President Trump has proposed a universal 10% tariff on U.S. imports and has been met by universal derision among professional economists. Not so fast! High tariffs were a feature of Republican governance before the Great Depression. While they operated on a “beggar my neighbor” basis against the British steel industry, for example, they have retained an inchoate appeal to Republican voters that Trump exploited in his 2016 campaign and as President. A low universal tariff, such as Trump now proposes, may be both politically and economically optimal, as I shall explain.
There is no doubt that the high, indeed extortionate tariffs imposed by Republican Congresses from 1862 to 1930 were perverse in their effects. Before 1860, U.S. tariff policy had been a moderate compromise between northern and southern interests, as exemplified by President James Buchanan’s Tariff of 1857. However, from the 1862 Morrill tariff on, tariff rates were so high as to prevent imports, and were imposed arbitrarily, at different rates for different products, after heavy lobbying by domestic manufacturing interests. This shut competitive British producers out of the U.S. market while British and Empire markets were generally open to U.S. producers (since Britain persisted in its self-destructive policy of unilateral free trade). This discrepancy gave U.S. producers the ability to bulk up at high selling prices, making them ever more competitive against undersized and underinvested British producers.
Theoretically this advantage could have allowed the U.S. to drive up wage rates, achieving a “workers nirvana” in 1870-1900 instead of in 1945-1970. However, high and unrestricted immigration allowed employers to hold down U.S. wage rates, pushing up profits instead. Thus, the teeming slums of the largest U.S. cities; thus, the inordinate wealth of the “robber barons.”
After 1930, with Democrats generally in control, policy changed. Tariffs on industrial goods were gradually reduced, while agricultural products were subject to government subsidies and in some cases, such as sugar and cotton, bans on imports above a low quota. This gradually rebalanced world trade (while after the 1944 Bretton Woods Conference preventing Britain from maintaining its rational and modest system of “Imperial Preference” which imposed a 10% tariff on imports into the Empire). Then after 1994, with the Soviet Union disappeared, the 19th century Whig dream of global free trade was imposed (except on U.S. and EU agricultural products) and the World Trade Organization was instituted to arbitrate trade disputes.
Over the past almost three decades, the defects of the globalist Whig view have become apparent. Fueled by two decades of low interest rates, much of U.S. manufacturing has decamped to China, while U.S. multinationals constructed endlessly fragile “supply chains” in which parts were outsourced to the lowest worldwide bidder, regardless of the political or economic dangers of doing so. The WTO, while a good idea in principle, has proved utterly ineffective in policing the increasingly frequent and flagrant transgressions of international trade agreements.
Consequently, the world trade system has descended to the rule-free chaos of the jungle, swarming with hungry predators, without the nutrient-rich environment that a jungle provides. The feeble rules enforcement has encouraged the rise of various unpleasant dictator states, reversing the move to democracy that the early 1990s appeared to have made final. The billionaire classes may benefit from this, and indeed have done so, but it does nothing for ordinary people, in the United States, the EU, East Asia or emerging markets in general.
A truly tariff-free world is destabilizing, unless it is combined with a Gold Standard that maintains fixed exchange rates between different currencies. In a floating-parity world, such as we have today, exchange rates fluctuate by up to 15-20% in any given year. As a result, within a period of a few years it may first be attractive to produce in country A and sell in country B, then shortly thereafter impossible to do that, but highly attractive to produce in country B and sell in country A. Add to this instability the fanaticism of modern accountants about marking to market, and you can see that a plant in country A may be hugely valuable one year and worthless the next, causing both financial losses and social disruptions as workers are laid off.
By and large, small and medium-sized companies, which often have only one product line made in one country, are unable to deal with this instability and therefore disappear. The beneficiaries, as in almost all our modern economic arrangements, are the corporate behemoths, which have a multiplicity of products and countries of operation, and hence can offset profits from one operation with losses from closing down another, with only the affected workers being immiserated.
As well as being destabilizing and tending to favor the behemoths, the Whiggish dream of a tariff-free world is geo-strategically dangerous. If all countries are perpetually at peace and there are no “spheres of influence” or other reasons for preferring one producer over another, as appeared to be the case in the 1990s, then the tariff-free-world offers the theoretical benefit of optimizing production locations. However, in the real world the dangers of this exceed the benefits. You only have to consider the strategic dangers being opened up by the combination of the absurd “climate change” mandating of electric automobiles with the coming monopolization of both that market’s raw materials and its production capacity by a potentially hostile China to see that the Whiggish free trade dream would be as fatal for the United States today as it was for Britain in 1873-1914.
Finally, there is the revenue argument. Before 1914, Britain could operate its government, even building a fleet of Dreadnought battleships, without significant revenue from tariffs or income taxes above a maximum rate of about 12%. With today’s bloated governments, the fiscal strain of attempting this is highly damaging to economic health; without tariff revenue income taxes and social security taxes are pushed to absurdly high levels (as, in Europe, is Value Added Tax). A modern fisc without tariffs is completely unbalanced; all the tax burden is laid on domestic citizens, while foreign producers escape entirely untaxed. A tariff-free world gives an unfair benefit to international traders, at the expense of heavily taxed individuals who create value in other ways, for example by inventing entirely new products (think Thomas Newcomen, who was entirely uninvolved in international trade).
President Trump’s proposed 10% flat tariff is expected to yield $300 billion a year; that does not solve the problem of a budget deficit which in the year to September 2023 will total close to $2 trillion, but it at least makes a start on a solution, restoring some balance to the U.S. Federal government’s income sources.
The tariff instituted must however be carefully designed. We should avoid the excessively high rates and discriminatory imposts of 1862-1930, as well as the political log-rolling that disfigured their design. Those tariffs often made the excessively protected goods far more expensive than necessary, raising costs for domestic users and bloating the robber barons’ profits. They also, by blocking trade altogether, constituted close to an act of war against foreign competitors. Britain was excessively wimpy in 1873-1914 in raising no effective protest against the U.S. barriers to steel imports, a technology developed in Britain and first demonstrated in Cheltenham. A more robust British government might have repeated the 1814 expedition to Washington, but this time burning Congress, the source of the tariffs, rather than the White House.
Quotas are even more to be avoided; they do not even generate revenue and have the effect of an infinite tariff against imports above the quota level – thus potentially costing far more than even McKinley-era tariffs. Quotas currently in the system should be abolished, or replaced with moderate tariffs, allowing poor countries to produce sugar and cotton, for example, and sell it into the U.S. market. Much of the most labor-intensive U.S. agriculture should be replaced by imports from Latin America, which would be far less damaging to U.S. society than imports of Latin American workers on rock-bottom wage rates. The Ricardian model of comparative advantage applies with more force to quota-protected goods and to non-strategic commodities than it does to tariff barriers.
However, Trump’s proposal of a 10% flat tariff does not suffer from either of these defects. Being applied across all products, there will be no log-rolling in Congress to subject disfavored products to tariffs to protect local producers. Being set at a low level, it will not distort trade significantly; indeed since we live in a world of witlessly fluctuating exchange rates, it should somewhat stabilize it, since temporary exchange rate fluctuations will not shift production arbitrarily overseas and back again. It will also be wholly non-discriminatory between foreign producers, so will raise no excessive political animosities. Indeed, if it is accompanied with an abolition of quotas, it will even improve relations with nations such as Brazil whose sugar-based ethanol (much more efficient than U.S. corn-based ethanol) is barred from the U.S. market. Finally, there is that $300 billion of revenue, a blessed contribution to a budget deficit that will be a nightmare to close.
As with many of his proposed policies, President Trump’s original tariff proposal outrages conventional wisdom, but on examination proves far better than the tired, outdated unrealistic Whiggish approach of the “experts.” Truly, the Washington intellectual Emperor has no clothes!
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)