Stupid or Liar: Tariffs

Is Donald Trump stupid and honestly believes that China pays his tariffs or is he a liar who doesn’t want American voters to understand that they’re the ones paying? Tariffs on Chinese goods are simply an additional tax on the American consumer and it’s really a pretty simple thing to understand.

Let’s say a Chinese manufacturer makes a thingamajig. The cost per unit is $100 and they sell it to an American retailer for $120. The American retailer then sells the thingamajig for $144 to an American consumer. Now let’s say the United States government imposes a 25% tariff on the thingamajig made in China. The cost per unit is now $125 ($100 + $25 tariff). In order to maintain their margin, the Chinese manufacturer raises the price of each thingamajig to $150 when they sell it to the American retailer. In order for the American retailer to maintain their margin, they have to sell the thingamajig for $180.

It may be true in the sense of who “writes the check” to the US Treasury for the cost of the tariff that it’s paid by the Chinese firm. However, who is actually bearing the cost of the tariff? The Chinese retailer maintains a 20% margin (20/100 = 20%, 25/125 = 20%) and the American retailer maintains a 20% margin (24/120 = 20%, 30/150 = 20%), but it’s the American consumer whose thingamajig now costs 25% more (36/144 = 25%), the exact amount of the tariff.

As you can see from this example, tariffs are simply a tax on the American consumer. An argument can be made that the increased cost of thingamajigs will lead to less demand from consumers. This would hurt the Chinese firm’s bottom line because they will sell less thingamajigs unless they accept lower margins, i.e. bear some of the cost of the tariff instead of passing 100% of it onto the American consumer. In theory, this would make locally-produced thingamajigs more competitively priced and/or force the Chinese manufacturer to build a factory in the United States in order to avoid the tariff altogether.

The problem with this theory is that China no longer just makes t-shirts and cheap plastic knock-offs. Chinese firms are increasingly producing high-value products that compete with American and western firms on more than just price. Chinese technology and manufacturing quality is on par with, and in some instances may even exceed, what American and western firms are capable of.

In sectors where final products from western firms are still preferred, many small internal components are produced in China and then assembled locally in countries where they’re sold. It will be extremely costly for these supply chains to be re-routed back to the United States and for the internal components to be produced there instead.

The cost of rerouting supply chains back to the United States will certainly be passed onto the American consumer. At the end of the day, while a locally-made thingamajig may be cost-competitive with one made in China after accounting for the cost of tariffs, it will very likely still cost more than the $120 pre-tariff price tag from the example I provided earlier.

When China was admitted to the World Trade Organization in 2001, it marked a great leap forward in the globalization of supply chains. This allowed American multi-national corporations to send expensive manufacturing jobs offshore to China and save a boatload of money. These savings boosted profit margins to record highs and the windfall largely flowed upwards into higher pay for executive and massive returns for shareholders, even after the Great Financial Crisis. The workers whose jobs were sent overseas received little in return, especially after the Great Financial Crisis. Let me be clear, these jobs were not “stolen” through unfair Chinese trade practices, they were sold in exchange for compensation.

Few in the political establishment had a problem with this until China started to assert itself around the world both economically and militarily. In 2014, China stopped using the dollars we sent them to buy United States Treasury Bonds and instead starting loaning dollars to developing countries to build large-scale infrastructure projects. As outlined in Confessions of an Economic Hitman, this is a scheme the United States had been the dominant player in for decades, but was now facing stiff competition and in fact losing out handily in many cases.

The United States cannot be wholly reliant on Chinese manufacturing and technology in order to function if they wish to counter China’s rise as a global superpower. China would be in a position to cripple the United States economically if the status quo remains unchanged. An economic crisis would seriously limit the capacity of the United States to stand up to China militarily on a sustained basis were a flashpoint to occur between the two countries.

One apparent solution to this problem is to reroute existing supply chains out of China and back to the United States. In the long run, this will certainly increase the United States’ domestic manufacturing capacity and secure a higher level of independence from bottlenecks within the global supply chain. However, one must ask, who will pay the high cost of de-globalization?

As I showed in the example earlier, American consumers are undoubtedly the ones who pay the tariffs that aim to force a re-organization of global supply chains. Middle class workers paid dearly 20 years ago when their jobs were off-shored to China and the gains went straight to the bottom line of American corporations. Now the American middle class is being forced to pay higher prices in order to cover the cost to corporations of re-shoring all that manufacturing capacity. At the end of the day, these tariffs aren’t about forcing China to “play by the rules” or “level the playing field”. These tariffs provide cover for American corporations so that they can keep the windfall they received for selling out American workers.

Fool me once, shame on me. Please don’t be fooled again.