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Commentary: Unintended economics – the Mexican chapter

It is simple Economics 101. When you tax something, you get less of it. When you subsidize something, you get more of it.

Great news! The December 2017 TCJA (Tax Cuts and Jobs Act), dramatically cut the corporate tax rate from 35 percent to 21 percent. Before its enactment, the U.S. had the highest corporate tax rate among industrialized countries. The cut in corporate tax rates was badly needed, and resulted in an economic boom in 2018, because just as ‘when you tax something, you get less of it,’ when you lower taxes dramatically, you essentially subsidize it and you get more of it.   

Bad news. A tariff is a tax. A tariff on imported goods is a direct tax that is paid by the people buying those goods, but this is only the first way that tariffs destroy economic activity. Tariffs destroy trading relationships and increase the friction of trade with other countries. They destroy jobs and wealth in the countries exporting the goods, but they also destroy the relationships between the people and businesses in the exporting country and the people and businesses in the country importing the goods. In general, anything that inhibits trade in the long-run results in lower prosperity for everyone globally.

In future articles, I intend to dive deeper into the math of trade and how vital it is for the U.S. economy and the economies of our trading partners. Today I want to outline the consequences and highlight the unintended consequences of inhibiting trade with Mexico.

As the third-largest trading partner of the United States and its second-largest export market, Mexico is important to the U.S. economy. Raising tariffs on trade with Mexico will damage the U.S. economy, but it could push the Mexican economy into a severe recession. Why? The U.S. represents over 80 percent of Mexico’s exports. The Mexican market is important to the U.S., but the U.S. market is paramount to the Mexican economy. Simply stated, neither country can afford a trade war or tariffs.

President Trump’s recent tweets about imposing tariffs on goods imported from Mexico sent shivers through the financial markets, but marketplace intelligence suggests significant issues with our southern border trading partner began two months ago.

Starting in late March/early April, my sources indicate that U.S. Customs and Border Protection enforcement at all U.S. southern border crossings began to become increasingly more stringent. Wait times went from 15 minutes to an hour to two hours and then to four hours. As it took longer and longer to clear trucks going north, the Mexicans started to retaliate and take longer to clear trucks going south.

Reported wait times have continued to escalate, as each side has made ‘tit for tat’ moves to punish the other for wrongs. Whether these wrongs were real are perceived doesn’t matter. What matters is that my sources at large trucking companies and large truck brokerage firms that do significant amounts of cross-border trade are reporting that what used to take 15 minutes is now taking two days or more. So, long before the threatened tariffs are enacted, trade with Mexico is already being severely damaged.

As is often the case with any government regulation, the unintended consequences can be more powerful than the initial regulation and produce results that are counter to the initial regulation, or both. In this instance, at least so far, it appears that the unintended consequences are leading the charge in destroying the economic prosperity of free trade.

Stay tuned…

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Donald Broughton, Principal & Managing Partner, Broughton Capital

Prior to starting Broughton Capital Mr. Broughton spent nine years as the Chief Market Strategist and Senior Transportation Analyst for Avondale Partners. Before that, Mr. Broughton spent over twelve years at A.G. Edwards. At A.G. Edwards, in addition to being the Senior Transportation Analyst, he was the Group Leader of the Industrial Analysts and served on the firm’s Investment Strategy Committee. Prior to going to Wall Street, Mr. Broughton spent eight years in various distribution and operations management roles in the beverage industry, including serving as the Corporate Manager of Distribution for Dr. Pepper/Seven-Up companies and Chief Operating Officer for Bevmark Concepts.

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