Nonzero: Trade edition

The real cost of protectionism

I’ve always viewed myself as a right wing economist, despite generally holding “liberal” views on many social and foreign policy issues. In my view, left wing economics puts too much weight on redistribution and too little weight on growth. A focus on redistribution would be appropriate if the economy were a zero sum game, but it isn’t. Indeed Bryan Caplan argued that almost all of global poverty reduction has come through growth, and very little has resulted from redistribution.

Today, I worry that the right is beginning to pay insufficient attention to “efficiency” issues. The smarter economic nationalists understand the argument for free trade, but nonetheless favor protectionist policies to address specific issues such as regional income disparities and national security. Unfortunately, these pundits greatly overestimate the effectiveness of protectionism and underestimate its costs. Economic nationalism doesn’t work.

The media often suggests that the cost of tariffs is higher prices for consumers. In my view, that’s hardly a cost at all. Unless we have a miraculous reduction in spending, the US will need more revenue. And any new tax will hurt consumers, not just taxes on imports. The actual problems with tariffs are much more subtle, more indirect. Here are just a few of them:

1. Tariffs hurt export industries, even if foreign countries do not formally retaliate. That’s because a tax on imports is essentially a tax of trade. Indeed a 10% across the board tariff on all imports is roughly equivalent to a 10% tax on all exports.

2. Foreign countries are likely to retaliate. China will likely buy Airbus jets instead of Boeing jets. This will damage one of America’s most successful manufacturing firms, and one that is especially important with respect to national security.

3. Tariffs make economies less technologically sophisticated. Protectionism will bring back a few jobs in lower tech industries such as textiles and steel production, at a cost of hurting our high tech industries such as computers and aircraft. More than almost any other country in the world, America’s future national security will depend on our ability to stay at the leading edge of high tech industries, not our ability to produce lots of tanks and ships. When there is a need to address a specific weakness (say chip production), subsidies for reshoring are far superior to tariffs. Subsidies for chip making help our industries that use chips, while tariffs on chips hurt those industries.

4. One argument for tariffs is that free trade costs jobs in blue-collar industries, making our society less equal. But tariffs are an extremely regressive tax, which hits the young and the working class much harder than affluent older people like me. The vast majority of working class people work in areas like services, construction, mining and agriculture. All those groups are hurt by import tariffs. Even many workers in manufacturing are hurt by tariffs; especially if they work in export industries or domestic industries that rely on imported components. Brian Albrecht has an excellent post on this problem.

5. Nineteenth century “infant industry” arguments have no bearing on a 21st century economy with complex global supply chains that would take many years to disentangle. A recent study by David Baqaee and Hannes Malmberg suggests that tariffs reduce capital formation, which slows economic growth:

   This short note shows that accounting for capital adjustment is critical when analyzing the long-run effects of trade wars on real wages and consumption. The reason is that trade wars increase the relative price between investment goods and labor by taxing imported investment goods and their inputs. This price shift depresses capital demand, shrinks the long-run capital stock, and pushes down consumption and real wages compared to scenarios when capital is fixed.

6. Protectionism is even worse if combined with other nationalistic policies that increase global distrust by reducing student travel, business travel, and tourism. The more isolated a country becomes, the more susceptible to crude nationalistic arguments than can eventually lead to war. Furthermore, protectionism reduces the cost of military aggression, by making countries less susceptible to economic sanctions. Protectionism also leads to greater animosity. US economic sanctions were a significant factor in Japan’s attack on Pearl Harbor.

7. A major trade war is likely to throw monetary policy off course, potentially making any resulting recession much worse than what you’d get from the direct effect of tariffs (which is actually fairly modest.) And a major recession would discredit the mercantilist argument. Personally, I don’t much care if the argument does get discredited for the wrong reasons, but I would think that an economic nationalist would care a great deal. And of course recessions are bad!

I wish that people who worry about national defense and regional income disparities would spend more time thinking about successful cases like Switzerland—which doesn’t rely on trade barriers—and less time trying to emulate countries with per capita GDPs that are only a small fraction of the US (such as China.) What explains Switzerland’s big trade surplus? A high saving rate. Of course Switzerland is just one small country, but basically all of northern Europe, from the Alps to Scandinavia, runs big surpluses with relatively low trade barriers.

Unfortunately, the economic populists in charge of fiscal policy are about to make our already dire fiscal deficit even worse. Early indications are that Congress is likely to pass a horrifyingly bad budget. Why is trade viewed as a national security issue, while fiscal policy is not? I suspect the answer is “ignorance”. How many people in the Trump administration understand that low saving rates worsen trade deficits? Roughly zero?

[Privately, Republicans in Congress are terrified of the budget issue. They understand that decades of GOP dishonesty about fiscal policy is about to get exposed. The truth is that the GOP loves big, reckless budget deficits, and will keep doing them even when they control all the branches of government.]

An intelligent administration that worried about the welfare of American blue-collar workers and the strength of our national security would focus like a laser on a few key issues:

1. Make our economy as productive as possible, through free market policies. The richest countries are usually the most powerful. Economics is not a zero sum game, and protectionism makes us poorer and less productive. It doesn’t even help our manufacturing sector. At best, it helps a few manufacturing industries, while hurting many others. Economic success is one reason why Israel consistently defeated much larger Arab nations.

2. Strengthen our alliances with like-minded democratic nations, if only so that they will continue to supply us with needed components in any future economic conflict. Instead, we are doing the opposite.

3. If we must intervene to strengthen a particular industry that is crucial for national defense, use subsidies, not tariffs.

4. Reduce our budget deficit.

5. Become deeply entangled with our potential future adversaries. German gas imports from Russia are often cited as an example of the dangers of trade, and yet Germany was able to find alternatives after the Ukraine War began, while Russia paid a price in terms of lost export markets. The more integrated the US and Chinese economies become, the less likely it is that there will be a future war with China. The Taiwanese understand this, which is why they’ve chosen to make their economy deeply integrated with Mainland China.

6. Encourage many more Chinese students to study in America, and vice versa. This also reduces the risk of war. The recent isolation of China has contributed to the sharp deterioration in relations. Most Americans, even most highly educated Americans, are shockingly ignorant of recent changes in Chinese society. Cultural change there is now happening at an startling rate, in the direction of what some call the “Japanification of China”.

PS. As I keep saying, late 20th century neoliberalism is the best thing that ever happened: