August 2018

Tariffs & Arkansas Trade

August 2018 Issue

By Mervin Jebaraj | Director of Center for Business and Economic Research

Uncertainty about trade policy has spoiled the celebrations from the corporate tax cuts that were passed by Congress at the end of 2017. The announcement in March that the U.S. would be imposing tariffs on our allies and trading partners has caused businesses across Arkansas and the country to rethink plans of using the corporate tax savings for investment spending. The steel and aluminum tariffs imposed on some of Arkansas’ largest trading partners have triggered a series of retaliatory tariffs that threaten farming, manufacturing and construction sectors in the state.

Oddly enough, we may have embarked on a global trade war based on a faulty assumption that the U.S. runs a massive trade deficit with its trading partners. Official statistics indicate that the U.S. trade deficit is about 3 percent of the gross domestic product. Recent research from Guvenen et al., Stuyven et al., Brad Setser and others indicates that more than half of the trade deficit may be due to accounting procedures involved in corporate tax avoidance. Exports from U.S. technology companies, pharmaceutical companies and others may be booked from foreign subsidiaries, therefore artificially depressing the size of the U.S. exports. These studies estimate that the trade deficit may be more accurately estimated at between 1 and 1.5 percent of the U.S. gross domestic product. The aforementioned corporate tax reductions, if they result in fewer companies availing themselves of tax avoidance strategies, may greatly reduce the size of the trade deficit without the need to resort to blunt instruments like tariffs and quotas.

Nonetheless, the tariffs imposed by the U.S. and the series of retaliatory tariffs are the new reality and unless there is quick global drawdown in the trade war, the implications for Arkansas businesses promises to be negative. Farm incomes have been declining over the past few years (in fact, the median on-farm household income is negative) and are now going to be hit hard by the retaliatory tariffs imposed by our trading partners in China and the European Union. According to analysis from the University of Arkansas System Division of Agriculture, the retaliatory tariffs faced by Arkansas farmers could result in an output loss of $243.7 million in oilseed farming and $191 million in grain farming. The overall economic impact of these losses is significant and could cost the state more than 4,000 jobs, diminish labor income by $261 million and produce a negative economic impact of more than $890 million. The impacts of these tariffs would extend from farmers to manufacturing employment in the food-processing industry. Furthermore, the announcements of these retaliatory tariffs came at the worst possible time, during planting season in Arkansas.

Retaliatory tariffs imposed by our NAFTA partners, with whom Arkansas enjoyed a $650 million trade surplus, will target the manufacturing employment in the paper products industry, steel and aluminum industry and the lawnmower manufacturing industry. According to Business Insider, Canada’s retaliatory tariffs alone target more than $228 million worth of goods produced in Arkansas. Meanwhile the price of steel has climbed nearly 40 percent, more than the amount justified by tariffs, and is pinching Arkansas manufacturers that use it. In a survey conducted by the Arkansas District Export Council and the World Trade Center, 16 percent of Arkansas manufacturers reported that the tariffs would lead to a loss of business and cause layoffs. Tire cord manufacturers in Arkansas who use imported steel have already cancelled proposed expansion plans because of the tariffs and without exemptions will be forced to cut capacity or close operations in the state resulting in thousands of job losses. It is important to note that since neither Canada nor Mexico impose steel tariffs, manufacturers may find it reasonable to move their production to those countries and export the finished product back to the U.S. The efforts of the governor and the Arkansas Economic Development Commission to attract manufacturing investment from China have yielded a lot of positive results, but some of these projects have now been delayed or halted because of the concerns surrounding the tariffs. Arkansas and the U.S. have had a mini-boom in manufacturing employment from on-shoring jobs that were lost in previous off-shoring cycles, but there is a genuine threat that some of those jobs will be off-shored again to avoid the tariffs.

The construction industry is one of the largest consumers of steel, so construction prices, which are already high due to lack of crews, will rise some more. Combined with rising interest rates, this will make commercial and multifamily construction much more expensive. It remains to be seen what effects the tariffs will have on consumer goods like soup cans, beer cans and washing machines. If manufacturers pass on the tariff costs to consumers, this will dilute the modest tax savings that most people are receiving on their individual income taxes. If manufacturers don’t pass on the costs, it will lower corporate earnings and will make the recently passed corporate tax cuts less valuable.

The best possible outcome is for the U.S. and its trading partners to suspend these tariffs and return to the negotiating table. Instead, if we go down a path of escalating tariffs and retaliatory tariffs we might find ourselves staring at the type of trade war that the U.S. launched in the 1930s. I don’t believe anybody wants a return to the 1930s.

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