The president's sudden announcement recently of tariffs on steel and aluminum imports has caused quite the stir among markets and media alike. The use of tariffs cast a classic debate about protectionism and domestic labor markets. On one side you have the mainstream economic opinion, born by empirical research, that the outcome of tariffs is net negative for countries imposing them. And on the other you have those who believe that tariffs should be used to shield domestic labor from competition with comparatively low wage global labor markets. This conversation is indeed important again with the election of President Trump, who ran explicitly on the platform of more protectionism and now has officially announced his intention to tariff steel imports at 25% and aluminum imports at 10%. I'll start my dissection by defining the areas of the economy affected by the tariffs.
Global Trade: The purpose of protective tariffs is to make imports more expensive, making domestic products cheaper by comparison. This means that domestic consumers will consume more domestic products and fewer imports, assuming the tariff pushes the import price above the domestic price. The preferred outcome is that domestic markets, including their labor markets, will benefit from protective tariffs inducing greater domestic production. The effect is to reduce global trade between countries who normally exchange the newly tariffed goods. Usually tariffs are defended on the grounds that low-wage countries arbitrarily keep their wages and import prices low with subsidies and government bail-outs, and since this prevents efficient market equilibria, tariffs are justified.
Domestic Prices: Depending on the good being tariffed, there will still be a significant impact on domestic goods prices. Because tariffs raise the price of imported products, including those used in the production of other goods, tariffs can also increase the cost of production to domestic producers. Who will then pass along this increased cost to consumers in the form of final goods price increases. While protective tariffs may benefit the specific industries being tariffed, they may also cost other industries who rely on imported goods for production. Further, some domestic consumers will no doubt also prefer imports. These consumers will now face increased international prices due to the tariff, and may simply pay that increased price instead of substituting to the domestic good.
Domestic Labor Markets: The sector whose benefit the very justification for tariffs rests is the domestic labor market. It isn't enough for an industry to produce more goods, policy makers want increased production to lead to increased employment. This creates a multiplier effect from the improvement in the domestic economy from increased domestic production as a result of the protective tariff. However, if the labor market doesn't see improvements then the multiplier is muted and the benefit to the broader economy equally so. It is crucial to the success of a tariff that it creates large structural changes to the domestic labor market, otherwise the benefits are likely to be very small and only concentrated in the few markets directly concerned with the tariffed good.
So, the question on steel and aluminum is will the Trump Tariffs create large-scale improvements in domestic steel/aluminum production, employment, and subsequently domestic economic outcomes? First we must ask if the tariffs will cause a substantial increase in international steel/aluminum prices. At 25% for steel and 10% for aluminum, the Trump Tariffs likely represent significant price increases for imported steel/aluminum, of course the steel tariff being the more impactful of the two. I would expect the trade between U.S. and steel/aluminum exporters to significantly reduce.
Second we ask if the tariffs will result changes to domestic products who use steel/aluminum in their production. Again, the sizable tariffs will cause domestic producers to pay increased prices on imported steel/aluminum who will no doubt pass these cost increases on to consumers. The effect here is that domestic real wages fall as prices rise due to increases in production costs. The real question is whether this decrease in real wages is buoyed by any increase in wages as a result of increased production among domestic producers. We can expect that the tariff will moderately increase domestic production of steel/aluminum, but since these industries are relatively small in the broader U.S. economy, we wouldn't expect wage increases to occur other than maybe within the steel and aluminum industries.
Lastly, we come to the potential impact on domestic labor markets. The steel/aluminum domestic labor markets will most likely see moderate improvement as a result of the tariff. But, again, since the steel/aluminum employment is a very small portion of the economy, the improvements to the domestic labor market will be muted. In fact, since there are more jobs tied to industries which use steel/aluminum as inputs than there are in actual domestic steel/aluminum production, the impact on the domestic labor market may in fact be net negative. The 2002 steel tariffs for example resulted in net job losses in the U.S. economy.
And of course none of this even discusses one of the most worrisome aspects of protective tariffs, retaliation. Suffice it to say there is a reason that mainstream economists do not favor the use of protective tariffs to assist domestic labor markets.