The Art of a Bad Deal

On Thursday, February 28th President Trump announced new tariffs on imported steel and aluminum. Our trade partners and allies are outraged at this unilateral move that was done without discussion or negotiation. Many Republicans (as well as White House staff) were flabbergasted at the sudden move, which came without consultation with leading party bigwigs. In fact the only people that praised the move were Democrats, union leaders and steel manufacturing CEOs.

The unilateral imposition of tariffs is nothing new. George W. Bush tried the same thing in 2002 when he raised the tariffs on various steel products from 8 to 40 percent. His move was met with outrage very similar to that of President Trump’s proposal. The European Union and others filed cases proposing retaliatory tariffs on US products with the Dispute Settlement Body of the World Trade Organization (WTO), which agreed and authorized our trading partners to impose billions of dollars of new tariffs.

Our trading partners are not dummies. Their new tariffs were on US exports from important swing states such as oranges from Florida and autos from Michigan. The US threatened to continue the tariffs on steel despite the WTO ruling but fairly quickly backed down and rescinded the tariffs. The whole process took about a year and a half to run its course during which the US notched a slight increase in domestic steel production. Economists, however, estimate that about 200,000 jobs outside the steel industry were lost. The Bureau of Labor Statistics showed that employment in primary metal industries (which includes steel) fell almost 50,000 during the same period despite the tariffs.

So what is different in steel tariffs round two a la Trump that makes this an even worse deal than President Bush’s fiasco? And why is he spending so much political capital on a losing proposition? I have always said that you can make a good deal with bad assets and you can make a truly horrendous bad deal with good assets. These tariffs look like a particularly bad deal. What reason could he have to enter into such a bad deal?

On March 2nd, President Trump tweeted:

We must protect our country and our workers. Our steel industry is in bad shape. IF YOU DON’T HAVE STEEL, YOU DON’T HAVE A COUNTRY!

Let’s take a look at some of the reasons that may be behind President Trump’s proposed action.

No Employment Impact

According the American Iron and Steel Institute the US steel industry employs around 140,000 people directly and almost one million indirectly (of course, most of those indirect jobs are indifferent to whether the steel they use is domestic or imported). The same institute also notes a five-fold increase in steel labor productivity since the 1980’s going from 10.1 man-hours per finished ton to 1.9 man-hours per finished ton in 2015. Most of the lost steel jobs have been due to technology and not to competition. Voestalpine’s plant in Austria produces a half million tons of steel annually with only 14 workers. The Higher tariffs will not do much to increase steel employment as technology continues its relentless march.

Final Blow to NAFTA

Unlike President Bush’s steel tariff, President Trump’s proposal applies the tariff to steel and aluminum exports from our neighbors Canada and Mexico. Over the weekend he tweeted that the tariffs will continue until Mexico and Canada submit to his demands. President Bush excluded them not only because they are our friends and allies, but more importantly because doing so would violate the terms of the North American Free Trade Agreement (NAFTA) (originally signed by his father, George H.W. Bush, along with Mexican President Salinas de Gortari and Canadian Prime Minister Mulroney). Chapter 19 of NAFTA subjects antidumping and countervailing duties to a binational review panel. Companies harmed by the new tariffs can also sue under Chapter 11. The proposed tariffs on Canada and Mexico would be a final blow to the renegotiation and updating of NAFTA and would lead to the dissolution of the agreement. Whether you are pro or anti-NAFTA, the abrupt termination of the agreement would create severe economic turmoil that would harm all three nations and their citizens.

Not Strategic

President Trump has cited the strategic importance of the steel industry for national defense as a justification for protecting our domestic industry (which can be permissible under WTO terms in certain cases). And he is correct if the next war we fight is going to be a repeat of World War Two. But that’s not going to happen. The F-16, introduced in 1978, is only 8% steel. The updated 2005 F-22 is only 6% steel. I couldn’t find any steel in the F-35 which is made mostly composite materials or in the MQ-9B Reaper drone. If the next war were going to be fought with aircraft carriers and tanks, the steel industry would be vital to our defense. My brother was in the Navy and sailed LSTs, which stands for Landing Ship Tank and was used to land our troops on islands all across the Pacific in WWII. But my brother told me that LST actually stood for Large Slow Target and that is what our steel-laden aircraft carriers and tanks will be on the next battlefield.

Weaken Relations with Allies

Even if a strong steel industry was in our strategic interests for national defense, so are the relations with our allies around the globe and especially with NATO. A trade war precipitated by these tariffs would not only be devastating economically but would also weaken our ability to defend our country and maintain peace in the world. China’s Brobdingnandian levels of steel and aluminum production are not just a US problem; they are a global problem. And global problems need a global solution. We need our friends and allies to help counter China’s mercantilist actions.

China Unaffected

It is undeniably true that China dumps its steel and aluminum on the world market and it is also undeniably true that this impairs the ability of US steel producers to compete in that world market. But raising tariffs on US imports will do little to change that world market. It will raise the cost of products made from steel imported from Canada and Mexico our two largest steel suppliers but will do nothing about all the other products we import that are made from Chinese steel. We could, of course, create new tariffs on other products that contain Chinese steel but I think you can easily see how the complexity of international trade relations makes these simplistic solutions unviable.

Fatten Wallets of Steel CEOs

One thing that the tariffs are certain to do is to fatten the wallets of the steel CEOs that visited President Trump last weak. Nucor Corporation, the largest US steel producer (which was previously headed by Trump advisor Dan DiMicco) has a return on equity of 15.92%, which exceeds the ROE of the total market (excluding financials) of 14.54%. The new tariffs will allow producers of steel and aluminum to increase their ROE, which will go to executive compensation and (if they are lucky) to shareholders.

So, given all the above reasons why raising tariffs is a dumb thing to do, why is President Trump raising tariffs on steel and aluminum, threatening to raise tariffs on other goods, and laughing off a potential trade war? I dunno. Unless he is a dumb fuck that doesn’t know shit about international trade. Or a bully that pushes other people around just because he can. Sorry. Can’t say that. It’s not respectful.

If President Trump is using these tariffs to browbeat our neighbors into submitting to his demands on NAFTA, then shame on him. If his aim is to strike back at China’s excessive steel production then his blunderbuss approach is hitting just about everybody but China. Any way you cut it, these tariffs are a poor way for the leader of the free world to act. It may not do much to stop our headstrong president, but I am sending a copy of this essay to my elected representatives. If you agree you should also let your representatives know as well.