Discover more from Rational Exuberance
The dangers of tariffs
The rise of protectionism has hurt Americans and the world
The rise of populism against the ‘neoliberal order’ on both the left and right has come to an unfortunate head, with free trade becoming the scapegoat for many perceived shortcomings of modern America. Trade war rhetoric started by Donald Trump and continuously pushed by the group of ‘New Republicans’ consisting Josh Hawley and Marco Rubio, has creeped well into the Overton window. Trump’s harmful tariffs have been surreptitiously continued by President Biden, along with harmful “Buy American” policies, the logic of which lies in dishing out placatory bromides to disaffected voters in the swing states of the rust belt. In an age of aggressive inflation and expensive infrastructure, paying higher prices to buy American are likely to exacerbate the upward pressure on prices and undermine American state capacity.
In reaction to supply chain backlogs, it has become increasingly popular to grill free trade institutions such as the WTO for undermining “national sovereignty” and “destroying American jobs.” In Josh Hawley’s recent op-ed, he presents a plan that explains, “If companies want access to the American market for these critical and essential goods, then over 50 percent of the value of those goods they sell in America must be made in America.” The forceful re-shoring of American jobs and the massive government overreach required in such a plan would inevitably drive prices through the roof of all kinds of products, leaving Americans poorer than before.
Trump’s “national security” based trade war is one example of the problems with re-shoring American production. The Trump tariffs present three problems: they hurt American consumers, American exporters of related industries, and American exporters of industries that fall victim to retaliatory tariffs.
The harm to American consumers is obvious—consumers must either pay the tax (because a tariff is just a tax on an arbitrary foreign product) or they pay the more expensive “Made in America” price. This price is a very high price. According to empirical work about American protectionism (shown in the figure above), saving manufacturing jobs through tariffs has cost American consumers $500,000 per job. We see this play out in the sugar industry, where heavy sugar protection since the country’s founding have allowed sugar producers to extract rent-seeking profits and making sugar more expensive.
Retaliatory tariffs are also quite intuitive—countries that are upset at new tariffs respond in kind with their own tariffs, hurting American exporters of industries that are sometimes completely unrelated and arbitrary to the initial round of American tariffs, but who have now lost market share to uncompetitive foreign firms.
The final pernicious more nuanced damage of tariffs is its impact on American exporters and economic competitiveness. By creating a tariff, American companies have automatically and artificially lost ground to foreign firms that they compete with. This has been documented in the sugar industry tariffs, with multiple companies shifting candy production to Mexico and Canada due to the access to cheaper sugar. In a study by Aaron Flaaen and Justin Pierce, the Trump tariffs to “boost national security and manufacturing” actually decreased the number of US manufacturing jobs by 0.6% compared with the counterfactual. With manufacturing costs being sensitive to input costs, price hikes on products lower down the value chain raise the costs of the production of final products. When steel and aluminum tariffs make steel more expensive for American car makers, American cars become more expensive to produce, making Ford and GM lose competitive ground to Volkswagen and Toyota, companies which pay cheaper world market prices for steel and aluminum.
The ultimate issue with national security tariffs is that it opens the door to anti-competitive rent-seeking by domestic producers, who now have every incentive to lobby government officials to impose tariffs and insulate them from foreign competitors. Companies that succeed will no longer be those that can compete with efficiency. A companies’ ability to survive in the ruthless world of competition will be determined by its ability to earn a rubber stamp of “national security” approval from Congress, content to overcharge Americans and underdeliver on service from its protection.