This week, Donald Trump proposed imposing massive tariffs on cheap overseas goods and services as a way of protecting the American economy from "cheap foreign labor". A lot of people, even many progressives, liked this plan.
It rejected 200 years of economic thinking, however.
Why is Trump's idea a bad one?
Producers are willing to supply lots of goods at a high price, and fewer goods at a low price. If we graph this, we create a "supply curve". Similarly, consumers will buy lots of goods at low prices, and few goods at high prices. Graphed out, this created a "demand curve". Where the two curves intersect is the market price -- the amount of goods an economy will produce, at the price consumers find reasonable. Anything below the supply curve is "producer surplus" (profit). Anything above the supply curve, and below the demand curve, is the satisfaction people get from consuming the good (whether it's nails for building a house, food, clothing, music, books, or gardening supplies).
What happens when we expand this model to an international one? Let's do so, assuming that foreign companies with "cheap labor" can produce the same-quality good but at a lower price. Some consumers are willing to pay a higher price for goods. But some are not. Imports occur when a foreign producer can supply the unmet need at the lower price. Society is better off.
We can represent the cost of goods produced by "overseas cheap labor" by a dotted line, which we'll call P-world. We can put it anywhere on our graph, so long as it's below the domestic market price. The amount of imports can be identified where the world price (P-world) line intersects the demand curve and the supply curve. Notice that a big chunk of Producer Surplus is now gone, turned into Consumer Surplus. That's because consumers were able to purchase the good at a lower price than domestic producers could supply it. But also notice that a certain amount of Producer Surplus now is above the supply curve. That's profit which the domestic economy cannot recapture.
Let's note some things here.
First: Over time, if domestic producers are not able to manufacture the good more cheaply, foreign producers will take over the domestic market.
Second, imports reduce domestic employment in domestic industries which are not able to manufacture the good more cheaply.
Third, imports put downward pressure on wages in domestic industries which are not able to manufacture the good more cheaply.
Are these bad things? We don't know. We need to measure the satisfaction consumers derive from the imports and weigh that against the lost wages in the domestic industry. For example: The microchip industry is highly automated. It employs few workers, albeit at a high wage. Foreign companies can produce microchips much more cheaply, at the same quality. But they do not pay the high wage. Is American consumer satisfaction from having high-quality, inexpensive microchips greater than the small number of high-wage workers who've lost their jobs? Definitely. But where the wage gap between American workers and foreign workers is not as clear, or where much larger number of workers are involved, the trade-off might not be favorable.
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Tariffs are a form of corporate welfare. They protect domestic inefficiency, protect domestic employment, and protect domestic high wages. And they raise the cost of efficient foreign goods.
Let's graph it, and see what a tariff does. The tariff raises the price of imports from the world price (P-world) to the world-plus-tariff price (P-tariff). First, notice that the amount of imports shrinks. But notice, too, how much more Producer Surplus is lost overseas. The purple area represents Producer Surplus now captured by the tariff (tax revenue going to the federal government). But what about those red areas? That's Consumer Surplus which is lost because foreign manufacturers can no longer meet that need. This surplus is not captured by the tariff, so it represents the loss to society created by the tariff. This is also called the "deadweight loss".
Generally speaking, tariffs are considered economically inefficient. They protect domestic production inefficiency. They prevent consumers from being better off. They create deadweight losses. They shift producer surplus overseas. They do NOT increase domestic employment, unless the tariff raises the cost of foreign goods higher than the domestic price. They do NOT raise domestic wages, under any circumstances.
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Are their conditions under which a tariff can be economically efficient? Yes, there are.
Tariffs can be efficient when intended to protect an infant industry or to protect a developing economy. Tariffs can also be effective when foreign governments engage in corporate welfare and the U.S. does not.
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Historically, tariffs were rejected by almost all industrialized nations of the world in the 1920s. One of the things that exacerbated the Great Depression were high tariffs, which the United States and most of Europe adopted as a means of stemming the effect of the economic collapse of 1929. When these tariffs hit in 1930 and 1931, they worsened international trade and caused the Great Depression to worsen several-fold.
The General Agreement on Trade and Tariffs (GATT) was established at Bretton Woods in 1945 to generally establish a system of tariffs to protect war-devastated and emerging post-colonial economies. One of the key aspects of GATT, however, was to also seek to reduce these tariffs over time. In addition to general reductions in tariffs, countries could also grant exemptions from tariffs by giving an ally Most-Favored-Nation status. Once worldwide tariffs reached an almost nonexistent level in 1986, GATT was succeeded by the World Trade Organization (WTO) -- which maintains that status quo. The WTO has also established some import caps for certain kinds of cheap foreign goods, provides a means of resolving disputes about tariffs, and is an impartial way for nations to impose penalty-tariffs if WTO finds another nation has abused the process. (For example, when China was found to be dumping steel in the U.S. at ultra-low prices in violation of import quotas, the U.S. was permitted to establish a punishment tariff of 30 percent.) Tariffs are also permitted under the WTO scheme when a country does not wish to engage in the same corporate welfare as a competitor nation. (For example, the U.S. does not offer universal healthcare like France does, so the U.S. gets to impose a tariff on French goods to make up for France's corporate welfare.)
Trump has suggested tariffs because he wants to protect American industry. American industry is at a competitive disadvantage because corporations -- not the U.S. federal government -- provide healthcare; corporations must provide old-age pensions (Social Security is only a partial scheme); the U.S. has a poor educational system; the U.S. permits racism and misogyny to affect the workplace; and the U.S. has no workforce labor protections.
Trump wants to overcome these disadvantages by imposing tariffs. Is that the solution? Hardly.
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What about the wage imbalance? American wages seem quite high compared to foreign wages. Would tariffs not help?
No, they don't.
First, international trade is a two-way street. Foreigners cannot consume U.S.-made goods unless they have U.S. dollars to purchase them with. The primary way they get these dollars is by selling goods in the United States. While tariffs may cause an immediate increase in domestic employment as foreign goods are shut out, this is swiftly followed by a loss of jobs in domestic export industries.
Second, tariffs are essentially a massive transfer of wealth from consumers to corporations. Under a low-tariff system, consumers benefit since they are able to obtain more and better goods at lower prices. High tariffs invert this system, providing only the producer (corporations) with the benefit. Workers have no means of capturing this benefit from the corporation.
Third, it's not wages per se that are the issue. It's wages PER UNIT. Nations like the U.S., which have high wages, are markedly more productive and efficient than nations where workers are paid a pittance. Thus, the wage cost per unit is much lower in the U.S. than in an overseas "cheap labor" market. Now, in some cases, such as grunt labor (twisting widgets onto gadgets), a foreign nation may have a work cost per unit advantage over domestic industry. What does a tariff do in this case? Imposing a tariff (a) transfers wealth from consumers to producers; (b) raises prices for domestic consumers (due to no more cheap foreign goods); and (c) creates inefficiency in the domestic economy. The tariff does not boost domestic employment, and the tariff does not boost domestic wages.
A better response would be to enhance domestic efficiency by enhancing productivity. We do this through better worker training, improved working conditions, investment in plant and equipment, improved assembly procedures, and/or automation. If domestic efficiency can't be enhanced, then the company would be better off going out of business and the workers employed in an efficient way. The role of government, therefore, would be better off NOT imposing a tariff but in providing worker retraining, high unemployment benefits, free education, free or subsidized child care, and adjustment services.
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Tariffs suck for another reason: They are horribly difficult to implement.
We haven't even begun to talk about retaliatory tariffs... That's what happened in the Great Depression, as high tariffs in one nation led another to retaliate with even higher tariffs. Suddenly, international trade has collapsed. Retaliatory tariffs are a major problem, and generally create immense misery in post-colonial, developing, and undeveloped nations. They worsen natural resource exploitation, and create hunger and poverty worldwide.
We should also note how complex tariff implementation is. Tariffs are not neutral or rationally applied; they are almost universally abused by governments (especially democracies), which respond to corporate political donations and interest group pressure to impose and the manipulate the size of tariffs in order to achieve greater amounts of corporate favoritism and corporate welfare. Consumers are never the beneficiacy: Corporations engage in what's called "rent seeking behavior" by seeking tariffs from willing politicians, who "protect" domestic industry from overseas competition without any commensurate improvement in consumer satisfaction, domestic employment, or domestic wages.
Tariffs are also hard to enforce. Here's a real-world example: Solar panels in the 1980s cost $50 per watt to manufacture. By 2010, this cost had fallen to $0.80 per watt. The fall in price came not just from rapid advances in technology and materials, but because the Chinese had a competitive wage differential vis-a-vis American manufacturers. The U.S. imposed a 37 percent tariff on Chinese solar panels. China then shifted assembly plants overseas (primarily to Taiwan, Japan, and Korea), and sent the solar panels to the U.S. The tariff caused solar panel prices in the U.S. to rise dramatically. The price then fell, as Chinese-made but Korean-assembled solar panels flooded the U.S. market again. But it didn't fall back as far as it could have, because the cost of solar panels was now higher than if they'd been made and assembled in China.
End result: No change in domestic worker hiring. Higher solar panel costs for American consumers, without any change in quality. Delayed implementation of solar energy, and continued reliance on fossil fuels.
The United States cannot prevent China from owning off-shore firms, and it's next to impossible to determine which these are in any way that would make the tariff enforceable. In the end, the tariff created very high short-term costs, moderately high long-term costs, no protection for the domestic solar panel industry, and indirect and high long-term costs due to pollution and worsened global warming.
The pernicious side-effects of tariffs are numerous, and often hard to quantify. No wonder that venal democracies love tariffs! Industry benefits (but not consumers), and the indirect costs are high but not paid for.