The Risk of Weaponizing Tariffs by Dr Balraj Kistow – February 2025

The Risk of Weaponizing Tariffs by Dr Balraj Kistow – February 2025

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The Risk of Weaponizing Tariffs by Dr Balraj Kistow – February 2025

The Risk of Weaponizing Tariffs

The ascendancy of Trump to the Presidency of the United States has once again moved US policies to the extreme right with some added bonuses in this new term.  This Republican government seems to want to impose its will forcefully not only on the domestic front but on a much broader international scope.  Not only has the President threatened the sovereignty of Canada and Greenland, but he has also unilaterally renamed the Gulf of Mexico, signaled an intention to reclaim greater influence over the Panama Canal, and pulled out of the Paris Accord and the World Health Organization (WTO).  Whether the latter was done in a manner that is in keeping with proper protocol and the rule of law is irrelevant here.  What matters is there is a strong signal of intent.

What is even more interesting is how this new administration has sought to weaponize the use of tariffs as a threat to other countries to impose its will on them.  Before the election, there was the threat of imposing a 25% tariff on Canada and Mexico, claiming that they were not doing enough to stem the flow of migrants and illegal drugs to the US.  In that same flurry, China was also threatened with the imposition of a 10% tariff on goods from that nation.  A few days later, then-candidate Trump threatened the grouping of BRICS nations with a 100% tariff should they introduce a currency to rival the US dollar.

What once seemed like a mere threat has now become a reality as the President has enforced a 25% on Colombia in response to its refusal to allow a military plane full of migrants, supposedly from that nation, to land at its airport.  This tariff would double to 50% in one week’s time.   Further, to show that he is keeping his election promise, the US government confirmed that it would impose a 25% tariff on goods from Canada and Mexico and 10% tariff on goods from China effective February 4th, 2025.  There was a lower rate of 10% on oil and gas coming from Canada.  This announcement triggered an immediate response from both the leadership of Canada and Mexico.  Canada announced retaliatory tariffs of 25% on $30 billion worth of goods from February 4th, 2025, and on a further $125 billion worth of goods coming from the US in three weeks’ time.  In the first instance, it would include American liquor like beer, wine and spirits, vegetables, clothing, shoes, and perfume.   The US has initiated a trade war with key trading partners without clear justification.

By definition, a tariff is a tax imposed on goods coming into a country at its point of entry.  It can be a flat specific amount or an ad-valorem tariff, where it is imposed on the value of the goods, as with the 7% online tax that was introduced by the Minister of Finance of Trinidad and Tobago in 2016 to deter online purchases in the face of increasing strain on the foreign exchange reserves.   The beneficiary of a tariff is the tax authority, which collects the tax imposed and the protected producer in the domestic market.  The consumers are the big losers when a tariff is imposed.  The extent to which the producer can pass on the increased cost from the tariff is dependent on the price elasticity of demand.  Economic theory also demonstrates the concept of a “dead-weight” loss which represents an overall inefficiency to society.

This is not the first time that the US has used tariffs as a means of driving its domestic political and economic agenda.  The problem is that the result is never good and has a strong potential to have far-reaching consequences on the global economy.  President Trump has tweeted that “trade wars are good and easy to win”.  However, history would show quite differently.  Experts point to the Smoot-Hawley Tariff Act passed in June 1930 by the US Congress to illustrate how tariffs can be “economic bombs” that can have significant negative outcomes for all, including the country imposing the tariff.

In 1922 the US Congress passed the Fordney-McCumber Act which raised tariffs on imported goods by 40% and became one of the most punitive protectionist measures passed in the country’s history.  European countries promptly retaliated, but this had little effect on US prosperity at the time.  US farmers faced increasing competition during the 1920s as European farmers recovered from World War 1.  This resulted in falling prices due to overproduction and US agricultural interests lobbied for the imposition of tariffs on imported agricultural goods.  During the 1928 Presidential Election campaign, then-Republican candidate Herbert Hoover promised to impose tariffs on imported agricultural goods.  When he won the election, other economic interests encouraged him to go beyond agriculture with the protectionist measures.

In June of 1930, the US Congress passed a bill sponsored by Reed Smoot of Utah and Willis Hawley of Oregon.  This Act was the last legislation under which the US Congress set actual tariff rates.  This Act came several months after the stock market crash of 1929 and at the time of the Great Depression of 1929.  The US however had not yet seen the full onset of the Great Depression and the thinking of the US Congress and then President Herbert Hoover at the time was that increasing taxes on thousands of imported goods, irrespective of which country they came from was a good way of protecting US farmers and securing the national economy.

US Economists and scholars argued at the time that the measure would not only hurt the US economy but have negative implications for the global economy.  The Bill narrowly passed Congress but made it easily through the House of Representatives.  Despite a petition from 1000 economists urging President Hoover to veto the legislation, he kept his campaign promise and signed it into law.

Once law was passed it triggered a fall in stock prices and when it was signed into law in June 1929, the stock market further plummeted, in anticipation of the negative outcomes.  The law raised tariffs by approximately 20%.  A group of 23 US trading partners protested the higher tariffs but it was ignored by the Hoover Administration.  Given this response, countries responded by placing their own restrictions on US imports.  Canada, the U.S. largest trading partner at the time, imposed extra duties on some American goods and cut tariffs on imports from the rest of the British Empire.

Within two years, some two dozen countries adopted similar “beggar-thy-neighbour” duties, making worse an already beleaguered world economy and reducing global trade.  This only made it harder for the US to pull itself out of the depression.  Imports became largely unaffordable, and people who had lost their jobs could only afford to buy domestic products which  led to U.S. exports falling from $7 billion in 1929 to $2.5 billion in 1932. Farm exports were down by one-third from their 1929 levels by 1933 and international trade plummeted by some 65%.  Foreign investors withdrew their money from the stock market resulting in widespread losses for investors as the stock market crashed (Figure 1)

The Smoot-Hawley Tariff Act did not create the depression but in the opinions of many experts, it certainly prolonged the depression and possibly deepened it around the world.  It has also been argued that the deepening of the depression contributed to the rise of political extremism that fuelled the political rise of leaders like Adolf Hitler.

Figure 1 – Impact of Smoot- Hawley Tariff Act on US Equities

Source: https://corporatefinanceinstitute.com/resources/economics/smoot-hawley-tariff-act/

Ultimately, the failure and the myopic logic of the Smoot-Hawley Tariff Act influenced the longer-term trade policy of the US.  In 1934, the newly elected President, Franklin D. Roosevelt, signed the Reciprocal Trade Agreement Act, reducing tariff levels and promoting trade liberalization and cooperation with foreign governments.  Since 1945, both Republican and Democratic presidents have generally pursued lower trade barriers and negotiated reciprocity agreements.  This position of promoting free trade by the US is also reflected in their leading roles in the General Agreement on Tariffs and Trade (GATT) agreements, the establishment of the World Trade Organization (WTO), and the initial establishment of the North American Free Trade Agreement (NAFTA).

For the most part, tariffs have been used as a defensive tool with the intention of protecting domestic industries.  However, whether it is the infant industry argument, where it is used to give new firms time to grow and develop, or to protect established sectors from international competition to further political agendas, the long-term consequences have never been good.  Latin American and Caribbean countries used the infant industry argument to justify an import substitution approach to economic development in the 1960s-70s.  What happened was that these industries never developed as they became dependent on tariff protection.  It was Over 1,000 experts warned the Hoover Administration of the negative consequences, but they still pursued the policy to the detriment of people all over the world, mainly to adhere to a political agenda.

Once again we are seeing a political agenda driving this new wave of tariffs.   The approach of this new Trump Administration, however, is to use tariffs as an offensive economic weapon against countries that he claims are responsible for fentanyl coming into the US.  This is not only an act of bullying but also callous, given the lessons of the past.  In a world that is much more connected and interdependent than the world of the 1920s, retaliation from countries could go downhill pretty fast to the detriment of the wider global economy.  This has already been set in train as Canada has already announced retaliatory tariffs and Mexico promising the same. Even more concerning, the US President appears oblivious to the dire consequences of these tariffs believing it is a good way to enrich the country.  Of course, the revenue from the tariff and making American-made goods more competitive might be the real reason for its imposition but this approach is taking the most advanced nation in the world 100 years back.

The lessons of the 1929 Smoot-Hawley Tariff Act have taught us that while tariffs may seem politically expedient in sending a message of protecting domestic industries, they come at a great cost to consumers and investors.   Consumers would pay more for products that are now taxed, and trading partners retaliate, leading to reduced international trade and income and a loss of investor confidence that depresses the stock market.

This is a fluid situation.  At the time of writing, the US and Canada have agreed to halt the tariffs for 30 days, staving off, for now, an eminent trade war.  This is most likely not the last twist in this saga. Both the Canadian Prime Minister and US government officials have warned their population to expect tough time ahead and made appeals to support domestic producers.  The US has also signalled that it would apply additional tariffs in response to the tariffs from Canada and Mexico, and President Trump has gone so far as to reiterate a threat to the sovereignty of Canada.  This is not where the world needs to be this time after coming out from the doldrums of COVID-19.  But this is what happens when persons in high office with great power adopt a myopic self-serving approach and seem to believe that it is a good thing.  History and economic theory tell us this would not end well if a trade war is to happen.  Leaders need to be mindful of the intricate and deep consequences of their actions.  Despite expert advice and pleas to the contrary, they somehow insist on pursuing policies that are detrimental to society for the benefit of ego and petty political gamesmanship.

In summary, history has repeatedly shown that protectionist trade policies, particularly tariffs used as economic weapons, often lead to negative consequences for both the imposing country and the global economy. The current trade war initiated by the Trump administration, warns that such actions can provoke retaliation, reduce global trade, and contribute to economic downturns.  We should learn from history, avoiding short-term political gains at the expense of long-term economic stability, and recognizing the interconnectedness of the global economy.

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