Our Dangerous Slide Towards Protectionism
Only two months into President Trump’s term, the new administration’s rhetoric suggests that commercial relations between the United States and the rest of the world face grave challenges. Compounding uncertainties created by the president’s proposal for a punitive “border-adjustment” import tax, Commerce Secretary Wilbur Ross’ declared that he would not hesitate to “self-initiate” trade cases against trade partners on behalf of U.S. industry; and the head of the newly-created National Trade Council Peter Navarro accused Germany of predatory interventions in the foreign exchange market, likely hinting at the administration’s hostile posture towards other economies that have enjoyed a prolonged trade surplus with the United States.
While the unapologetic machismo in the trade space – much like its political counterpart – feels exceptional, Trump’s actions are not unprecedented: they are a meme of President Reagan’s protectionist attitudes from the 1980s. In fact, during the campaign, candidate Trump specifically pointed to punitive measures adopted by the U.S. Government against Japan in the 1980s as the blueprint for how his administration would restore American manufacturing jobs. The nomination of leading Reagan-era trade negotiator Robert Lighthizer as U.S. Trade Representative serves as further affirmation of Trump’s intention to model himself on the past. However, Reagan’s protectionist policies had a deeply detrimental impact on both U.S. trade competitiveness and the welfare of average Americans. Revival of this outdated mentality presents cause for deep concern.
Raw American Muscle… Squeezes American Companies
A key flashpoint in the U.S.-Japan trade dispute during the Reagan years, the semiconductor sector offers a clear example of how reflexive protectionism can be deeply injurious for domestic industries. In response to the growing share of Japanese memory chips in the U.S. market, and citing circumstantial evidence of unofficial import restrictions imposed by Tokyo, the U.S. Commerce Department self-initiated (unusual then, as it would be today) an anti-dumping case against semiconductor imports from Japan in 1985. The following year, Japanese negotiators accepted a two-part agreement to voluntarily restrain chip exports and double the share of foreign semiconductors in the domestic market. Despite this concession, U.S. chip producers complained of implementation delays – and Reagan, desperate to avoid criticism of weakness, imposed a 100% tariff on Japanese chip imports.
In a June 28, 2016 speech, then candidate Trump lauded this specific action as having had a “big impact.” In fact, several economists note that both the 1986 Agreement and the 1987 tariff “surely did more harm to U.S. industrial interests than it did to Japanese industrial interests.” Japan’s voluntary reduction of chip exports simply resulted in a reduction of global supply, raising the price of semiconductors and providing Japanese producers with windfall profit. Meanwhile, the increase in chip prices harmed the competitiveness of U.S. electronics firms, which had to assume higher input costs. In turn, these costs were passed on to consumers, weakening their purchasing power. This backwards outcome suggests that the Reagan Administration did not fully understand the nature of the semiconductor industry, and likely presumed that the tariff would allow struggling domestic producers to increase production and keep prices in check. However, unlike in conventional manufacturing where per unit production costs fall in proportion to increases in experience, production capacity in the semiconductor industry remains fixed. Efficiency gains come from increasing yield, which requires substantial trial-and-error learning. As such, domestic producers could not easily adjust their supply based on demand signals.
More so than the administration’s unfamiliarity with the industry, the self-harm to U.S. technology sector was a direct consequence of Reagan’s misdiagnosis of the challenges facing the domestic market. Cognizant of the immense capital requirements associated with building and maintaining fabrication plants, many industry experts point to Japanese firms’ affiliations to large banks with easier access to capital as an important differentiator that allowed them to outcompete U.S. counterparts. Meanwhile, U.S. semiconductor producers in the 1980s were struggling under the Federal Reserve’s high interest rate policies, which were implemented by Fed Chairman Paul Volcker to control inflation – a key policy objective endorsed by Reagan. In this environment, U.S. firms were less able to afford the high cost of capital amidst the market turbulence of the 1980s, and became less competitive worldwide.
When Bravado Trumps Good Policy
The U.S. semiconductor industry recovers in the 1990s by focusing on designing higher-value chips, not by beating Japanese exporters into submission. American firms were further buoyed by an overall improvement in the macroeconomic environment, including the steady reduction of domestic interest rates. In spite of the policy failures of the 1980s, the United States ultimately retains its position as a technology superpower. Reagan’s efforts had ignored domestic capacity to innovate and focused solely on defending an industry’s static position in the global value chain. Despite this precedent, engrossed by the image of Reagan’s toughness, the Trump Administration appears unable to recognize these lessons when addressing U.S. trade competitiveness today.
Here, some have alleged that the new administration’s hostility towards China’s nascent semiconductor sector is not dissimilar to the Obama Administration’s position. There is no doubt that the new administration will at some point leverage findings in the 32-page report by the President’s Council of Advisors on Science and Technology, which highlights zero-sum tactics employed by China to promote its semiconductor industry, including the forced transfer of technology in exchange for market access and theft of intellectual property. However, to suggest that the previous administration’s outlook aspired to emulate Reagan’s punitive measures would be to ignore the final two-thirds of the report, where President Obama’s key science advisors discouraged the White House from reflexively opposing Chinese advances in the sector and advocated for the creation of a more supportive business environment in the United States.
These recommendations are consistent with the lessons from Reagan’s misguided effort to protect domestic industries. They also carry direct economic implications for the American people. In terms of costs to the public, efforts early in the Reagan Administration to impose tariffs and quotas on key imports (for instance, voluntary export restraint agreement with Japan on automobiles in 1981, and on steel in 1984) constituted a regressive tax on the American people, with the lowest income bracket surveyed by the Federal Reserve study taking on what amounted to a 66% income tax surcharge in 1985.
Given his campaign platform to correct so-called abuses by trading partners, the new president may feel obliged to advance immediate, actionable accomplishments. However, history suggests that the very people that Trump purportedly advocates for, middle America that has missed out on the benefits of global trade, may have the most to lose when the government turns to protectionism.
Yong Kwon is a Washington D.C.-based strategy consultant, supporting firms engaged in trans-Pacific commerce and investments. His research interests include patterns of innovation in East Asia and economic nationalism.