by Robert Krol
Uncertainty is causing real damage to U.S. consumers and producers.
President Donald Trump’s trade policies are hurting the U.S. economy. The president thinks “tariffs are a great negotiating tool,” and that may be true. However, uncertainty over potential tariffs can be a nightmare for American businesses engaged in international trade. For instance, Trump’s recent plan to raise tariffs on Mexican imports would have hammered an automobile industry that has integrated Mexican production since the passage of NAFTA in 1994. Additionally, the administration is still considering imposing tariffs on $300 billion worth of imports from China, and the resolution of that trade war is still up in the air.
Tariffs raise the cost of imported goods for American consumers and businesses; these cost shocks have a negative impact on economic activity. The mere possibility of that shock affects the American economy more than many might think.
The president’s on-again, off-again negotiating approach to trade relations hurts the U.S. economy by raising the level of uncertainty over the future course of trade policy. Uncertainty—whether it is due to the normal ups and downs of the business cycle or Washington’s obscure vision of future policy—will inevitably cause businesses both large and small to slow or cancel business expansion plans both here and abroad. Uncertainty reduces prosperity.
Uncertainty over economic policy can be thought of as a lack of clarity over where the path future public policies will lead, in terms of taxes, regulation, government spending, and trade restrictions. Economists Scott Baker, Nicholas Bloom, and Steven Davis have constructed an index that tracks economic uncertainty in the United States and abroad. The raw data for the index come from a computer-based search of articles in major newspapers that discuss uncertainty related to economic policy issues. This data is then transformed into a numerical index. A higher index implies greater economic policy uncertainty (their tracks policy debates well.)
The overall uncertainty index has averaged just above 155 since President Trump won the 2016 presidential election. This compares with an average of 119 during the prior two years. The index has moved over a wider range since President Trump has been in office, suggesting that the president’s stop-and-go approach to managing commercial relationships with our trading partners, and his economic policy in general, has led to a lack of clarity as to future policies.
Researchers have attempted to quantify the impact of economic uncertainty by using this economic policy index. Baker, Bloom, and Davis found a statistically significant negative relationship between economic policy uncertainty and U.S. output and employment. My own research finds evidence that higher economic policy uncertainty depresses small business expansion. Furthermore, other research shows that economic policy uncertainty increases volatility in stock and foreign-exchange markets. Greater volatility in foreign-exchange markets has been shown to depress international trade and investment flows, which reduces living standards in the affected countries.
If you look at U.S. exports, there is empirical evidence that higher levels of trade and economic policy uncertainty depress U.S. exports because of retaliation by Washington’s trading partners. Higher economic policy uncertainty lowers imports by almost a half a percentage point after one year. This reduces product variety and results in higher prices paid by consumers. Moreover, because a little more than half of U.S. imports are intermediate goods (inputs) used to produce final goods in the United States, this affects business costs as well.
My research also suggests that higher economic policy uncertainty lowers direct foreign investment in the United States by almost 5 percent after about one year and increases its volatility as well. A recent United Nations report shows direct foreign investment into the United States declined by 9 percent between 2017 and 2018. The report blames Uncle Sam’s economic policy uncertainty as a principle cause, and none of this is good for economic and job growth, especially in manufacturing.
The president’s actual and potential on-again, off-again trade wars with major U.S. trading partners—China, Mexico, Canada, and the European Union—are disruptive to supply chains and international commerce.
It appears as though the president is willing to throw away the higher standard of living—about $7,000 per-capita (inflation-adjusted) since the end of World War II—gained from previous tariff reductions and international agreements, because of his misconceptions and poor advice on trade. To avoid attacks on prosperity in the United States, Trump should rethink the behavior that is causing uncertainty and, more fundamentally, change his view on trade.
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