China and the United States are at war — a trade war. And the main weapon? Tariffs.
This week, Donald Trump announced a new round of $200 billion in import tariffs on Chinese goods, and China has promised to retaliate with a further $60 billion in tariffs on U.S. imports. How do tariffs work and what does this all mean for the average American consumer?
Hiroki Watanabe, Lamar University assistant professor of economics, said the economy has a natural tendency to let whomever can produce goods and services most cost effectively to actually produce them. As an example, Watanabe compared himself to the EDM musician Zedd.
“Let’s say I can write a paper in one month and a song in two months,” Watanabe said. “Zedd, on the other hand, can write a paper in one month and a song in one month as well. It looks like it makes no difference whether I or Zedd writes a paper. We both take a month to write one. However, I should be, and will be, the one writing a paper because I have a comparative advantage in writing papers.
“Consider how many songs we have to sacrifice to write a paper. It takes me a month to write a paper, and with that time I could have completed just half a song. On the other hand, Zedd will have to sacrifice as many as one whole song to write a paper. The number of songs that you have to forgo is called the ‘opportunity cost of a paper,’ and this is the only cost concept we use in economics.
“In this case, Zedd is less cost effective in paper writing than I am because his cost of production is one whole song rather than mine — I can get away with just half a song of sacrifice to write a paper.”
Watanabe said that whomever has the lower opportunity cost has the comparative advantage. However, tariffs interrupt this process and create artificially high costs, he said.
“Suppose the government of my country decided to impose a tariff on Zedd’s song, to protect my songwriting ego,” he said. “With the tariffs, Zedd’s songs’ price will become artificially high to the point where it goes above my songs’ price.”
Tariffs disrupt the free market and create unnecessary production, Watanabe said.
“(The tariff) sends out a wrong message to the world, and I start spending my time writing songs because, although I suck at songwriting, I can still beat Zedd’s price thanks to the tariff — at the expense of as many as two papers per song,” he said. “Zedd can do it by giving up just one paper. As the tariff distorts the free market, both I and Zedd start to produce things that we do not have a comparative advantage in.”
Watanabe said eventually the price of the songs from Zedd would become so expensive that people who were willing to buy those songs will no longer be able to afford them.
“Zedd used to be able to sell his songs and earn some profit, which makes him happy, and the buyers used to be happy because they could buy what they wanted for the price lower than what they were ready to pay,” he said. “All the happiness is now gone because of the tariff. In economics, this reduction is called a ‘deadweight loss’ — neither Zedd nor potential buyers will win in this otherwise mutually beneficial situation.
“’Deadweight loss’ is any economist’s nightmare and we work very hard to find a way to eliminate it. In this case, the solution is pretty simple — drop the tariff.”
Watanabe said America needs to be producing whatever it has a comparative advantage in, instead of products like steel, for example, because there are countries that can produce steel more efficiently than the U.S.
“The current tariffs seem to be based on the alleged unfair trade tactics by our trading partners and protectionism for our domestic industries,” he said. “If one country is subsidizing materials needed for production, then I am getting those materials at a discount because the other country’s taxpayers are paying for my cheap materials. If this is for protectionism, I may secure an industry like steel instead of where my comparative advantage lies, but my people will have to pay an unnecessarily high price for steel and we will see some deadweight loss.”
Kelly Weeks, LU professor of management and marketing, said that when the playing field of the world trade market is imbalanced, tariffs are imposed in order to balance it, but it doesn’t always solve the problem at hand.
“The country that has the tariff imposed on them retaliates and then imposes their own tariffs,” he said. “For instance — China. Trump imposed a 25 percent steel tariff on them and then they imposed tariffs on the U.S.
“The playing field keeps shifting and then there’s a domino effect, and it continues to shift which makes the situation more complicated. Trump’s idea behind imposing those tariffs was to level the imbalance in order to try and fix or help our trade deficit.”
Weeks said that the tariffs Trump imposed on China are having a positive effect on the economy so far.
“There’s a lot of indicators you can use to measure how an economy is doing compared to the past,” he said. “One of those is unemployment rates. Right now, I think it’s the lowest it’s been since 2000, it’s somewhere around 3.8 percent.
“You can use the gross domestic product. I believe at the end of President Barack Obama’s second term the GDP was around 1.8 percent and right now GDP is 4.2 percent, so we can see GDP has more than doubled since Trump took over. We can see what the stock market has done since President Trump took over so I think (the tariffs) are already having an impact and, according to the data, it’s a very positive impact.
“I think what a lot of people need to do is kind of put aside their personal feelings — we all have personal feelings for this or that kind of candidate — we need to put that aside and just look at the facts.”
Watanabe said that the trade war with China is a lot like the Smoot-Hawley tariff act of 1930.
“(That tariff) greatly exacerbated the Great Depression,” he said.
The Smoot-Hawley tariff act implemented protectionist trade policies and resulted in raised tariffs on more than 20,000 U.S. goods. The retaliation of the tariff act by America’s trading partners reduced U.S. imports and exports by more than half during the Great Depression.
However, Weeks said the overall economic impact of the current situation is hard to say.
“I don’t think it would ever get to the point of a full-blown trade war because we need China and China needs us,” he said.
Story by Olivia Malick, UP managing editor