When Zero-for-Zero Tariffs Are a Bad Idea
Q. Did we learn anything from the shortages we experienced during the pandemic?
Before answering that question let’s start with a refresher: when the pandemic hit, we ended up with shortages of masks, personal protective equipment, and ventilators. People, including frontline workers, died. Once the People’s Republic of China locked down as a result of the pandemic, shortages affected an even wider range of goods.
Free Market Fundamentalism and Shortages
We know why those shortages happened. The approach to globalization that prevailed from the end of the Cold War to the pandemic was, at its core, an internationalized version of trickle-down economics. The negotiations that led to the creation of the World Trade Organization were launched during the Reagan Administration and, accordingly, Milton Friedman-esque in their orientation: free market fundamentalism good, government bad.
That approach meant that the system was designed to give corporations as much latitude as possible to maximize returns; as a result, governments saw that they could attract investment by depressing production costs, undercutting others through mechanisms like labor rights suppression, lax environmental enforcement, and subsidies. The PRC did a bangup job on cost suppression and ended up becoming the world’s “factory floor.” A lot of economists would call that “efficiency.” A lot of other people would call it a “race to the bottom.”
The efficiency crowd thought that having the PRC make a lot of our stuff was a terrific outcome.
Then the pandemic hit, and the “efficiency” of supply chains turned out to be lethal.
Zero-for-Zero Tariffs and Concentrated Supply Chains
A frequent response to Liberation Day has been a recommendation to negotiate “zero-for-zero” duties. That sounds reasonable, since zero-for-zero duties are, in fact, reciprocal. Zero-for-zero duty proposals are, however, a tool from the pre-pandemic trade toolbox.
Let’s walk through what happens when the United States reduces its duties to zero, and see how it contributes to supply chain concentration.
Producers can offshore to places like the PRC and export back to the United States, duty-free. In fact, if the PRC devalues its currency, those exports are even cheaper. (Competitive currency devaluation was the real “beggar-they-neighbor” problem of the 1930s.) The United States, at a disadvantage with countries rigging the cost structure, has no tariff to act as a deterrent to offshoring for export back to the United States. That seems to be exactly what happened with information technology products. Get rid of your duties, and most of the production ends up in the PRC. Zero-for-zero!
Ok, at this point you may be persuaded that we shouldn’t do zero-for-zero duties with governments that distort costs and monopolize markets on the scale of the PRC. But what about others? Isn’t zero-for-zero duties with the EU a good idea?
To figure it out, you have to analyze the likely outcome. Will it promote manufacturing in the U.S. and the E.U., and away from cost suppressors?
Let’s look at how the application of zero duties would work. The first step is to figure out whether a particular good qualifies for zero duties when traded between the U.S. and the EU. These are what “rules of origin” are for. People probably assume that a good traded between the United States and the European Union is mostly made in the United States or the European Union. For some products, that’s true. A cow isn’t made up of parts sourced from different places. But it’s not necessarily true for manufactured goods. As we learned during the pandemic, a lot of inputs for things we make are themselves made in the PRC. That’s why the PRC lockdown triggered cascading problems throughout our supply chains.
If a key input is only made in once place, that’s a chokepoint in your supply chain. And when that chokepoint chokes, the rest of your supply chain is toast.
Zero-for-Zero Tariffs and More Resilient Supply Chains
So, you want diversified supply chains because chokepoints are a problem. Great! Here’s what you need to think through as you figure out what a zero-for-zero deal between the U.S. and the EU would look like:
How do you design supply chain rules that incentivize sourcing in the U.S. and the EU while recognizing that, at least as of today, some of the inputs are only, or predominantly, made in places other than the U.S. and the EU?
What percentage do you allow to come from non-parties?
Do you reduce that amount over time, to induce production currently occurring elsewhere to shift to the U.S. and the EU so that our manufacturing isn’t only assembly of parts made elsewhere?
What’s the timeframe for ramping up the incentives to sourcing from places other than e.g. the PRC?
Isn’t this exercise going to be unique to every sector, and perhaps even every product? If tariffs on the PRC remain very high, how will you manage the strong incentives to circumvent those tariffs through transshipment?
Is this really only about two parties, or should democracies be working collectively to build resilience? So, if the U.S. and the EU are negotiating zero-for-zero duties, should, say, Canada and Norway be treated differently from the PRC?
Can you do all of this analysis in 90 days?
Some people are going to suggest we just pick up where TTIP left off. Well, to the extent the rules of origin were in advanced stages before the negotiations lapsed, it’s important to remember that those rules were devised during the pre-pandemic era, when having the PRC be the factory floor was thought to be a grand idea. In other words, if your goal is integration between two parties and one of them isn’t the PRC, those rules are unlikely to be fit for purpose.
A quick flip through the rules in the EU’s agreement with Canada tends to validate that concern. It looks like only half the content of a car has to come from Canada and the EU. The other half can come from anywhere - including the PRC.
And none of the foregoing gets into a core issue this Administration will have to face: its has promised that its trade actions are in furtherance of boosting American manufacturing. But there is no guarantee that, even if you get the rules of origin right, zero-for-zero tariffs with the EU, or anyone else, will do that. In theory, at least, it is possible that zero-for-zero tariffs, even with better rules of origin, lead to more manufacturing in the EU, without increasing manufacturing in the U.S.. This is especially true if the United States is an unstable place to invest.
Zero-for-zero tariffs are not the answer for what ails us. But neither is the supply chain shock we’re getting with aggressive and unstable tariff policy.
Building Blocks for a Better Version of Globalization
When we were in office, we knew these issues were tricky. As we wound up our time, we put out this supply chain paper, which digs into the challenge and suggests some ways to address it.
In the wake of turmoil unleashed since January, foreign governments are frantic, grasping for quick solutions. The panic is understandable. But in their panic, many of these governments seem to be defaulting to the very “solutions” that got us into trouble in the first place.
This same dynamic played out when the pandemic hit - the trade blob (an opportunistic bunch who resist updating their priors) insisted that more Milton Friedman was the answer. As a sign of the stubbornness of dated approaches, just a few years out of the pandemic we’re back to dunking on textile and apparel production, even though textile and apparel producers are the ones who stepped in to make masks when none of that offshored production was available to us.
If this kind of passé analysis is all too common among trade negotiators, it’s dominant among finance ministers, who typically think the only factor of production that matters is capital.
So, back to the question: Did we learn anything from the pandemic?
A. Apparently not.