How to Win a Tariff War
May 31, 2012
I wrote an article on Envy, Asians, and Tariffs. Almost as soon as it was published, I received this email.
I am a regular reader of your articles published on LewRockwell.com, and most of the time I agree with you. I consider myself a "conservative" Libertarian. That is, I believe in the capitalist and free market system, small government, less regulation and less government intrusion into our private lives -- the same as a classic Libertarian.
Where I part ways with your thinking is over the issue of tariffs. Tariffs are anathema, of course, to classical Libertarians, because tariffs violate their commitment to "free trade." The problem with that position is that we don't have free trade. Our manufacturers are required by government regulation to pay a minimum wage, to provide medical coverage, to limit the work day to 8 hours, to provide a myriad of other costly benefits to workers, and to permit unions to extort even more costly benefits out of the hapless factory owner, all of which drive prices up. Then, if Libertarians have their way, these put upon factory owners are required to try to sell their goods in the ostensible "free market" in competition with, say, Chinese factory owners, who pay their workers $10 per day, provide no benefits and require their workers to work 12 hour shifts. That's not a "free market!" The only way to rectify this and bring manufacturing back to our shores is to impose a tariff so that it costs just as much to make a product in China as in the United States.
But that would result in higher prices, you might say. Yes, it would. But we've paid a terrible price for the "low prices" we find at Walmart. We've ruined our own
Here is my answer.
"Common sense economics" is a phrase used to describe the economic reasoning of the proverbial man in the street. In many instances, this knowledge may rest on principles that are essentially correct. For example, we have that old truism that there are no free lunches. If some of our professional experts in the field of governmental fiscal policy were to face the reality of this truth, they might learn that even the skilled application of policies of monetary inflation cannot alleviate the basic economic limitations placed on mankind. Such policies can make things worse, of course, but they are powerless to do more than redistribute the products of industry, while simultaneously redistributing power in the direction of the state's bureaucratic functionaries. On the other hand, not all of the widely held economic beliefs are even remotely correct; some of these convictions are held in inverse proportion to their validity. The tariff question is one of these.
The heart of the contradictory thinking concerning tariffs is in the statement, "I favor open competition, but. . . ." Being human, men will often appeal to the State to protect their monopolistic position on the market. They secretly favor security over freedom. The State steps in to honor the requests of certain special interest groups--which invariably proclaim their cause in the name of the general welfare clause of the Constitution--and establishes several kinds of restrictions on trade.
Fair trade laws are one example. They are remnants of the old medieval conception of the so-called "just price," in that both approaches are founded on the idea that there is some underlying objective value in all articles offered for sale. Selling price should not deviate from this "intrinsic" value. Monopolistic trade union laws are analogous to the medieval guild system; they are based in turn upon restrictions on the free entry of nonunion laborers into the labor market.
Tariffs, trade union monopolies, and fair trade laws are all praised as being safeguards against "cut-throat" competition, i.e., competition that would enable consumers to purchase the goods they want at a cheaper price--a price which endangers the less efficient producers who must charge more in order to remain in business. The thing which most people tend to overlook in the slogan of "cut-throat competition" is that the person whose throat is slashed most deeply is the solitary consumer who has no monopolistic organization to improve his position in relation to those favored by Statist intervention.
People are remarkably schizophrenic in their attitudes toward competition. Monopolies of the supply of labor are acceptable to most Americans; business monopolies are somehow evil. In both cases, the monopolies are the product of the State in the market, but the public will not take a consistent position with regard to both. The fact that both kinds operate in order to improve the economic position of a limited special interest group at the expense of the consumers is ignored. Business monopolies are damned no matter what they do. If they raise prices, it is called gouging; if they cut prices, it is cutthroat competition; if they stabilize prices, it is clearly a case of collusion restraining free competition. All forms may be prosecuted. No firm is safe.
The State's policies of inflation tend to centralize production in the hands of those firms that are closest to the newly created money--defense industries, space-oriented industries, and those in heavy debt to the fractional reserve banking system. It is not surprising that we should witness a rising tide of corporate mergers during a period of heavy inflationary pressures, as has been the case during the 1960s in the United States. Yet, with regard to business firms (but not labor unions), the courts are able to take action against almost any firm which is successfully competing on the market.
As Dr. Richard Bernhard has pointed out, "What is becoming illegal under federal law in the United States is monopolizing--as the law now defines monopolizing; and, since this is now considered a crime, it is possible that perfectly legitimate business actions by one firm may, if they 'inadvertently' lead to monopoly power, put a firm in jeopardy of the law." Thus, we see a rational economic response on the part of business firms--consolidation for the sake of efficiency on an increasingly inflationary market--prosecuted by the State which has created those very inflationary pressures. There is an inconsistency somewhere.
TARIFFS ARE TAXES
A tariff is a special kind of tax. It is a tax paid directly by importers for the right to offer foreign products for sale on a domestic market. Indirectly, however, the tax is borne by a whole host of people, and these people are seldom even aware that they are paying the tax.
First, let us consider those in the United States. One group affected adversely by a tariff is that made up of consumers who actually purchase some foreign product. They pay a higher price than would have been the case had no duty been imposed on the importer. Another consumer group is the one which buys an American product at a high price which is protected by the tariff. Were there no tariff, the domestic firms would either be forced to lower their prices or shift to some line of production in which they could compete successfully. Then there is the nonconsumer group which would have entered the market had the lower prices been in effect; their form of the "tax" is simply the inability to enjoy the use of products which might have been available to them had the State not intervened in international trade.
Others besides the consumers pay. The importer who might have been able to offer cheaper products, or more of the products, if there had been no tariff, is also hurt. His business is restricted, and he reaps fewer profits. All those connected with imports are harmed. Yet, so are exporters. They find that foreign governments tend to impose retaliatory tariffs on our products going abroad. Even if those governments do not, foreigners have fewer dollars to spend on our products, because we have purchased fewer of theirs.
Two groups are obviously aided. The inefficient domestic producer is the recipient of an indirect government subsidy, so he reaps at least short-run benefits. The other group is the State itself; it has increased its power, and it has increased its revenues. (It is conceivable to imagine a case where higher revenues might in the long run result from lower tariffs, since more volume would be involved, so we might better speak of short-run increases of revenue.) We could also speak of a psychological benefit provided for all those who erroneously believe that protective tariffs actually protect them, but this is a benefit based on ignorance, and I hesitate to count it as a positive effect.
A second consideration should be those who are hurt abroad, although we seldom look at those aspects of tariffs. Both foreign importers and exporters are hurt, for the same reasons. The fewer foreign goods we Americans buy, the fewer dollars they have to spend on American goods and services. This, in turn, damages the position of foreign consumers, who must restrict purchases of goods which they otherwise might afford. This leaves them at the mercy of their own less efficient producers, who will not face so much competition from the Americans, since the availability of foreign exchange (U.S. dollars) is more restricted.
The tariff, in short, penalizes the efficient on both sides of the border, and it subsidizes the inefficient. If we were to find a better way of providing "foreign aid" to other countries, we might provide them with our goods (which they want) by purchasing their goods (which we want). That would be a noninflationary type of aid which would benefit both sides, rather than our present system which encourages bullies in our government and creates resentment abroad.
PROTECTING VITAL INDUSTRIES
What about our vital industries, especially our wartime industries? If they are driven out of business by cheaper foreign goods, what will we do if we go to war and find our trading patterns disrupted? Where will we find the skilled craftsmen?
There is some validity to this question, but it is difficult to measure the validity in a direct fashion. It is true that certain skills, such as watch making, might be unavailable in the initial stages of a war. There are few apprentice programs available in the United States in some fields. Nevertheless, if there really is a need for such services, would it not be better to subsidize these talents directly? If we must impose some form of tax subsidy, is it not always preferable to have the costs fully visible, so that benefits might be calculated more efficiently?
A tariff is a tax, but few people ever grasp this fact. Thus, they are less willing to challenge the tax, re-examine it periodically, or at least see what it is costing. Indirect taxes are psychologically less painful, but the price paid for the anesthetic of invisibility is the inability of men to see how the State is growing at their expense. What Tocqueville referred to as the "Bland Leviathan"--a steadily, imperceptibly expanding State--thrives on invisible and indirect taxes like inflation, tariffs, and monthly withdrawals from paychecks. It ought to be a basic libertarian position to discover alternative kinds of tax programs, in an effort to reduce the economic burden of the State by making the full extent of taxation more obvious.
TRADE WAR, STATIST STYLE
One advantage of the direct subsidy to protected industries is that such subsidies would not normally result in trade wars. When one nation sees its products discriminated against by another State, it is more apt to retaliate directly. It threatens to raise tariffs against the offending country's products unless the first country's tariffs are reduced. If there is no response, pressures arise within the threatening country's State bureaus to enforce the threat. That, it is argued, will frighten other nations which might be considering similar moves. So the tariff war is born. The beneficiaries are the inefficient on both sides of the border and the State bureaucrats; the losers are all those involved in trade and all consumers who would have liked to purchase their goods at lower prices. This kind of war is therefore especially pernicious: it penalizes the productive and subsidizes the unproductive.
Another cause is the fear of State bureaucrats during times of recession or depression that domestic industries will not be favored when domestic populations buy from abroad. This was the case under the infant neomercantile philosophies so popular in the 1930s. The depression was accompanied by a wave of tariff hikes in most of the Western nations, with reduced efficiency and economic autarchy as a direct result. Domestic manufacturers cry for protection from foreign producers. What they are crying for with equal intensity is protection from the voluntary decisions of their own nation's domestic purchasers; it takes two parties to make a trade, and protection from one is equally protection from the other.
The effect of tariff wars is reduced efficiency through a restriction of international trade. Adam Smith, in the opening pages of Wealth of Nations, presents his now famous argument that the division of labor is limited by the size of the market. Reduce the size of the market, and you reduce the extent of the division of labor. The cry for protection should be seen for what it is: a cry for a reduction in efficiency. But there are so few vocal interest groups representing those who benefit from freer trade, while those who have a stake in the intervention of the State make certain that their lobbyists are heard in Washington. The scapegoat of "unfair foreign competition" may be small, but being small, it is at least easy to sacrifice.
THE BALANCE OF TRADE
In precapitalistic days, economists believed that nations could experience permanent "favorable" balances of trade. A favorable balance was defined as one where you sold more goods abroad than you imported, thus adding to the national gold stock. Wealth was defined primarily in terms of gold (a position which, even if fallacious, makes more sense than the contemporary inclination to define wealth in terms of indebtedness). Prior to the publication of Wealth of Nations (1776), the philosopher, David Hume, disposed of the mercantilist errors concerning the balance of trade. His essays helped to convert Adam Smith to the philosophy of classical liberalism. Hume's essay, "Of the Balance of Trade," was published in 1752 in his Political Discourses; it established him as the founder of modern international trade theory.
The early arguments for free trade still stand today. Hume focused on the first one, which is designated in modern economic terminology as the price rate effect. As the exported goods flow out of a nation, specie flows in. Goods become more scarce as money becomes more plentiful. Prices therefore tend to rise. The converse takes place in the foreign country: its specie goes out as goods come in, thus causing prices to fall. Foreign buyers will then begin to reduce their imports in order to buy on the now cheaper home markets; simultaneously, consumers in the first nation will now begin to export specie and import foreign goods. A long-run equilibrium of trade is the result. A second argument is possible, the income effect. Export industries profit during the years of heavy exports. This sector of the economy is now in a position to effect domestic production, as its share of national income rises. It will be able to outbid even those foreign purchasers which it had previously supplied with goods.
Last, we have the exchange rate effect. If we can imagine a world trading community in which we have free floating exchange rates on the international currency markets (which most governments hesitate to permit), we can see the process more easily. In order to purchase domestic goods, foreigners must have a supply of the exporting nation's domestic currency. As demand for the goods continues, the supply of available currency drops lower. Foreigners competitively bid up the price of the exporting nation's currency, so that it costs more to obtain the currency necessary to buy the goods. This will discourage some of the foreign buyers, who will turn to their own markets. Where we find fixed exchange rates, the same process exists, but under different circumstances. Either black markets in foreign currencies will be established, or else some kind of quota restrictions will be placed on the availability of the sought-after currency, as demand rises for exchange. Foreigners will simply not be able to obtain all the currency they want at the official price. Thus, what we witness is an equilibrating process of the exchange of goods; there can be no long-run imbalance of trade. No nation can continue to export more than it imports forever.
TARIFF WAR, LIBERTARIAN STYLE
When some foreign State decides to place restrictions on the importation of goods from another country, what should be the response of that latter country's economic administrators? Their goal is to make their nation's goods attractive to foreign purchasers. They should want to see the international division of labor maintained, adding to the material prosperity of all involved. If this is the goal, then policies that will keep the trade barriers at low levels should be adopted. Instead, there is the tendency to adopt retaliatory tariff barriers, thus stifling even further the flow of goods. This is done as a "warning" to other nations.
If the 1930s are anything like representative years of such warnings, then we should beware of conventional tariff wars. In those years a snowballing effect was produced, as each nation tried to "out-warn" its neighbor in an attempt to gain favorable trade positions with all others. The result was the serious weakening of the international specialization of labor and its productivity. At a time when people wanted cheaper goods, they imposed trade restrictions which forced prices upward and production downward. Professor Mises' old dictum held true: When a State tries to improve economic conditions by tampering with the free market, it usually succeeds in accomplishing precisely the results which it sought to avoid (or officially sought to avoid, at any rate).
The best policy for "retaliation" would be to drop all tariff barriers in response. A number of things would result from such action. For one thing, it would encourage the importation of the goods produced by the offending country. Then the three effects described earlier would go into operation. The offending nation would find that its domestic price level would rise, and that its citizens would be in a position to buy more foreign goods (including the goods of the discriminated country). What would be done with the currency or credits in the hands of citizens of the high tariff nation?
They could not spend it at home. If we, as the injured party, continued to make it easy for our citizens to buy their goods, we would provide them with lots of paper money which could be most easily used to buy our goods in return. We would gain the use of the consumer goods produced abroad, and we would be losing only money. We would be getting the best possible goods for our money, so the consumer cannot complain; if we had imposed retaliatory tariffs, consumers would have had to settle for domestically produced goods of a less desirable nature (since the voluntary consumption patterns are restricted by the imposition of a tariff). Our prices would tend to go down, making our goods more competitive on the international markets.
The tariff is a self-defeating device. As American dollars came into the high tariff nation, they could be exchanged for our gold. But this would tend to increase the rate of inflation in that country, as the gold reserves would most likely serve as the foundation for an expansion of the domestic money supply. Domestic prices would climb, and the citizens would attempt to circumvent the tariffs in various ways. Black markets in foreign currencies and goods are established; foreign goods are purchased in spite of tariff barriers; pressures for freer trade can arise, especially if the discriminated nation has wisely refused to turn to retaliation in the traditional way.
The statist tariff war is irrational. It argues that because one's citizens are injured by one restriction on foreign trade, they can be aided by further restrictions on foreign trade. It is a contemporary manifestation of the old cliché, "He cut off his nose to spite his face." It is time that we accept the implications of David Hume's 260-year-old arguments. The best way to overcome restrictions on trade, it would seem, is to establish policies that encourage people to trade more.* * * * * * * * * * *
I wrote this article in 1969. It was published in The Freeman. I updated this number: 200 years to 260 (Hume's arguments). I did not have to change my arguments, because the critics' arguments do not change. They want to fight trade restrictions with more trade restrictions. They want to fight badges and guns with more badges and more guns. They want to fight tyranny with more tyranny.