The United States will choose its next president next month. One of the issues raised in the campaign could have a significant economic impact on consumers and investors alike. Donald Trump says that if he is elected, he will put (unspecified) high tariffs on all imports from all over the world. The costs of these tariffs, he says, will be borne by foreign workers and foreign industries and will result in billions and even trillions of dollars for the US Treasury. Considering how tight the presidential race is, it might just be wise for investors as well as ordinary consumers to consider tariffs and your investing as well as day to day purchases.
What Is a Tariff and What Is Its Purpose?
Tariffs, as noted by Investopedia, are taxes imposed at the border of a country on goods arriving from outside of the country. Although the tariff is paid by the importer, who really pays tariffs are those who purchase those products. In other words, the cost of tariff is passed on to the consumer as a penalty for buying a foreign product when a domestic one might be available. When domestic products are not available a tariff is simply a tax paid by the consumer. The reason for tariffs on things like Marlboro cigarettes in many countries around the world is simply to raise tax money without being seen to impose taxes. The other reason for tariffs is that by raising the price of a foreign made item it makes a domestically produced item more competitive.
The Effects of Tariffs on Consumers
The World Bank published a set of graphs showing effects of tariff revenue on consumer’s money and their welfare. A quick explanation of what they show is that tariffs make people poorer by making goods more expensive. And they harm consumer welfare in other ways by taking money out of circulation and putting it in the federal treasury. Because tariffs protect domestic industries, many have no need to make themselves more efficient or to reduce their profits in order to compete. While this may be of benefit for workers in a given industry it is also a benefit to millionaires who own and run companies that are inefficient and otherwise noncompetitive.
A Result of the Smoot-Hawley Tariff Act Courtesy of Encyclopedia Britannica
What Were the Smoot Hawley Tariffs?
Before looking at the effects of tariffs on industries and individual investments, it is useful to take a stroll back in history to 1930 and the Smoot-Hawley Tariff Act. The stock market had crashed the year before and the economy was in a recession. Congress passed a tariff bill in order to protect, primarily, American agriculture. The bill specified tariffs on more than 20,000 imported goods. For 900 goods tariffs were raised by 40% to 60%. This action was supposed to protect American agriculture and the economy at large and get the country out of its recession. When other nations retaliated these tariffs became a leading cause of the Great Depression. (Corporate Finance Institute) As a result of the tariffs US farm exports fell by a third and all US exports fell by two-thirds. The Great Depression lasted the rest of the decade and only got better with government spending for World War II. This was despite the government under President Roosevelt reversing the tariffs in 1933. In other words, unwise use of tariffs can hurt the economy and the effects can endure for years even when changes are made.
Effects of Tariffs on Your Investing
As noted in the Smoot-Hawley example, if widespread tariffs are used they can incite a trade war and damage all economies and therefore virtually all investments. Other effects are that protective tariffs can make industries less competitive, innovative, and prosperous over time. When a company has no economic reason to make any changes in their operations and can still make money that company starts to have a lower and lower intrinsic value over time, especially if at some point tariffs are reduced or removed.
Who Gets Tariff Protection and Who Does Not?
A common reason for imposing tariffs on foreign products is to protect industries that are critical to the national defense such as defense manufacturing, space technology companies, high speed computing, etc. However, we see tariffs on imported cut flowers, sugar, meat products, etc. These tariffs may indeed help protect domestic industries and workers but they can also be seen as political favors for campaign contributions. In such cases, businesses need to spend money supporting politicians year after year in order to keep receiving patronage and those companies without powerful patrons will fail to receive such perks even when their reasons for receiving tariff protection may well be much better. This area can be a hotbed of political patronage and favoritism making investment decisions in such industries a problem.
Effects of Tariffs on Small Businesses
Many times, small businesses rely on imported items which they include in their final products. Thus, tariffs can be a burden on small startups and favor larger businesses that typically include virtually all parts of a supply chain in their business operations.
Tariffs Versus Poll Taxes
Something that is undisputed is that tariffs are a regressive tax. They affect those with lower income disproportionally more than they affect the wealthy. This is because everyone has basic needs that they need to pay for no matter what their income or wealth. Many at lower income levels use up all of their income on necessities and for these people a ten for twenty percent increase in spending means destitution. A poll tax is a tax levied on every adult or tax payer. The tax is equal across the board for folks like Elon Musk, Jeff Bezos, or Bill Gates versus the part time waitress who serves at the local diner. Poll taxes are generally not popular when proposed because people see that they are basically unfair. However, tariffs that function much the same way as a pole tax are typically promoted as a way to protect industries, jobs, and to raise money without noting that they work pretty much like the poll tax.
Investing in a World of High Tariffs
Assuming that high tariffs do not lead to an all out trade war and global depression, how should you invest in a high tariff world? One approach would be to seek out companies that benefit from high tariffs. This search should start with defense contractors like Northrop Grumman, Lockheed Martin, Raytheon, General Dynamics or Boeing. If SpaceX ever becomes a publicly traded company, it would certainly be in this group. Other choices may be a bit iffy because you have to find out who is reliably getting political patronage in the form of tariff protection for their products. In this regard we recall the news anchor trying to keep a straight face years ago when reading the news about how US maraschino cherry producers were asking for trade protection as a critical industry!