2023 Theme: Protectionism II - What Are The Implications For Investors?
Last week, we wrote about the return to protectionism and why we will shortly find that many industries try and rebrand themselves as "strategic" in the months and years to come.
But if we are all protectionists now, what are the consequences of this momentous shift? Especially when it comes to your portfolio?
The Inflation Reduction Act, Chips Act, and Infrastructure Investment and Jobs Act were the trio of laws passed in 2021 and 2022 that were designed to overhaul and transform US infrastructure, its manufacturing sector, and its energy system for the coming century respectively.
They are all impressive pieces of legislation: ambitious, bold, all encompassing and seriously dedicated to totally transforming not just the US economy but the wider society as well.
On the surface this makes total sense. The US desperately needs better infrastructure and is incredibly behind in updating and transforming its energy grid and the climate transition. It has also, of course, famously discovered its very real and truly "strategic" vulnerability when it comes to its reliance on semiconductor chips almost solely produced in Taiwan.
So far, so good.
But, as we wrote last week, at their core, these laws also create distorting and wasteful subsidies and also contain "buy American" provisions that run throughout. This is especially true for the Inflation Reduction Act but do not sleep on the Chips Act either.
The outcome from these policies are clear:
Rather than the governments picking winners, as the promotional material will have it, it will instead be losers picking governments as uncompetitive firms try to cluster under the protection of government funds and other favors.
But what are the concrete implications here? Especially financially?
There are a few. We might summarize them as follows:
This shift isn't attached to any particular political party or orthodoxy rather it is broad based and newly dominant.
Overall it means higher costs, lower growth and lower returns (on equity or your investment dollar).
Lastly, it reinforces the trend of "big is better" from two different perspectives.
Of the three, the last one seems to be the least discussed and also the one you might be able to do the most about. Read below to find out more.
To start, however, let us deal with each in turn:
On the first point above, we noted with interest over the last few years that the current presidential administration were very quick to roll back, denounce and over turn as much of the Trump agenda as humanly possible with one large and very glaring exception: the infamous and infamously misguided tariffs on China.
Further, while the tariffs were widely condemned at the time, nothing underlines how much has changed than the fact they are almost never mentioned now - from the right or the left. It seems as if, upon reflection, we have decided that, as long as it isn't being pushed by Donald J. Trump, the "America First" approach isn't so bad after all.
Now, it is critical to understand that those Trump tariffs were not and are not trivial. One reasonably thoughtful analysis that keeps track calculates that, on 2021 import levels, these tariffs currently impact over $350 billion of goods and increase consumer costs by roughly ~$51 billion annually.
As we said, not small. However, these policies are also inflationary.
One economic estimate of their cost in 2022 was that rolling back the most flagrant of the Trump-era tariffs - and going no further - could deliver a one-time reduction in the US consumer price index inflation of around 1.3 percentage points. This would add up to being $797 per US household, or about half the size of pandemic relief in 2021. Not much, but also not nothing in a time when average earnings are being steadily eroded.
That never happened despite the immense political pressure on the Biden administration over inflation and also the deep vulnerability of supposedly not being able to "do" very much.
This isn't just politics either. Policy-wise, what was blasphemous way back in 2016 and 2017 is now considered straight gospel including in some academic departments and think tanks that most certainly know better.
It is telling that the risk of being seen to be "pro-China" and "pro Free Trade" might have been the only thing worse than letting these tariffs stand. We are, once again, all protectionists now.
Never underestimate the power of groupthink over not just critical thinking but also epistemic knowledge. Facts have nothing on belief.
As we said last week: we are all protectionists now.
On the second point, perhaps the most important takeaway is simply that the costs of this approach will be steep.
They also aren't mysterious. These are not just a known unknown to use Donald Rumsfeld's framing but rather a "known known." We know, with a high degree of certainty, all about the costs. We can estimate them with great precision.
For instance, as a fabulous report by the Peterson Institute entitled "Scoring 50 Years of US Industrial Policy" points out, for each steel job saved by decades of protectionism, the cost to the American taxpayer and consumer was roughly $900,000.
It also points out that for all the money spent to prop up the industry, we could have simply paid for those workers to really do whatever they wished and came out ahead.
These expensive "positives" are also far outweighed by the negative knock on effects as well.
For instance, as another paper makes clear:
President Trump’s Section 232 tariffs might have slashed employment by 433,000 jobs in the rest of the economy while increasing employment in the steel industry by just 26,000 jobs over three years.
That isn't just problematic, that is indefensible.
The most disturbing aspect might be how difficult it can be to roll back these costly Another present day example US is still laboring under the World War One era Jones Act. This law regulates maritime commerce and restricts what can be shipped between US ports to what can be placed on US-built, US-owned and US-operated vessels.
This ancient law has negatively affected all of us twice over in the last few years:
Once with the supply chain issues making it hard to ship goods where they need to be from American port to American port.
And the second time with our inability to easily ship oil and has from where it is produced to where it is being consumed.
The reason the US northeast imports natural gas all the way from Qatar and not Louisiana was the protection of another "strategic industry" - shipping over a century ago. One of the reasons the US is becoming a critical energy exporter is that it produces a lot of energy. That is fabulous but it is also true that we can't efficiently get the energy it produces to where it is needed domestically. Say, from the Gulf coast or West Texas to the Northeast which refuses to build pipelines through leafy and privileged suburbs.
These types of distortions will now be replicated throughout our economy and regrettably they will have a real and measurable cost. Sooner rather than later we will be able to quantify exactly what the green subsidies in the Inflation Reduction Act are costing us. Get excited!
On the third and perhaps least appreciated consequence of our new paradigm, these new and significant pieces of American lawmaking will directly challenge the multilateral system of trade, tariffs and above all, trust that we have spent decades building.
In particular, our new affinity for industrial policy does two things:
It encourages other countries to embark on similar policies which quickly start a tit-for-tat cycle that will be very difficult to arrest.
It privileges "bigness."
Narrowly this latter point seems great. The US is, after all, a very large and very powerful country and so what is not to like? To paraphrase our former President, won't we be winning all the time?
That is exactly wrong.
One of the most attractive things about the US is that for much of its history its primary business was, well, business. By building a global system where all could join and prosper this made "American" or Western values incredibly attractive for the simple reason that they were not imposed whatsoever.
Rather it was a big tent and Western values won out both because they had the confidence to compete without tremendous amounts of coercion. It was also tremendously kind to smaller and weaker countries. This combination of aspirational openness and equality is both extremely unusual in human history and made the West and its values extraordinarily attractive.
We are risking all of this now.
Europe has announced its own response to the Inflation Reduction Act - the Green Deal Industrial Plan (only in the EU bureaucracy could they come up with a name this bad).
This 250 billion Euro plan is going to try and do what the Inflation Reduction Act accomplished though because the EU is both a monetary union and a politically uneven one, it will likely be even less efficient and productive than our own.
One of the biggest problems for Europe is that it is made up of 27 countries and allowing subsidies and industrial policy to take hold will make it very hard to make sure that the small countries profit as much as the large - advantage France, tough day to be Irish or Slovakian or Portuguese.
The irony is that the EU has spent much of the last 30 years desperately trying to slowly force its constituents away from a dog's breakfast of beggar-thy-neighbor industrial policies and subsidies. They actually have strict rules against precisely this course of action and have laboriously tried to implement safe guards and agreement around NOT doing this course of action.
Now, however, as the Urukhai say in Lord of the Rings: Looks like meat is back on the menu boys.....
As we have said before, we are living through the great forgetting.
The most likely outcome of all this will be a mess. Once we quickly abandon free market competition for the most modern and innovative new industries and sectors at the outset it will be incredibly difficult to change that later on.
We will all be poorer and yes, that will show up in your returns. The silver lining might be that the US will be a relative winner in a system that privileges bigness and the near unlimited spending that controlling your own currency and monetary policy provides - at least for now.
And the US is the international reserve currency as well. We will discuss the implications for the US Dollar at some other time. For now, let us turn to some more immediate and sunnier (for February) news.
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