More on Tariffs

My previous post explained why the popular view of trade and the effects of tariffs is wrong. It did not explain why and in what sense tariffs make the country that imposes them poorer or what, if any, arguments for tariffs might survive the realization that a tariff reduces exports as well as imports and that the trade deficit is equal to the net inflow of capital, survive, more generally, a correct understanding of the relevant economics.¹

The Case Against Tariffs

The easiest way of seeing why our tariffs make us poorer is to think of trade as a technology for producing things. One way of producing cars is by building them in Detroit, another is by growing corn in Iowa, putting it on a ship, sending the ship into the Pacific to come back with cars on it. Doing that is profitable only if it costs less, in US resources, to produce cars by trade than by building them. An auto tariff taxes the lower cost technology for building cars in order to make us use the higher cost technology instead. We are getting our cars at a higher cost, so are poorer.

Qualifications of the Case

There are three qualifications that need to made to that argument. The first is that cost is being measured by dollars paid out to purchase American inputs, such as labor. Suppose you care less about the people who produce export goods than about the people who produce import competing goods, less, in my example, about farmers than about auto workers. You might then support an auto tariff as a way to transfer income from people you care less about to people you care more about. It is a costly way, for the reason sketched in the previous paragraph, but you might think it worth the cost. One reason could be that the auto workers voted for you and the farmers did not. Another, unlikely in the case of farmers and auto workers, more plausible if you are transferring from Silicon Valley programmers to factory workers, is that you are in favor of income redistribution from rich to poor — or, if the export industries are capital intensive and the import-competing industries labor intensive, from capital to labor.

The second qualification is that I am implicitly assuming that the tariff does not affect the world price of the good being imported. Suppose, however, that the US is the main consumer of the good in question and its supply is sufficiently inelastic that the reduced demand due to the tariff means we get the amount of it we still buy at a significantly lower price. The US is then collecting a monopsony profit at the expense of our trading partners — which might be sufficient to balance the efficiency loss. It could get a similar effect by using an export tax to reduce the world supply of something we export, in effect cartelizing the firms that produce the export goods to get a monopoly profit on their sale, this time assuming a sufficiently inelastic world demand for our exports.

Both production and consumption tend to be more elastic in the long-run than in the short, so the returns from this tactic are likely to decline over time, but it is a way in which a sufficiently large economy can potentially gain from trade restrictions at the cost of its trading partners.

The third and simplest qualification is the observation that a tariff, like other taxes, provides revenue to the government. It does so at a cost, but so do other taxes. Economic theory provides no guarantee of what form of tax has the lowest excess burden. US tariffs early in the country’s history were viewed primarily as a source of revenue.

Trade War As War

US tariffs may make the US poorer but they also make our trading partners poorer. That suggests several contexts in which imposing a tariff might be in the interest of the US. One is if they are levied against a country that has tariffs, or other trade barriers, blocking US imports. Such retaliatory tariffs do not cancel out the effect of the tariffs they retaliate for, two tariffs are worse than one, but they impose a cost on the country they are levied against and so give it an incentive to drop its trade barriers. A trade war is then a milder equivalent of a real war.

The same logic is an argument for restrictions on trade designed to punish a trading partner for something other than its tariffs. The obvious example at the moment is the restrictions on trade with Russia that the US and its European allies imposed in response to the Russian invasion of Ukraine. One argument for those restrictions is to deter Russia from invading its neighbors by imposing a cost on it for doing so. A second is that the restrictions, by reducing Russia’s ability to sell its oil and gas or to buy inputs to its military, such as computer chips to use in drones, makes it less likely to win a war we want it to lose.

Trade restrictions are usually, and probably in this case, less effective than their supporters imagine, given the flexibility of international trade. As long as there is some country willing to buy Russian gas and oil it can still sell them, although perhaps at a discount. As long as there is some country that we are willing to sell chips to that is willing to sell them to Russia, perhaps covertly, Russia can still buy them.

A third argument for tariffs along these lines is to weaken a country we expect to be at war with in the future. As of yesterday morning, that was a plausible explanation of Trump’s tariffs against China — to slow China’s economic growth and so reduce its future military strength. Since those tariffs have now been reduced to a level not that much higher than tariffs against countries we do not view as future enemies, seem likely to be further reduced in the next round of bargaining, that is no longer a plausible explanation of why Trump imposed them although still an argument for why he should have.

Not, however, a very good argument, for three reasons. First, US tariffs against China hurt both countries; it is not obvious that they change their relative power, or in which direction. Second, while they may impose significant costs in the short run, in the long run Chinese firms can and will reallocate their resources to produce for other markets. The costs imposed on China by a US tariff would be greater if China still had a socialist economy, but it doesn’t; market systems, even imperfect ones such as the present economies of China and the US, are more flexible. Chinese firms produce for the US market because that is a little more profitable than alternative markets, not because alternatives do not exist in the other three-quarters of the world economy.

Third, and most important, predicting who is going to be your enemy in the future is a chancy business. As I wrote thirty-six years ago, arguing for a non-interventionist foreign policy:

You may, to take an example not entirely at random, get into one war as a result of trying to defend China from Japan, spend the next thirty years trying to defend Japan (and Korea, and Vietnam,. ..) from China, then finally discover that the Chinese are your natural allies against the Soviet Union. (The Machinery of Freedom, second edition, 1989)

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1. An earlier post on the subject.