US President Trump has been strikingly consistent in his trade stance. He argues that, abetted by US leaders, foreign countries have taken advantage of the United States in trade. He wants to end this practice.
He is struggling to find a way. His campaign rhetoric about imposing a large tariff on imports from China was quickly cast aside. It was replaced by some passing interest in a “border adjustment tax”, which, as envisioned, would have taxed all imports into the US, while making exports tax free. This was initially to be part of the tax reform, but was dropped ostensibly due to the complexity, but it also a near-certain challenge at the World Trade Organization.
The US President has not given up. This week take of “reciprocal tax” has been resurrected. The idea here is that the US should match other countries’ tariff on US goods. Commerce Secretary Ross has already suggested how it would work. The EU puts a 10% tariff on auto imports from the US. The US puts a 2.5% tariff on auto imports from the EU. Ergo: the US should raise its tariff to 10%.
Although the US President’s intent is clear, the reciprocal tax idea is a non-starter for the same reason as the border adjustment tax, and speaks directly to our belief in the resilience of the global liberal trade regime. The US helped erect a multilateral rule-based system. The rules were designed to prevent defections and apply to the US as well as other members. The US tariff schedule, especially for goods, is not hardwired into the WTO and to change it would require negotiations with all the WTO members, and they may have little incentive to acquiesce.
Trade is considerably more complicated than many economic textbooks suggest. Trade is not primarily finished goods crossing national frontiers, but intermediate goods, frequently part of global supply chains, that can cross borders many times, and often moving within the same company (intrafirm trade).
There are two ways to measure tariffs. The first is straightforward and blunt. One finds the average tariff rate. In the US, for example, the average tariff is roughly 3.5%. In comparison, China’s average tariff is near 10%. The second measure weight the tariff by trade volume. The trade-weighted tariff in the US is about 2.4%, while China’s is near 4.4%.
The EU’s average tariff is near 5%, but the trade-weighted measure is about 3%. Japan’s average tariff is roughly 4.5% and its trade-weighted average is a little below the US at 2.1%. When countries identify sectors to be protected behind a high tariff for whatever reason (e.g., protect an infant industry, cultural values, or national security), it may lift the average tariff, while if it is a small sector, it may not have as much impact on the trade-weighted measure.
The Trump Administration see that if a European producer (e.g., Volkswagen) assembles an auto in Mexico. It can be imported into Europe duty free, but Europe would slap a 10% tariff on the auto import if it were from the US. It sounds unfair, but it is not. The EU and Mexico have a free-trade agreement. The US and Mexico have a free-trade agreement. The free-trade agreements typically lower the tariff schedule from the generalized WTO agreement. That car that Volkswagen makes in Mexico can be imported into the US duty-free too.
However, the US does not have a free-trade agreement with the EU. The Trump Administration has expressed its frustration with NAFTA and has eschewed multilateral trade agreements in favor of bilateral agreements, but the American First agenda may be deterring interest in bilateral agreements with the US. In addition to NAFTA, the free-trade agreement with South Korea is being re-negotiated.
The other check on the power of the US President to impose his will on trade is Congress. The power to regulate trade is given the Congress. The House of Representatives seemed more sympathetic than the Senate to the border adjustment tax, and may be more sympathetic to the Administration’s “reciprocity” talk. However, the Senate’s support is also necessary. Another mitigating factor is the midterm election in November. Polls and betting websites suggest that the Democrats may win control of the House, but may not be able to secure the Senate.