A simplified explanation of why Trump’s tariffs won’t work

Let’s review a very basic model of tariffs and see why they generally don’t work.

I’ve put together a basic, simplified graph to explain how tariffs work, and why Trump’s approach is going to harm consumers.

A supply and demand curve. Tariffs are introduced, shifting the supply curve up, reducing output and revenue.

In the graph, P is the price of a product, and Q is the quantity people are willing to pay at a given price. Curve D represents consumers’ willingness to buy a product. At a given price, consumers are willing to buy a certain amount of a product. The higher the price, the lower the quantity of product that will be sold.

Curve S represents a price at which suppliers are willing to sell a product. The lower the price, the less willing a supplier is willing to sell, and the lower the quantity. Before tariffs, market pricing is at point (p₁,q₁).

Now the US introduces a tariff. This represents an upward shift in the supply curve from S1 to S2. That upsets the equilibrium and causes consumers to by fewer products at the higher price. So a new price and quantity (p₂,q₂) is set.

What has happened? The consumer has paid a higher price, the foreign producer has sold fewer products and taken in less revenue.

So what is Trump’s point? He’s hoping that by increasing consumer costs for imports, a domestic supplier will enter the market in the US that offers the same product at a price below p₂. But it will not be so low as price p₁ unless something else changes. Otherwise the product would not have been imported in the first place. That can happen for many reasons, such as the foreign producer delivering better quality product or lower cost, just to name two.

That means that no matter what happens, consumers in America will always be penalized for tariffs with higher prices than they otherwise would have paid. What’s more, because consumers would always end up paying higher prices for the same product, they’ll have less money to buy other things. And that leads to a further shrinkage of the economy.

Worse, those tariffs could work in reverse. Imagine a market in which raw materials such as lumber are imported to the US from Canada, it is turned into furniture, and shipped back to Canada. In this case, the tariffs are actually making US exports less competitive, encouraging Canadians to make their own furniture. The same concept would apply for tariffs on any raw material such as steel. In addition, there are some products that the US cannot produce such as the rare metals found in most computers.

Another aspect that the curve above doesn’t really show is startup cost. The first unit of any product is always the most expensive, because it required a production facility to be built. But if Trump’s policies get reversed, or he reverses them himself, then that startup cost turns into a loss. If you were a producer, would you trust that tariffs would remain in place?

Putting aside those startup costs, there’s another problem: the US unemployment rate is relatively low. Put another way, we wouldn’t have enough people to operate the factories Trump wants to see built. How to add people to the workforce? The safest way is to allow more immigration. Florida is considering another approach for their worker shortage: child labor.

Obviously there’s a lot more to this, and there are a lot of assumptions that we can review. In my view, doing so makes it clear that the economics of tariffs for America only make things worse.

Yahoo! This will happen again

Yahoo! The breach of over 500 million accounts at Yahoo! has caused a number of my friends to deride the company for not applying sufficient protections of private consumer data. While it’s hard to argue with that claim, one thing is certain: this will happen again. Maybe not to Yahoo! but to some other giant web site, like Amazon or Facebook or Google or Twitter.

We have concentrated so much trust into so small a percentage of sites that if any one of them has a breach, it can impact hundreds of millions of people. Americans have previously spoken of banks that are too big to fail. Social networking sites are similarly so big that when they have an incident, it perturbs our lives in all sorts of ways that we only begin to understand after the fact.

These sites have an interest in maintaining their customer interest, and the network effect helps them: the more people who visit Facebook, the more people Facebook will attract. This is how the Internet and telephone networks came to be in the first place.

This vast concentration of consumers into a small number of sites also has its upsides: because they are regularly attacked, they have developed very strong expertise to fend off bad guys. That’s something the average consumer – and even most enterprises – will never have.

This form of market concentration is not an easy problem to solve. Imagine a world in which we all had software that sat on in our homes instead of in Facebook’s cloud (for instance). If the software were all the same, then one bug would impact everyone in much the same way as if the software were centrally located. The only question is how long it would take for an exploit of a vulnerability to propagate, and how long it would take someone to notice.

We know that such distributed software is a problem because one of the key vectors for infection these days is unused and out of date virtual machines or WordPress instances. This puts aside all the issues of cost of maintaining a WordPress site. How much does it cost you to maintain your Facebook account today?

One approach would a healthy exchange of social information across a reasonable number (perhaps in the thousands) of well managed sites. That requires a rethink about how we consider privacy and who is responsible. It also requires that incentives be aligned for that sharing to occur. We would in essence be suggesting that Facebook advertisers go elsewhere. That doesn’t seem like something Facebook would want to see.

Our Supposed Healthcare System

Let’s do a brief comparison of the U.S. to the civilized world, when it comes to healthcare insurance and what actually happens when a child is born. In Switzerland, when a child is born, both the mother and the child may stay up to five days in the hospital. For even the slightest complication that time gets extended for both.

In the U.S., an insured mother and her child are entitled two days. If there is a problem with one, as was the case with my new niece (she was jaundiced and required an extra day), she is separated from the mother, who in this case herself spent the night in the hospital lobby so that she could nurse her newborn daughter, three days after having given birth.

Which would you want for your wife, sister, or daughter? U.S. or civilized? If you answered “civilized”, then you get to answer another question: who are the people who should supervise our profit-oriented health insurance industry, and where are they? I personally would like to know. By the way, here in Switzerland my family and I pay less than most Americans our ages for healthcare, and we’ve not been turned down for anything we needed (in fact we’ve never even had an argument about it). Now- does that change your answer?

Net Neutrality Deal near betwen FCC and Telcos?

Today’s Wall Street Journal reports that mega-telcos Verizon and AT&T are in discussions with senior staff of the Federal Communications Commission (FCC) over a compromise for enabling legislation for the FCC to regulate access to the Internet. This is no small deal. Chairman Julius Genachowski has made very clear for quite some time that he thought there was a need to provide for some form of net neutrality to protect customers against service providers, and to insure openness. Another thing is perfectly clear to everyone: the rules of the 1980s and 1990s certainly are antiquated.

However, one problem with net neutrality is that it can mean different things to different people. To some it might mean protection from service providers charging for services that they themselves do not provide. To others it might mean an inability for service providers to manage what they deem as excessive use of a shared resource (their network) by some consumers, as their cost models are all structured on the notion of over-subscription. That is– if everyone tried to use a vast amount of bandwidth at once, we would all get very little, and not those megabits/second in the advertisement.

Here are a few facts to think about when you hear the term net neutrality:

The tools service providers might use to give themselves some sort of market advantage are the very same ones they may need to use to protect consumers against denial-of-service attacks: it is in the average consumer’s best interest that bandwidth from rogue BoTs be limited. Differentiating between protection against BoTs and protectionism may prove difficult to regulators.
Bandwidth on the Internet is not the same as a phone call. If you’ve ever been in a disaster situation, such as an earthquake or a hurricane, you’ll remember that there may have been times when you picked up the phone and got no dialtone. That is not how the Internet works. Most applications make use of Transmission Control Protocol (TCP), which is designed to share whatever bandwidth there is. While voice and video require a minimum to function properly, even modern day tools like Skype & iChat AV can step down their use of bandwidth when they see quality degrading.
Most of us weren’t born yesterday, and it’s plainly obvious that there are very few telcos in the United States. The government has, since the passing of the Sherman Act in 1890, taken the position, with good reason in my opinion, that monopolies are bad, and that high levels of concentration are not good for consumers, either. Prosecution through that act as a means of redress, however, is a last resort, because…
Such prosecutions take years if not decades, are often at the whim of administrations, and often do not succeed. Three examples of arguably failed prosecutions include IBM, AT&T, and Microsoft. In the case of IBM, the U.S. dismissed the case when Ronald Reagan became president. AT&T is arguably a failed attempt, because we are very close to right back where we started. In the case of Microsoft, European regulators have provided far more oversight than our own Justice Department, perhaps in part due to the non-European nature of the company, but also due to a lack willingness to go further by the Bush administration. Hence it is better to nip a problem in the bud. This is one reason for the FCC to have a role.
At stake is not whether or not consumers will see a choice of service providers, but whether content providers and etailers, sites like mlb.com and Amazon will have a choice. Otherwise, we get to a two-sided market, where those who own the so-called eyeball networks also own the other end, providing an enormous price control lever.
Properly considered, network neutrality as a concept protects against the idea that you have to go to a service provider to implement new applications features in the network. This is the core strength of the Internt, but it’s not clear that regulation is needed. For one thing, I would hope that providers understand that new features and applications are in their best interests, since they get to sell more bandwidth, and perhaps even offer a few such features to their, and other, customers.

That’s what all the fuss is about.

Wrap-up of this year’s WEIS

This year’s Workshop on the Economics of Information Security (WEIS2010) enlightened us about Identity, privacy, and the insecurity of the financial payment system, just to name a few presentaitons.

Every year I attend a conference called the Workshop on Economics of Information Security (WEIS), and every year I learn quite a bit from the experience. This year was no exception. The conference represents an interdisciplinary approach to Cybersecurity that includes economists, government researchers, industry, and of course computer scientists. Run by friend and luminary Bruce Schneier, Professor Ross Anderson from Cambridge University, and this year with chairs Drs. Tyler Moore and Allan Friedman, the conference includes an eclectic mix of work on topics such as the cyber-insurance (usually including papers from field leader Professor Rainer Böhme, soon of University of Münster), privacy protection, user behavior, and understanding of the underground economy, this year’s conference had a number of interesting pieces of work. Here are a few samples:

Guns, Privacy, and Crime, by Allesandro Acquisti (CMU) and Catherine Tucker (MIT), provides an insight into how addresses of gun permit applicants posted on a Tennessee website does not really impact their security one way or another, contrary to arguments made by politicians.
Is the Internet for Porn? An Insight Into the Online Adult Industry – Gilbert Wondracek, Thorsten Holz, Christian Platzer, Engin Kirda and Christopher Kruegel provides a detailed explanation of the technology used to support the Internet Porn industry, in which it claims provides over $3,000 a second in revenue.
The password thicket: technical and market failures in human authentication on the web – Joseph Bonneau and Sören Preibusch (Cambridge) talks about just how poorly many websites manage all of those passwords we reuse.
A panel on the credit card payment system, together with a presentation that demonstrated that even credit cards with chips and pins are not secure. One of the key messages from the presentation was that open standards are critically important to security.
On the Security Economics of Electricity Metering – Ross Anderson and Shailendra Fuloria (Cambridge) discussed the various actors in the Smart Grid, their motivations, and some recommendations on the regulatory front.

The papers are mostly available at the web site, as are the presentations. This stuff is important. It informs industry as to what behaviors are both rewarding and provide for the social good, as well as where we see gaps or need of improvement in our public policies, especially where technology is well ahead of policy makers’ thinking.