Trump's new trade idea may be a bigger mistake than tariffs

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President Donald Trump

• President Donald Trump and his administration are attempting to impose quotas instead of tariffs on six major trading partners.
• The quotas would limit the amount of steel or aluminum a country can send to the US in a year.
• According to trade experts, quotas impose similar economic problems as tariffs, such as inflationary pressure, but also present unique issues.
• Quotas open the door for corruption, don't raise revenue, and violate international trading rules.

President Donald Trump once again backed off a serious trade threat on Monday by extending steel and aluminum tariff exemptions for six US allies, but the president's new trade goal may be even worse news for the global economy.

The decision gave these countries 30 more days to work out a deal with the US to curb steel and aluminum trade imbalances. But, the Trump administration's stated goal for the negotiations may actually make the situation worse according to trade experts.

In Monday's statement, the Trump administration insisted that any country wanting to be exempted from the metal tariffs must agree to a quota system.

"In all of these negotiations, the Administration is focused on quotas that will restrain imports, prevent transshipment, and protect the national security," the statement said.

The Trump administration also already secured an agreement with South Korea which would exempt the country in exchange for a quota. The quota allows South Korea to export 70% of the average steel volume sent to the US over the past three years.

Peter Navarro, director of the White House National Trade Council, confirmed the quota goal during a talk hosted by the American Iron and Steel Institute and the Steel Manufacturers Association

"The guiding principle of this administration, from the president down to his team, is that any country or entity like the European Union, which is exempt from the tariffs, will have a quota and other restrictions," Navarro said.

Quotas hurt just as much as tariffs

Quotas, also known voluntary export restrictions (VER), may sound like a softer approach compared to tariffs but the approach may actually cause more problems than it solves according to experts.

On a basic level, a quota still presents similar economic issues as tariffs: it means the supply of a good from overseas decreases and the price subsequently rises. This in turn drives up costs for producers in the US and increases prices for consumers.

Plus, quotas are missing one specific benefit of a tariff - tax revenue for the US. In fact, a quota, or VER, could result in tax revenue for foreign governments if they sell export rights to companies, Dmitry Grozoubinski, an expert at the International Centre for Trade and Sustainable Development, pointed out.

"While fairly regressive and counterproductive, tariffs are still ultimately a form of tax in that they raise government revenue which can be reinvested," Grozoubinski said Monday. "A VER has all the downsides of a tariff, without any of the revenue."

Thus, a quota has all the economic downside of a tariff without the budgetary upside.

Problems beyond economics

Beyond the revenue problem, Chad Bown, a senior fellow at the Peterson Institute for International Economics, told Business Insider that a quota system also opens the door for corruption.

In order to control the amount of a metal being sent to the US and abide by the quota, Bown said, a country typically gives out licenses to certain businesses to sell to the US. Since the US is a lucrative market for exporters, businesses will do whatever they can to get those licenses.

"That breeds corruption," Bown said. "Because if I'm a government bureaucrat, I'm the one who gets to decide who gets the license. Well, now someone is willing to pay me something for that because it is so valuable. This is why the United States has, for decades, discouraged the use of quotas in countries around the world."

The US is not expected to allocate the licenses under the new system, though the details of the agreements are not clear, so these issues could pop up in other nations. This isn't to say that such corruption will occur, Bown said, but a quota system certainly opens up the possibility.

A third and final problem with the quota idea, according to Simon Lester, a trade policy analyst at the Cato Institute, is that it breaks international trade rules.

"[VERs] were a problem in the 1980s, and were prohibited in Article 11.1(b) of the WTO's Safeguards Agreement," Lester told Business Insider in an email Tuesday. "By agreeing to them, the US and the other country are pretty clearly violating WTO rules."

As Lester alluded to, the most famous example of VERs is probably the US agreement with Japan to limit imports of cars in the 1980s. The goal was to protect struggling US automakers from more efficient Japanese producers. According to most studies of the VERs, the boost helped in the short-run but was ultimately ineffective at best.

The decade of negotiations eventually led to Japan leaving bilateral trade negotiations with the US and working on a multilateral basis through the WTO.

All of the trade experts Business Insider spoke with say economic problems, the possibility for corruption, and the likelihood of undermining the international trading order mean Trump's push for quotas instead of tariffs may make the US trade situation worse, not better.