Leibowitz on Trade: Trump’s Tradeoff—Tariffs vs. Quotas

The subject is actually quite complex from an econometric point of view. But in simple terms, tariffs are a tax on imports that raise the cost of foreign goods. With less competition from imports, domestic suppliers may raise their prices above pre-tariff levels. Thus, the tariffs are paid for by the consumers of the material, not the countries subject to the tariffs. When prices increase, buyers tend to purchase less. So, tariffs have a direct effect on pricing and demand, economists explain.

Quotas, on the other hand, have a less direct effect on price because there is still competition between foreign and domestic goods until the foreign suppliers hit their limit on exports. With quotas, there is always the possibility the market will run short of import supply. Quotas tend to shift demand forward as buyers place orders early, which may benefit buyers but will increase inventory carrying costs. Service centers often stock up on inventory when quota merchandise can come into the country. Domestic producers are able to raise their prices because of the anticipated shortages. So, both tariffs and quotas affect demand and pricing of imports and domestic product.

A big difference is that tariffs generate revenue for the U.S. Treasury. How much is difficult to measure. Twenty-five percent of the roughly $30 billion in steel imports in 2018 would amount to $7.5 billion. But some amount of imports not subject to the tariff and those granted exclusions, a figure not publicly available, must be subtracted from the total. In the end, the revenue is not very significant. Something less than $7.5 billion in tariffs, which are entirely paid by U.S. importers and largely passed on to domestic end users, comprise less than 0.25 percent of federal revenues.

With quotas, the higher steel prices for imports go to the foreign sellers in the form of higher import prices. These higher prices are passed along to U.S. end users. Domestic mills will receive higher prices as well.

On the surface, replacing tariffs with quotas should benefit steel users, said Andreas Bokkenheuser of UBS Global Research. A tariff-free (lower) steel price should ease cost and working capital pressure on manufacturers and service centers, likely improving demand.

Then again, quotas can be worse than tariffs for end users in certain circumstances, he said. While higher prices are commonly assumed to apply only to product brought in when quotas are about to be filled, the market reality is harder to gauge. Even at the outset of a quota period, the impending limits on imports can have an effect on prices. If shortages are not anticipated, a sudden lack of supply, of course, can cause market prices to spike.

The energy sector is complaining about tariffs and quotas because shortages of oil and gas pipe (both line pipe and OCTG) can crimp plans for new drilling and production. Certain specialized energy-related products are only available from foreign sources. While product exclusions are a theoretical way to manage these specialized products, there have been a large number of domestic industry objections, which claim the ability to produce many of these products with little or no factual support. This could end up weighing on overall manufacturing/industrial production and, in turn, steel demand and prices, Bokkenheuser said.

The tariffs and quotas were imposed by presidential edict and may be repealed just as quickly. Bokkenheuser notes, “If there’s a ‘change in management,’ it could raise the risk of Section 232 being repealed, in our view, at least against U.S. allied nations. These include Canada, Mexico and Europe, which are the largest steel exporters to the U.S., accounting for almost 50 percent of U.S. steel imports. This may explain why U.S. steel producers continue trading at a 10-15 percent discount to spot HRC prices.”

Steel prices have moderated since the sudden run-up last year. If Canada and Mexico receive an exemption from tariffs and quotas as a result of the new USMCA agreement, the domestic price effects could be substantially reduced. However, if the tariffs are replaced by quotas such as those agreed to by Brazil and South Korea (70 percent of the three-year average), prices could resume their upward march. Canada and Mexico have said that they insist on exemptions as a condition to ratify the USMCA. 

It is hard to say whether tariffs or quotas are more disruptive to markets and trade. It depends on the magnitude of the tariffs and the quota limits imposed. Based on these variables, the Section 232 steel tariffs are probably less burdensome to consumers than across-the-board quotas at 70 percent of the three-year average of imports.

Lewis Leibowitz

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