Supply Chain

Tariffs – American Manufacturing in an International Economy

Paul Ericksen / April 16, 2018

Our government has recently announced general tariff applying a 25% surcharge on imported steel and a 10% surcharge on imported aluminum.  A tariff is a tax or duty paid on a particular class of imports and/or commodities. Although the current administration has suggested that there may be flexibility available about which countries are subject to that surcharge, it is generally targeted at China and India.

The use of the term commodity above is appropriate since this tariff does not tax the steel in imported parts, assemblies or products. So, for instance, foreign manufactured cars can still be imported to the U.S. outside of the tariff. This means that foreign manufacturers can purchase steel at below-tariff pricing from sources outside of the U.S., to be used without penalty in the manufacture of goods it exports to the our country. U.S. manufacturers of such parts, assemblies and products, then, will in effect be competing at a disadvantage since overseas competitors will have a raw material pricing advantage.

What Do Steel and Aluminum Tariffs Mean for American OEMs?

U.S. Original Equipment Manufacturers (OEMs) will then be faced with upward pricing pressure from their domestic suppliers who will not want to absorb this higher cost of material. Instead, they’ll try to pass it on. Those same domestic suppliers will also face higher pricing from U.S.-based mills since history shows that with tariffs domestic industries raise their prices so that they are only minimally below the pricing of competing foreign sources. This will apply pressure on American OEMs to buy parts and assemblies containing steel and aluminum —  as well manufactured products — off-shore. The end result of all of this will be higher prices for U.S. manufactured finished goods leading to job loss and higher prices.

Reading what I’ve outlined above you may think that I am against tariffs. This is not true. U.S. manufacturers are not currently competing on a level playing field. Something has to be done to rebalance competition worldwide and tariffs can certainly play their role in this leveling. But, two points need to be made about tariffs.

First, a general, shotgun-type application of tariffs usually does not produce the hoped-for results. Rather, to be effective, tariffs should be targeted at other countries the U.S. views as offenders. For instance, if the U.S. feels China is dumping steel on our markets, only imports of Chinese steel should be tariffed.

Secondly, if tariffs are not coordinated with a comprehensive array of other governmental economic actions and/or sanctions, there is a higher risk that other countries will enact retaliatory tariffs on our products, i.e., a trade war. This means that rather than strengthening our country’s overall economy, in the end, a tariff may actually weaken it.

You may ask, “How can this be?”

Putting U.S. Manufacturers in the Ring

I think the best way to answer this is to categorize a tariff for what it is. Specifically, a tariff is a kind of negotiating tactic. Negotiations can take many shapes depending on intent. Unilateral actions by one side or the other in an economic dispute are usually seen as a type of coercion. Enacting a tariff is like telling the other party, “If you don’t adjust your terms to where I want them to be we will to tax your imports.”  I don’t know about you, but when I’m in negotiations I generally don’t respond well to coercion. It gets my dander up and I look for ways to apply similar stress to the other side. Along these lines, I suspect some countries will react to our tariffs on their steel and aluminum by enacting tariffs on products we export to them.

Ladies and gentlemen, that’s how you get a trade war.

It has recently been tweeted that trade wars are easy to win.  That can be true, but only when one side has overwhelming leverage.  Is this ever the case?  I’ve seen many take it or leave it offers in company-to-company negotiations where the side that was being coerced took the offer because they didn’t really have much choice.

Biting off the Nose to...Save Face?

In the recent history of the world, there was actually an era where the United States had the type of leverage in manufacturing I’m talking about. It was after World War II when the United States had the only industrial base that hadn’t been savaged by warfare, as well as being the only country with a nuclear bomb capability. What did the United States do with this position?  We initiated the Marshall Plan for Europe and a similar economic assistance plan for Japan to help them rebuild their industries and infrastructures — providing both financial support and sharing technology. Without our help, countries like Germany and Japan would likely not be the fierce economic competitors that they are today.

People might say that helping our vanquished foes was a mistake, at least in the generous manner we did.  But you need to remember that at that time the world was worried about a “Domino Effect”  if the U.S.S.R. managed to gain leverage over Europe and the Far East. Our people were tired of war and our post-war government made the decision that the most effective way to prevent the spread of communism was to help those war-torn countries recover economically.

Needless to say, the United States does not currently enjoy that type of leverage.  Whether we like it or not, an international economy exists today with conflicting interests that must be taken into account during any sort of negotiations, including trade sanctions.  Coercion may work in business when one side or another has the bulk of the leverage. However, it must be realized that the leverage of the United States — large though it may be — is no longer big enough to outweigh the competing interests of the rest of the world, at least when we decide to go it alone, i.e., without allies. Unfortunately, with this tariff, that’s exactly what we seem to be doing.  Have you heard of any other countries supporting our new tariff proposition?

So, if  the United States doesn’t actually have the leverage needed to back up our take-it-or-leave-it tariff offer, we are, in effect, bluffing.  And bluffing in negotiations is a highly risky move.

A Trade War Probably Won’t Help U.S. Manufacturing

Where does this leave us, exactly?  As stated earlier, tariffs have their place in our industrial policy tool belt, but in applying them we need to make sure we are not biting off our nose to save our face.  Negotiations — not punitive actions — must always be the first approach.

World economics is a complicated issue.  If it were straight forward enough that a simple, one-step solution would actually lead all other countries to adopt free market strategies, that step would have been taken long ago.  So, in my opinion anyway, a single step solution like a tariff won’t be effective. Sure, it could hurt the economies of other countries. But it will also likely lead to negative impacts on our own economy by reducing our exports and essentially adding a tax on our manufactured goods.  Just because we might be able to quibble that the other side’s economy was hurt more by a trade war (which may or may not be true) none of that sounds like a win to me.

The next article will discuss in more detail the impact of this tariff will have on the small and medium- sized manufacturers that sell their goods to OEMs.  It will especially be pertinent to manufacturers of machined parts where steel and aluminum material price account for a large percentage of their Cost-of-Goods-Sold (GOGS).

Learn more about Paul Ericksen and his over 40-years in the manufacturing industry here.