Monthly Archives: June 2018

Tariff Jumping FDI: Harley Davidson Not Made in the USA

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There is an entire strand in the trade literature called “Tariff Jumping Foreign Direct Investment.” The idea is that, instead of exporting, firms may move production locations to avoid high tariffs. This literature is equally well known as the Tariff-Retaliation literature, which outlines that tariffs are seldom imposed unilaterally, but followed by retaliation from countries that are hard hit.

Donald Trump has just provided two new case studies. His tariffs on European Steel produced retaliatory tariffs from the EU — The EU tariffs then induced Harley Davidson to move production out of the US and abroad to avoid the tariffs. As theory predicts, trade restrictions reduce national income and employment.  No one but Trump is surprised. perhaps with the exception of Peter Navarro.

In keeping with Trump’s previous attempts to micromanage multinational investment decisions, he  threatened  to tax Harley-Davidson “like never before.” His statements that “A Harley-Davidson should never be built in another country-never!” implies he is unaware that Harley Davidson is already a multinational company with factories in Brazil, India and Australia.

“IMF never again”: Argentinean Assessment Of The $50Bil IMF Deal

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“IMF never again” says this graffiti in Argentina. There is widespread suspicion in Argentina about the new IMF deal, reports the BBC. Why? If, as the IMF Managing Director stated that “As we have stressed before, this is a plan owned and designed by the Argentine government, one aimed at strengthening the economy for the benefit of all Argentines.” “At the core of the government’s economic plan is a rebalancing of the fiscal position,” reports the IMF. Why the cryptic language use of the fancy term “rebalancing,” and why are Argentines suspicious?

STEEL (Again): Trade and National Security

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Econfact  reviews the case of US steel tariffs, after the Department of Commerce concluded that under Section 232 of the Trade Expansion Act of 1962 (19 U.S.C. 1862(b)(1)(A)) steel and aluminum imports constitute a “national security threat.”

But wait there is more, on May 23rd 2018, the administration initiated a new investigation to determine whether imports of automobiles also threaten US national security.

Prior to the two Trump cases, the Department found national security threats in only two cases in the past 56 years (both involving oil). How could this be true? Well because the Department of Commerce recently adopted a new “definition” of “national security.” Commerce Secretary Wilbur Ross stated that

“National security is broadly defined to include the economy, ….to include employment, to include a very big variety of things… 

So national security = economy = a very big variety of things.

This raises an interesting question, what is the effect of a steel tariff on the economy. Since steel is an important intermediate input, the tariff implies higher prices not only for consumers but also producers (e.g., of cars). Here is a summary of the economic effects from Econfact:

  • “Imposition of these tariffs under the guise of national defense could have large negative economic effects even in the absence of retaliation. For instance, one estimate indicates a 40,000-job loss in the automobile industry (a heavy steel user) from the steel tariffs alone. With the expiration of exemptions on the EU, Canada and Mexico, some $50 billion of steel and aluminum imports are now covered by tariffs. One can expect the employment impact to be even more substantial. Adding in retaliation (but incorporating the now defunct exemption for Canada and Mexico), the consulting firm Trade Partnership estimated a net loss to the economy of 470,000 jobs. The Peterson Institute for International Economics estimates a 25 percent tariff on imported automobiles (currently at 2.5 percent for non-Nafta members, and 25 percent for trucks) would reduce employment by 195,000 over the course of three years. With retaliation, that number would rise to 624,000.”

Under the above definition of national security, maybe we should subsidize steel?

Trade Creation / Trade Diversion

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Menzie Chinn is getting exasperated, here is his post ad verbum:  Things I Never Thought I’d Have to Explain on Econbrowser: Trade Creation/Trade Diversion:

Suppose you (the UK) are in a tariff-ridden world, getting butter from your former colony and current Commonwealth partner New Zealand, the global low cost producer. Then you (the UK) decide to join a customs union that encompasses Denmark, which produces butter at a lower cost than the UK, but higher than New Zealand. In plain words, the tariffs between UK and Denmark on butter go to zero, while those between UK and NZ remain. Is the UK better or worse off?

This depends on whether the benefits of trade creation (increased amount of trade with the lowest cost producer within the customs union) outweigh the costs of trade diversion (no longer sourcing imports from the global lowest cost producer). This can be shown simply (albeit in a partial equilibrium setting):Trade creation UK butter diagram

Source: EconomicsOnline.

There is always a gross loss from trade diversion unless the global low cost producer is in the customs union. The question is the net effect. Is the home country better or worse off than before? This is an empirical question. If areas b and d sum to less greater than that of e, then benefits of trade creation exceed that of costs of trade diversion, and vice versa. (Assuming the marginal utility of a dollar to producers and consumers is equal, as is usually the case in simple welfare analysis.)

I never thought I’d have to explain this, but apparently I do, because of this comment:

…trade diversion was being presented as bad and due to the current ZTE sanction/tariff actions, but trade diversion has many other causes (taxes, sanctions, political changes, trade agreements, etc.) and is not necessarily bad. What amazes me is the the lack of understanding of the bigger picture surrounding Trump’s actions. Negotiation leverage may be manufactured and alleviated when needed.

and

Trade Diversion, a 1950s term/finding, was coined before the major implementations of the VAT. It assumes efficiency of production of products naturally means lowest price for products and subsequent purchases of them in international trade. The VAT changed that assumption. There are far more changes that impacted international trade since the 50s. It is, therefore, more difficult to determine the negative impacts of Trade Diversion on “NATIONAL” economies today than in the 50s.

The specific reference is Jacob Viner, “The Customs Union Issue” (1950).

If the US imposes sanctions on China and the rest of the world is in a global free trade area with the US (that is the idea of a WTO), and China is the low cost producer of, say, carpet sweeper parts, it may very well be the case the benefits outweigh the costs. It depends.

To my knowledge, imposition of a VAT does not change the analysis. In fact, all it does is make the relevant costs inclusive of taxes and fees. One might as well say the presence of sales taxes invalidates the trade creation/trade diversion analysis. (In point of fact, I suspect that since a VAT is typically less distortionary than other taxes, the idea of VATs invalidating the analysis makes the least sense — but I’m not an expert on this issue, so I leave to others to debate).

I could see that the development of global value chains might impact the standard analysis. However, to the extent that rules of origin along with content requirements are in force, I don’t see how. About the only thing I can think of that might affect the bottom line is macro in nature; in a world with exchange rate fluctuations, who is the lowest cost producer might vary over time (depending on the extent of the cost advantage; if it’s sufficiently large, the lowest cost producer might remain the lowest cost producer, although profit margins will then vary).

GrExit, BrExit, now ItExit

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The recent political crisis in Italy has given rise to expectations that President Matarella has in effect launched a referendum on the EU/euro. This makes for a wonderful application to study interest parity. The Wall Street Journal’s Daily Shot Blog as (as usual) all the relevant graphics: Italian 2 year bond yields experienced the greatest one-day increase in years (NB: yields were negative just a few days ago!): Source: Bloomberg

 

And, to complete the interest parity case study, here is the 10 year Bond Spread to Germany, which has the identical currency!

And then there is contagion with immediate spillovers into Spain and Portugal, as their CDS Spreads* and Bond Spreads widen:

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[*CDS or a Credit Default Swap is referred to as its “spread,” and is denominated in basis points (bp), or one-hundredths of a percentage point. For example, right now a Citigroup CDS has a spread of 255.5 bp, or 2.555%. That means that, to insure $100 of Citigroup debt, you have to pay $2.555 per year]