Trump’s trade war is a losing investment — just look to Harley-Davidson

In retaliation against U.S. steel tariffs, the European Union has raised its tariff on U.S. imported heavyweight motorcycles from 4 percent to 31 percent. Already facing higher costs for steel and aluminum from U.S. tariffs, Harley-Davidson announced it was shifting production outside the U.S. to avoid the tariffs.

The move by Harley is a case study in the downside risk of President Trump’s trade policies. The steel and aluminum tariffs have gotten the U.S. into a trade war with some of its largest trading partners. On a parallel track, Trump is renegotiating NAFTA with little success, has threatened to leave the WTO, and has alienated the Group of Seven and other economic allies.

U.S. and global firms see a future where a predictable, rules-based order for international trade and commerce is threatened and uncertain. My own research on trade policy uncertainty shows that bilateral and multilateral trade agreements reduce uncertainty and promote investment and exports. These benefits are eroded by brinksmanship on trade policy ostensibly meant to protect American jobs and get a better, fairer deal for the United States.

{mosads}If there is a strategy here, it appears to be that the U.S. is large enough to use trade restrictions to cajole other countries into doing what it wants. But U.S. import tariffs hurt U.S. firms and consumers too, even if they might help a few concentrated sectors.

Knowing this, the EU and China have retaliated, inflicting some pain on their own markets to pressure Trump into backing down. U.S. firms can’t simply write off the losses either — China and the EU have each have their own domestic markets that rival the U.S. in size. Moreover, they can carefully target specific U.S. imports rather than all major trade partners. This asymmetry limits the impact on their own consumers and leaves firms the option to find other suppliers.

With global supply chains and just-in-time, lean manufacturing principles in place, disruptions and frictions in trade flows can have large effects. For example, recent research shows that after the Tohoku earthquake and tsunami, the output of Japanese affiliate firms in the U.S. declined precipitously. For ,-Davidson the Trump-induced disruptions are already here. They aren’t going to abandon the U.S. market, but they are rightly concerned about the risk of a Trump tariff tsunami crashing down.

Trump walked into this trade war by naively making American 1980s trade policy mistakes — again. As Dartmouth’s Doug Irwin has documented, Harley-Davidson was once the recipient of temporary protective tariffs of 45 percent on heavyweight motorcycles in the 1980s. They weren’t that effective. Honda and Kawasaki were already producing heavyweight motorcycles at U.S. plants and not subject to tariffs. Other foreign firms adapted by producing bikes with 699cc engines to evade the tariff cutoff at 700cc. Harley eventually petitioned the government to remove the tariff before it expired.

Meanwhile, the U.S. raised the tariff on light trucks to 25 percent following a different trade dispute over EU tariffs on chicken in the 1960s. The Big Three U.S. automakers specialized in light trucks and SUVs. Japanese firms expanded in fuel-efficient sedans instead. The 25 percent tariff on light trucks, once levied as retaliation in a trade war only economists remember, became the official WTO tariff commitment.

Nevertheless, when Harley announced its plans, Trump was caught off guard and lashed out on Twitter, writing

“Surprised that Harley-Davidson, of all companies, would be the first to wave the White Flag. I fought hard for them and ultimately they will not pay tariffs selling into the E.U., which has hurt us badly on trade, down $151 Billion. Taxes just a Harley excuse – be patient! #MAGA”

But we already know three important factors were at work. First, punitive tariffs and trade wars alter incentives enough to have large unintended consequences in industry structure. Second, the ground operations of U.S. multinational firms are just as mobile as their Japanese counterparts in the ’80s. Third, temporary trade barriers may persist indefinitely.

In Harley’s SEC filing, the company clearly assessed the situation and made a business decision. Harley estimates the EU tariffs would increase costs by $2,200 per exported motorcycle, or $30 million to $45 million for the remainder of 2018 — and up to $100 million over the next year. They also cite “uncertainties regarding the size and duration of EU tariffs.” Trump only offered a vague hint that they won’t face tariffs. So admonishing Harley-Davidson to be patient offers little reassurance.

Global firms like Harley-Davidson are adept at managing risk and uncertainty. While Harley-Davidson is the latest prominent example, it’s likely a number of other privately held firms have quietly shelved expansions plans in the U.S. or decided to expand their overseas operations instead. Electrolux already announced it would delay a $150 million new plant in Tennessee because of the Trump tariffs back in March.

Longer term, the damage from Trump’s trade policy brinkmanship may outlast his tariffs and his presidency. Trump’s actions are eroding the value of international policy cooperation at the WTO and in regional agreements like NAFTA. In my recent work with Nuno Limão at the University of Maryland and Jeronimo Carballo at University of Colorado, we found U.S. trade agreements like NAFTA reduced economic and policy uncertainty during a the Great Recession and cut the cumulative reduction in U.S. exports by about one-third. Economic growth is high now, but there will be less insurance against protectionism in the next downturn if Trump leaves a weakened global trade system in his wake.

Of course, all policymakers want businesses to relocate and expand in the United States. But the message right now is not compelling: locate here to serve our domestic market without punitive tariffs, stay for the unpredictable input tariffs and supply chain risk. The trade war rhetoric plays well on Twitter, but less so with businesses that have to make payroll, fill orders and answer to shareholders in real time.

American firms won’t wait to find out whether they are on the losing end of trade war. 

Kyle Handley is assistant professor of business economics and public policy at the University of Michigan Ross School of Business.