Donald Trump’s trade war is a failure, but his policies are not alone in creeping global protectionism. There is growing pressure on politicians around the world to place tariffs and other barriers to the free movement of goods. For centuries now, economists have known protectionism a fool’s errand. And yet, somehow we need a reminder as to why, so here it is.
But before we can understand why protectionism is bad, we have to take a step back and correct a misconception perpetrated by politicians like Trump when talking about the trade deficit. Trump frequently refers to the US as “losing” money when other countries buy fewer American products than Americans buy in return. This is flatly untrue. Countries don’t trade with each other; people and companies within those countries do. When a business/person decides to buy something made locally or internationally, they are making that choice in their own interest. No one country is “losing” or “winning.” The fact that the transaction took place means that it was beneficial for all parties involved.
Deconstructing a Pervasive Myth
Over a hundred years ago, famed Economist Henry George, in Protection or Free Trade trashed protectionism with basic common sense. He deconstructs the argument against free trade quite succinctly. He notes, for example, if you were starting a brand new city and you could chose any place on Earth to locate it…where would you place it? Would you place it in the middle of a desert to isolate the city from shipping lanes and land trade routes? Or would you locate it next to a river or ocean with easy access to trade? The fact that virtually all major cities today are located on bodies of water answers this question for us. If trade were bad or harmful, cities would flourish in in the Sahara Desert, but as we can see, the most prosperous cities are located along easy trade routes.
But perhaps, you might say, while trade is overall good, one must protect certain key industries with tariffs. This notion also flies in the face of logic. Remember that people and companies trade, not countries. The borders between countries are as arbitrary and man-made as the borders within countries, such as those between towns, cities, provinces…etc. If protectionism of key industries was good for growth, naturally it would make sense that all government jurisdictions at every level engage in it to protect local jobs. For example, Ohio would benefit if it placed tariffs on cars coming from Michigan and Illinois would benefit if it taxed oil imported from Texas. Everyone knows that such protectionism would be not be beneficial for anyone, yet they fail to extend this same logic to international borders.
This discussion leaves aside the fact that most countries, in an effort to discourage protectionism, impose reciprocal retaliatory tariffs. So when the US places tariffs on Chinese goods, China responds in kind. This causes economic damage to both sides, benefiting no one, except perhaps a small group of vested interests that use their political power for rent-seeking. Rent-seeking, by the way, it just a fancy way of using markets distortions to extract wealth for oneself.
Corruption and Taxes
Tariffs open the door to immense government corruption and rent seeking. Many of the tariffs put in place by President Trump are economically destructive, but prized by vested interest groups. In effect, the government, is now picking the winners and losers in the market. This runs contrary to any notion of free market enterprise.
It is also important to remember that tariffs are taxes. As far as taxes go, tariffs rank near the bottom in terms of tax efficiency. In other words, from a taxation standpoint, tariffs are some of the worst taxes you can impose on a nation. Not only do they penalize beneficial economic transactions in pursuit of foolish protectionism, they also impose significant “dead-weight loss.” Deadweight loss just refers to the loss of economic activity beyond the total tax itself (a hidden tax on the tax). Tariffs are also regressive, meaning they harm the poor and middle class more than they do the wealthy.
While it is certainly true that free trade causes harm to some groups in some industries, this is simply because, just as is the case in any market, there are winners and there are losers. In those areas where people are harmed, it’s the government’s job to step in, providing retraining opportunities to the people affected and opening the door to new growth opportunities in other areas of competitiveness. The government, as general rule, should create an environment that makes the nation competitive.
If the political and economic structures of a nation were well designed, that nation will flourish and remain competitive. If that nation is failing to compete, that is not cause to blame other countries and impose harmful tariffs, it is cause to reexamine domestic conditions, policy, and governance. For America, this means no more scapegoating and casting blame elsewhere, and instead investing and boosting competitiveness at home.