Beware The “Surprise Fees” In Biden’s 200% Aluminum Tariffs

In March 2018, then-President Donald Trump invoked his powers under Section 232 of the Trade Expansion Act of 1962 to restrict most imports of steel and aluminum on dubious national security grounds. Last month, citing Russia’s “unjustified, unprovoked, unyielding, and unconscionable war against Ukraine” and the Russian aluminum industry’s alleged role in the war effort, President Biden amended Trump’s five-year old order with an official proclamation increasing tariffs to 200% on aluminum and derivative aluminum products from Russia, which just went into effect on Friday.

As with most of the many sanctions imposed on Russia since its invasion of Ukraine, the expectation is that the tariff increase will help deprive Moscow of the wherewithal to continue its aggressions. That’s a worthy objective, indeed. But inching toward that outcome by restricting trade in aluminum is a path certain to generate far greater economic costs, foment discord with trade partners, and assist China in its effort to assert greater leverage over the global supply of a critical metal.

President Biden’s tariff decision exploits a common misconception that trade is a competition between “our” producers and “their” producers, where exports are our points and imports are their points. That makes it more tempting to view import tariffs as a cost borne by foreign producers without any domestic pain. Then why not slap tariffs on all products from all rivals and adversaries?

One reason is that every year, approximately half the value of all U.S. imports comprises of “intermediate goods” – the raw materials, industrial components, machinery, and other inputs required by U.S. businesses to produce their own downstream products. By making intermediate goods more expensive to U.S. purchasers, tariffs drive up the costs of production for these businesses and the costs of living for American families – unwelcome outcomes, especially in a period of high inflation.

But the president knows this. In fact, his proclamation mentions that Russia’s war “has caused global energy prices to rise, causing direct harm to the United States aluminum industry,” which is nothing less than a full-throated acknowledgement of the relationship between input costs and the bottom line.

The aluminum industry – especially the primary aluminum producing sector – is extremely energy intensive. Electricity accounts for up to 40% of the cost of aluminum production. Higher energy prices mean higher aluminum production costs. So, what about the relationship between aluminum costs and the bottom lines of producers for whom aluminum is an important input?

Aluminum, like energy, is a perfect example of an intermediate good. It is an ingredient relied upon by many users across a spectrum of industries, including aerospace, electronics, machinery, automotive, and food and beverage packaging. Tariffs on aluminum raise the cost of production of goods made from aluminum and, ultimately, the prices charged to consumers. Perversely, the adverse impact on U.S. aluminum-using firms is doubled because their foreign competitors, who are not burdened by the tariff, have lower production costs and can therefore offer lower prices to consumers in the United States and abroad. It would not be surprising to see some of these downstream industries seek their own tariff relief from import competition as a result.

The fact is that President Biden has a grievance with Russia for driving up energy costs, yet his tariff decision will visit the same kind of systemic cost increases on thousands of downstream, aluminum-using businesses in the United States.

The president’s proclamation notes yet another objective of the tariff, which is “to further reduce imports…and increase domestic capacity utilization.” That was precisely Trump’s rationale for the original tariffs. Keep imports at bay with higher taxes. See aluminum prices rise. Watch producers react by restarting idled smelters and other production assets. And, voila, the U.S. national security problem of too much reliance on undependable or potentially hostile foreign sources goes away.

Well, it didn’t quite work out that way for Trump, and Biden should expect the same outcome.

Trump’s 232 plan set a domestic aluminum production capacity utilization rate target of 80 percent. Today that rate hovers at about 55 percent – even lower than it was before 2018. It failed to induce domestic production but generated higher costs across the manufacturing sector. Apparently, there are more powerful variables influencing decisions in the aluminum industry.

Through 2000, the United States was the world’s largest producer of primary aluminum. By 2021, U.S. production slipped to 908,000 metric tons (from a peak of 5.1 million in 1980), making it the ninth largest producer, accounting for less than 2% of global primary aluminum output.

Relatively high U.S. electricity prices make it economically sensible to forgo new production and instead import from sources that have comparative cost advantages. Imports account for 80% of U.S. domestic aluminum consumption. Global production capacity utilization averages a much higher rate of 88%, with Canada (and its relatively inexpensive hydroelectric power source) being the largest foreign supplier of primary aluminum in the United States and the fourth largest producer in the world.

Inversely, China is the fourth largest supplier to the United States, but the largest producer in the world by orders of magnitude. Last year China produced 40 million metric tons of aluminum – 10 times more than India, the second largest producer.

Unless energy generation and transmission costs fall far enough in the coming years, the U.S. economy is likely to become more dependent on imports for its growing demand. Metal industries consulting firm CRU International forecasts North American aluminum demand will increase by 5.1 million metric tons, or 45% by 2030 (from a 2020 baseline). CRU estimates about half that growth will occur in the transportation sector as North America becomes a major electric vehicle production location. Over the same period, packaging and construction demand is expected to increase by 27%. Access to imported aluminum will be essential to U.S. success in electric vehicle production and other burgeoning green industries.

Aluminum imports from Russia in 2022 amounted to 209,000 metric tons, 3.3% of the 6.4 million metric tons of imports for all sources. The 200% tariff will likely be “prohibitive,” meaning it will drive imports from Russia to zero. But the cost pressures on aluminum-consuming sectors and the U.S. economy, broadly, are likely to be significantly amplified when President Biden’s second shoe drops.

On April 10, a separate 200% tariff will be imposed on aluminum and derivative articles from anywhere that contain any amount of aluminum that is smelted or cast in Russia. The intention of this measure is to ensure Russian aluminum doesn’t circumvent the U.S. tariff through incorporation into aluminum products finished in and shipped from other countries. Imports from those countries that impose their own tariffs of at least 200% on Russian aluminum will qualify for exemption from the U.S. tariff.

What does this all mean? In all likelihood, imports of aluminum will decline by much more than just the volume currently coming directly from Russia. It will take time for foreign producers who comingle their domestic aluminum with Russian aluminum to develop new supply chains and production processes. Facing a 200% tariff, those supplies are unlikely to arrive on U.S. shores. The inconvenience and higher costs on businesses around the world having to comport with what amounts to extraterritorial U.S. tariffs is sure to ruffle diplomatic feathers and reconfigure supply chains in unpredictable ways. For example, China – the megaproducer with low production costs due its ongoing use of coal – could be the only country capable of filling the supply shortage and, in the process, building its leverage over the global supply chains that produce and distribute this crucial industrial input.

In his zeal to apply pressure to the Russian economy, President Biden has discounted the cascading, adverse economic and geopolitical consequences of his actions. Hopefully, the administration will revisit and revise these decisions soon.