Who’s “protected” by tariffs?

Outdated policies: Tariffs worse than pre-Adam Smith era

A mere recital of the economic policies of governments worldwide is calculated to cause any serious student of economics to throw up his hands in despair. What possible point can there be, he is likely to ask, in discussing refinements and advances in economic theory when popular thought and the actual policies of governments, certainly in everything connected with international relations, have not yet caught up with Adam Smith? Present-day tariff and trade policies are not only as bad as those in the seventeenth and eighteenth centuries but incomparably worse. The real reasons for those tariffs and other trade barriers are the same, and the pretended reasons are also the same.

While it might appear that the above was written as a response to Trump’s tariffs, I would have to point out that it was written in 1946. Almost 80 years have passed, and yet governments around the world continue to indulge in the same flawed policies.
Both the title and the opening paragraph are from Henry Hazlitt’s classic “Economics in One Lesson.” The entire book is a must-read for everyone to understand the fallacy of the broken Keynesian Economics that is widely adopted today as a policy framework. Plenty of websites provide a free version, and one such can be found at[1]. Chapter 11 deals with tariffs. It is a very simple and easy-to-read 15-minute essay.

Every President should read the above to understand the wrong advice given to them by his economic advisors. In the case of Trump’s “sucker” comments, it is just incredibly naïve especially given that he tried the idea of tariffs in his first term only to see the trade deficits expand. Biden continued with the Trump Tariffs, and trade deficits increased further over the years.

The fallacy of tariffs stems from the fundamental flaw of not considering the second—and third-order effects of economic policy, i.e., “considering merely the immediate effects of a tariff on special groups and neglecting to consider the long-run effects on the whole community.” In fact, the same can be said for many economic concepts, such as deficit spending, the broken window fallacy, price controls, quotas, state-administered pricing, etc.

What is fundamentally wrong with Tariffs?

Chapter 11 of the book mentioned above offers the best description of the system of tariffs. The explanation is simple yet comprehensive and looks at the issue from multiple perspectives. It also enumerates the specific circumstances under which tariffs make sense. It’s so well written that any rephrasing I attempt cannot make it better. So I am not going to attempt one here.

Besides, hopefully, people who read Chapter 11 will also feel motivated to read the other chapters. The common person can understand more about Economics from that book than most professional economists who have studied Keynesian Economics do in their lifetimes.

For the sake of people who are unable to read the chapter, here is a summary – In creating tariffs, we raise the price of products than would otherwise be the case. The government is thus depriving consumers of other potential goods/ services they would have consumed that would have befitted other industries. They are also diverting capital towards inefficient industries, making the entire ecosystem less efficient. To save one industry through tariffs, ten other industries might shrink marginally due to the reduced demand/ higher cost of raw materials or the scarce capital that was made unavailable to them through tariffs. These latter effects are unseen, while the former is very visible.

Let us consider the simplest case of Steel: Many countries levy an import duty on Steel. Trump levied a duty of 25% on steel, citing “National Security”. Does it protect the US Steel Industry? Of course, it has – From importing more than 40MT of Steel in 2014, the US today imports less than 30MT. So the Steel industry has been a major beneficiary of the tariffs. But what are the second-order effects? Other industries (automakers, durable goods manufacturers, construction, etc.) pay a higher price for steel than would have otherwise been the case. What are the other consequences? By definition, capital/ resources are scarce, and in diverting resources towards inefficient industries (steel in this case), capital has been diverted away from companies and industries where the US could have become an exporter of or could have exported more. The net result is an overall deterioration where a visible minority gains at the expense of a diffused majority.

Let us delve further into steel. China is the world’s lowest-cost steel producer despite not having captive raw materials—they import both the high-grade iron ore and coal required for steel making. So, it is not the non-replicable natural advantages that have been bestowed upon them that give them a competitive edge. Whatever advantages they have created (e.g., power, infrastructure, etc, that lowers their cost of production), they also have a disadvantage in shipping costs and higher labor costs (at least relative to developing economies like India).

So, what should the government do to make their steel industries more competitive in the short run (recognizing that power and infrastructure cannot be replicated in the short run)? The government can lower the cost of operations by reducing royalties, taxes, and regulations. To complete the second-order consequences on this front as well, reducing taxes/ royalties without an accompanying reduction in government expenditure would mean replacing the above direct taxes with the inflation tax. As with most economic issues, as we dig deeper, solutions would come from limited government, balanced budgets, and sound money.

US dollar and tariffs

Tariffs are the worst possible solution for the US as they render otherwise competitive industries less efficient and socialize the economic losses amongst the vast majority in an opaque manner. Convoluted economic rationale destroys the advantages of free trade and comparative advantage. The distortions introduced by tariffs should be evident to the DOGE team and at least a few conservative economists. Surprisingly, none of them have pointed out Trump’s basic fallacies, and he only seems to double down with time despite ample evidence to the contrary.

The US dollar is on its way out as the world’s reserve asset, and gold is on its way in (through the BRICS currency or an equivalent arrangement). There is little that Trump can do to change that. The wheels were set in motion in 1971, and what we are observing today is the culmination of decades of corruption of Capitalism by the fiat monetary system. But if Trump believes tariffs can be used to either alter the path or even postpone the inevitable, it will backfire spectacularly. The only legitimate way for the US dollar to retain its status as the reserve asset is a return to the economic system of Capitalism that made it the reserve asset in the first place, i.e., limited government, balanced budgets, and sound money.

Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

Reference:

[1] Economics in One Lesson by Henry Hazlitt – FEE.org

For all the latest updates, download PGurus App.

The post Who’s “protected” by tariffs? appeared first on PGurus.