can provide equally good lumber to U.S. consumers for cheaper, then the American lumber industry can remain relevant. This is good news for all the companies and workers in the U.S. lumber industry, including associated industries, such as furniture producers. As such, they would favor barriers to trade in Canadian lumber. It would allow them to stay in business.

Assuming that the quality of Canadian lumber is comparable with American lumber, consumers are inclined to purchase the cheaper one. In this context, tariffs are a government-sanctioned method of distorting the price of the imported lumber. The government is basically picking favorites with its domestic lumber companies. While this is good for American lumber workers, it has other ramifications. If the price of Canadian lumber would be cheaper without tariffs, then U.S. consumers would not be artificially guided to one product over the other. They would just buy the cheaper lumber.

There are several reasons as to why some products from other countries are cheaper than domestic ones. Sometimes, it's because of cheap labor costs. It could also be geographical reasons. Saudi Arabia is better than Brazil at producing oil. Ghana is better than Sweden at growing cocoa beans. Chile is better than Japan at digging up copper. That makes Ghana's cocoa beans cheaper than Sweden's. These factors are outside of any government’s control. Sometimes, however, a government makes strategic policies to encourage the development of different industries. Taiwan, for example, is really good at producing semiconductors, which are tiny processors found in almost all electronics, from phones to TVs and laptops. South Korea is a hub of consumer electronics, and is home to firms such as Samsung, LG, and SK Hynix (a chipmaker). In one generation, South Korea has transformed from a rural, agrarian society to one of the most robust, technologically forward countries in the world, largely thanks to government policies that enabled the development of various industries. What a country is good at producing can be the result of several factors. Some countries are better than others at producing certain goods. Tariffs distort this reality by favoring one local industry over a foreign one, regardless of which country is better at that industry.

Raw resources are often incorporated into more complex products that are then shipped the world over. International trade allows countries to produce what they are good at and integrate it into a wider system to make sophisticated products. Take an iPhone. It’s made out of several parts to make one final product that we all love (but Androids are better). LCD screens are made of aluminum and silicon. China is the leading producer of both. Lithium-ion batteries are made of lithium, manganese, cobalt, and a bunch of other minerals you learned in eighth grade. Australia and Chile are some of the leading producers of lithium. Processors have tiny amounts of metals, many of which come from African countries. The amount of resources needed for an individual smartphone is insignificant. Now consider 2.5 billion, the number of smartphone users projected for 2019. Now consider the number of TVs, tablets, PCs, laptops, and gaming consoles that people own all over the world. Producing the goods we take for granted is only possible because countries engage in an intricate web of commerce through which resources are traded. And this applies to all industries.

Each dot represents one iPhone component from that country

Barriers to trade distort this reality. They impede the flow of goods to maintain a status quo that is beneficial for a domestic industry. Workers in that industry usually favor such barriers, but they can actually cause more harm in the long-run by limiting choices for consumers. For the past few decades, however, it has been the official policy of all U.S. government administrations to remove barriers to trade. This can be traced back to the passage of the North American Free Trade Agreement (NAFTA).

With Donald Trump's latest moves, he is enacting trade policies that the U.S. hasn't used in almost a century. It's no secret why he is doing this: he wants to make a scapegoat of countries like China and get brownie points from his base by acting tough. In doing so, however, the Trump administration is actively hurting entire industries that rely on fast, cheap trade from other parts of the world. This will affect hundreds of billions dollars worth of trade and jobs that depend on importing and exporting. Tariffs are an outdated method of doing business and reinstating them makes the American economy less competitive, rather than more so as Trump claims.

Oh, and the Trump administration claiming that tariffs are needed for national security measures: that's nothing more than a legal excuse to justify the tariffs. There's nothing threatening about a German Mercedes or an Italian Maserati being imported to this country, except for maybe a douchey photo of its owner standing in front of the car on Instagram.