• Abiye Alamina

Why Trump Could 'Win' on Tariffs

Going against trade policy advice from his now former chief economic adviser, against pleas from members of his party including key leaders, and against objections from key US political allies, Trump went ahead to impose 25% tariffs on steel imports and 10% tariffs on aluminum imports, excluding temporarily only Canada and Mexico pending the outcome of NAFTA negotiations.

This has left many scratching their heads. You do not 'win' Trade wars. So what exactly is Trump gambling on here? Why might he actually win?

It is surmised that we have here a confluence of good old redistribution politics, a prepped environment, and strategic maneuvering , which combined could see Trump actually 'win' on this. This is perhaps what he is banking heavily on.

Redistribution Politics

There is the strictly political angle, which any political analyst knows about. Trump campaigned strongly on the basis of revamping American manufacturing including steel production, and on protectionism, and won. This is simply a policy nod to his base by fulfilling a campaign promise.

At some level, this move could be a political winner, because while the impact of the tariffs is also expected to affect some other manufacturing industries adversely, so long as costs can be passed on to consumers, these businesses may see no issues with the tariffs.

Further, on the consumer side, there are apparently many Americans who think little or see no relationship between tariff policies and the economy as a whole, so the tariff in effect delivers political net gains.

This tends to be the case when policy is explicitly redistributive. It provides concentrated visible benefits, but spreads the costs throughout the economy. This is usually the case with protectionist policies and this is one such instance.

It is difficult to see any problem, much less to blame anyone for any observable bad outcome, which could very easily be confounded by other plausible explanations: if higher prices are observed, we are not likely to blame it on tariffs but perhaps on a tightening economy etc.

Prepped Environment

Now couple the preceding with the fact that while we should expect prices to go up as a result of these tariffs, we are also seeing at the same time higher wages from both Tax Reform policy and from the economy operating at full employment levels.

If the prices of goods somehow related to higher steel and aluminum prices are going up, but wages are also going up because the economic environment is pushing them up, consumers may therefore not notice any impact on the purchasing power of their incomes.

This is also true for those businesses which might face higher costs in light of the tariffs. Tax reform by design was overly generous to businesses of all stripes, so whether these are the businesses that use aluminum and steel inputs, or they are the ones exporting products, that might be hit with retaliatory tariffs, the impact of possible higher costs as events unfold will be mitigated by the benefits from tax reform law.

In other words the present environment is already prepped, even if inadvertently, to blunt the negative impacts to be expected from the tariffs.

Strategic Maneuvering

But there is more. The presumption of a trade war resulting is the expected rational outcome from Trump's tariffs, and all the pundits have focused on this, but we could be in a trickier political situation.

When trade wars are expected to occur, it is known or believed that all sides suffer, and most models even assume that the suffering is symmetric.

In practice this is seen in the standard rhetoric from trade partners that they will retaliate by imposing their own tariffs, and somehow this is combined with the notion that the imposing country is taking those steps with fingers crossed, that retaliation will not happen.

It is then plausible for countries to conceive of their trade policy interactions as a coordination game and rational to avoid the trade war by choosing not to restrict trade.

However, given the confluence of the attractiveness of redistributive politics, and a prepped environment, what may be the more apt game that countries could play is a war of attrition.

In other words, the foregoing, by introducing asymmetries in the payoffs - whatever suffering we would have experienced from the tariffs and any retaliatory tariffs will be mitigated, which is not necessarily the case for our trade partners- creates opportunities for Trump to restructure the 'game' as a war of attrition and to win.

War of Attrition?

In a war of attrition, opposing sides engage in a war where the strategy involves trying to wear the other side out. The war is therefore typically won by the side having the greater amount of resources, or perhaps, the one with the will and ability to hold out the longest.

So how does this apply to the current tariff scenario?

The US steel tariffs will affect in large part the following trade partners: Brazil, South Korea, Australia, the EU and China and Japan.

The EU has outlined plans to impose tariffs on select products that should affect adversely industries and production in some US states that could put electoral pressure on legislators from those states. The plans include possibly targeting Bourbon, Harley-Davidson motorcycles, and Levi’s jeans, all targeting production from states represented by the Senate majority leader, the House Speaker and the House minority leader respectively.

China holds its own possibilities of retaliation in the areas of largely agricultural products including soybeans, many of which are produced in states that Trump won in.

Japan and South Korea have also talked tough, warning largely that trade wars are likely to result from these and so suggest that they would single out American exports to their economies for tariffs in retaliation.

Brazil also has responded suggesting that it may take action on its coal imports from the United States by looking elsewhere which would have an adverse effect on the coal industry in the US, as Brazil are the second largest importers of US coal, after the Netherlands.

Australia however, though not a major exporter to the US, has taken a more conciliatory approach, warning against a trade war being bad for all involved, but hoping for exemptions from the tariffs.

The question though is, should these countries choose to respond with retaliatory tariffs on US exports to their countries, would these inflict both visible and nontrivial hardship where it can really hurt Trump or/ and key Republican legislators?

Alternatively, can these countries hold out long enough for their retaliatory tariffs to affect, in a significant way, the ballot box implications such as would drive the Trump Administration to reverse action on the tariffs? The point being that as much as they are already hurt by the Trump tariffs, they also hurt themselves as well by imposing those retaliatory tariffs.

Attrition Wars: The Winning Strategy

There are a few elements that are important in winning a war of attrition. A commitment to fight, and the presence of superior resources relative to the opponent's. Trump has these locked up...

Credible Signaling

President Trump has taken a position in which he has signaled to the world a tariff position on steel and aluminum that he does not intend to back down from.

We have twitter and public comments on his knowledge of the possibility of a trade war and he has in no uncertain words said, “bring it on”. It is good, it is easy to win, we will win.

But talk might be cheap. Well, we have seen his willingness to part with his chief economic adviser over this issue, and to discard his party's advice on the tariffs, even though encouraged by leaders in both the House and the Senate to consider alternatives.

For all intents and purposes, we have to interpret all of this as a credible signal of Trump's commitment to fight.

Divide and Conquer

With respect to the tariffs, President Trump excluded Canada and Mexico. He has further opened up the possibilities of trade partners affected by the tariffs, if they choose, to come to the negotiating table if they want to be exempted.

A report from the New York Times on Friday, suggested that countries have already begun to jostle to for consideration for exemptions. For instance, Australia is taking a more conciliatory approach to the steel tariffs by lobbying several channels for exemptions. Even the EU while considering its options continues to make their plea for reconsideration as part of maintaining their historic trade relationship.

Without a unified stance against the US, it becomes harder for countries to do so on their own, as the cost becomes even greater for holding out and coming to the table late. This situation is akin to creating the 'superior resource' position for the US - the US opens up opportunities for countries to profitably deviate from any unified coalition, and this undermines the coalition. It then becomes a race to obtain exemptions instead of a coordinated retaliation against the tariffs.

Further, should any country agree to come to the table to negotiate and in effect obtain an exemption, it suggests that Trump's position on the current situation being biased against US workers rings true, reinforcing his position and unwillingness to budge with respect to other nations.

Why might countries seek unilateral deals to obtain exemptions? A war of attrition wears them out, it is too costly. It is optimal to deal early, especially knowing the other player - the US - will not be dissuaded from their position and, as explained earlier, have an environment prepped to mitigate their own losses.

Fight or Quit

The war of attrition involves a simple choice each country has to make. To fight on, or to quit. An unequivocal decision has been made by the Trump administration to fight. Will trade partners fight? Given the setting, it may not be in their interest to, unless they can coordinate and strike really hard so that the US electorate feel the effect, and care about that more than blind partisan loyalties.

In the standard analytical game of the war of attrition with symmetrical payoffs, the pure strategy Nash equilibria will have one player choose to fight and the other quit, and this happens immediately in the first period. In effect no costs are incurred. It thus pays the player who can credibly signal a willingness to fight to do so, and this will lead the other player to quit.

A mixed strategy Nash equilibrium for that game however has the probability that they will both fight increase only when the value of winning gets large, and the probability that they will not fight increases, if the cost of fighting looms large.

In this practical situation, from the setup, we have asymmetric payoffs where the value of winning is higher to Trump than it is to the trade partners. Trump is initiating this to appease his base by fulfilling a campaign promise. It also bolsters his reelection chances. The other countries on the other hand are simply reacting with no clear benefit associated with a decision by Trump to back down or not.

Similarly the cost of the war is smaller to Trump than it is to our trade partners. Our economic environment is prepped to mitigate the costs, not quite so for the other countries. The democracies among them will likely face electoral pressures from the resulting hardship imposed, and for countries like China, this may not be their fight, as the tariffs do not impact them significantly. Brazil has only just emerged from a very severe recession and to engage in a trade war will only worsen their plight.

The intuitively likely outcome then is that a trade war is averted as Trump (the US) fights and our trade partners acquiesce (quit). So Trump wins.

Egg on all our faces?

By all our faces I mean all the economists and pundits who predict a trade war resulting and many bad outcomes. Perhaps this will still materialize, but we have to wait to see how this plays out. To the extent that a trade war results, it will be on the grounds of particular countries engaging on the basis of principle, but it will likely be short lived, with these countries acquiescing.

Quite naturally a part of us wants the outcome to be the prolonged trade war in which Trump sees the error of his ways and where we can say, 'Mr. President, we told you so'.

Now we can only hope that if Trump wins that we will not see calls for a revision of all our models on trade. They still hold true, but a political win is not the same as an economic win. We still lose.

#steeltariffs #tradewars #tariffs #TrumpTariffs #warofattrition #protectionism

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