In Breaking Down the Effects of 2018-2019 Tariffs on America’s Global Manufacturing Sector (forthcoming) Aaron Flaaen and Justin Pierce of the Federal Reserve Board write:
The unprecedented increase in tariffs imposed by the United States against its major trading partners in 2018-2019 has brought renewed attention to the economic effects of tariffs. Although many theoretical and historical books document the effects of changes in trade policy, it is unclear how the previous estimates work in the absence of almost any contemporary episode of large, advanced economies raising tariff rates comparable to the US during this period. Another difficult measure of cost impacts is the rapid expansion of interconnected global supply chains, where prices can have an impact through channels beyond their normal effect of limiting import competition.
Another important aspect of these costs is that they were imposed, in part, to improve the US manufacturing sector by protecting against what were considered unfair trade practices of trading partners, especially China. Therefore, understanding the impact of manufacturing costs is very important, as some may view the negative effects of tax increases documented in existing research—including higher prices, lower consumption, and reduced business investment—as an acceptable cost to improve manufacturing activity in the United States.
…on the other hand, US import tariffs may protect some US manufacturers from import competition in the domestic market, allowing them to gain market share at the expense of foreign competitors. On the other hand, US prices are also imposed on intermediate inputs, and the associated increase in costs may harm the competitiveness of US firms in production for both export and domestic markets. In addition, US trading partners have imposed retaliatory tariffs on US exports of certain goods, which can also put US firms at a disadvantage in those markets, compared to their foreign competitors. Distinguishing the effects of these three channels and determining which effect dominates is a very important fundamental question.
…Our results suggest that the common use of trade policy as a tool to protect and promote domestic manufacturing is complicated by the existence of interconnected global supply chains and the retaliatory actions of trading partners. Indeed, we find that the impact from the common channel of import protection is completely offset in the short term by reduced competition in retaliation and especially by higher costs in downstream industries…[the] the net effect is a relative reduction in productive employment.
Most famously, Whirlpool predicted that higher prices for washing machines would be good for Whirlpool’s profits, but their excitement turned to disappointment when they realized that higher prices for steel and aluminum would increase their input costs.
Hat tip: Kevin Lewis is fantastic.
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