In the light of escalating protectionism, spearheaded by the United States much akin to the early 1930s, it’s clear that Donald Trump is a staunch supporter of this approach. Indeed, he furthers the legacy of Senator Smoot and Representative Hawley who were known for initiating the notorious Smoot-Hawley tariff in 1930. However, by comparison, even Joe Biden is not far behind in adopting protective measures, notably, his recent tariffs on Chinese exports worth $18 billion (€16.75bn).
Especially of note, is the US tariff on electric cars which is expected to spike four-fold to a huge 100 per cent. Trump retorts to this with, “Where have you been for 3½ years? They should have done it a long time ago”, and reveals his plan to implement a 10 per cent tariff on all imports, excluding China, for which he intends to levy a whopping 60 per cent tariff. Trump believes these tariffs might compensate for the revenue plunge resulting from his high-stakes 2017 Tax Cuts and Jobs Act extension.
Politically, these strategies remain enticing. Victims of tariffs, though relatively unseen, are typically powerless, and holler – the tariffs serve as a mechanism to rectify the misdeeds of malevolent foreigners. Yet, these are flawed policies.
To comprehend this, we must discern a difference established in early 1960s economic theory, validated from the scrutiny of the role of trade policies in the breakthrough export-driven development of Taiwan, South Korea and later, China.
The message is straightforward. There may be valid reasons for government intervention in the economy like decreasing inequality, lessening insecurity, fostering nascent industries, curbing macroeconomic volatility and limiting strategic vulnerabilities. However, trade policy, and protectionism specifically, would seldom be the most effective way to reach this goal. The plea for free trade is not an advocate of laissez-faire. It is a proposition for utilising means other than trade obstacles whenever feasible.
To grasp why tariffs are infrequently the prime policy instrument, it is necessary to comprehend their function.
Tariffs act as duties on consumers, with the proceeds partly going to the government but largely to producers. Essentially, they are instances of “tax-and-spend”, albeit the tax is buried in the inflated price of the goods and the spending is hidden in the increased remunerations to manufacturers.
Policies like these are not accurately directed towards anything other than stated objectives. Comparable to any other tax, tariffs impose an additional financial burden on the individuals purchasing the goods, whether they are consumers or manufacturers. Nevertheless, they also contribute to broader economic implications and foster a strong inclination towards domestic markets.
In simpler words, an import tax simultaneously acts as an export tax. Let’s consider Trump’s proposed 10% tariff on all imports to unravel this. Initially, it appears akin to a devaluation, solely for imported commodities. The purpose is to reduce the import of such goods. Nonetheless, there’s no direct influence on the current account balance unless it consequently alters the total income and spending in the economy. Consequently, the reduced import demand decreases the need to purchase foreign currencies. This situation boosts the dollar’s strength, making exports less competitive, therefore reducing them.
Country’s best manufacturers are exporters. Subsidising the producers of non-competitive imported substitutes at their cost seems unreasonable.
This is not theoretical. Those with experience working in countries with extreme protectionist trade policies have witnessed such outcomes. I was in India working for the World Bank in the 1970s. Protectionist trade policies didn’t lead to self-sufficiency. Instead, it stifled exports making the country more susceptible.
That’s not the end of it. It also leads to harmful distribution consequences. An insightful recent study titled, Why Trump’s Tariff Proposals Would Harm Working Americans, by Kimberly Clausing and Mary Lovely, affiliated with the Peterson Institute for International Economics, analyses evidence suggesting Trump’s goals for another term are “ tantamount to regressive tax reductions, only partially counterbalanced by regressive tax hikes. A conservative cost estimate to consumers indicates that the tariffs would lower post-tax earnings about 3.5% for those in the bottom half of the income distribution.”
Correspondingly, a study released by the National Bureau of Economic Research in 2024 deduced that the trade war initiated by Trump in 2018-19 had “to this date, did not yield any economic benefits to the US heartland: the import tariffs on overseas goods neither increased nor lowered US employment in the newly protected sectors; the retaliatory tariffs had noticeable negative employment impacts, predominantly in agriculture; and these harms were only partially offset by compensatory US agricultural subsidies”.
In essence, though the policy may appear politically sound, it’s fundamentally flawed.
Is it plausible that Biden’s intensified efforts towards promoting the manufacturing of electric vehicles will show favourable results? This prospect seems doubtful, owing to a rather straightforward reason. While this strategy will safeguard manufacturers operating within the US market, the market size is far too diminutive to ensure these domestic manufacturers gain a competitive edge internationally. The International Energy Agency reported in 2023, that the demand for battery-electric and plug-in hybrid vehicles within the US was merely 17 per cent of that in China. The US’s consumer dominance in global consumption has substantially dwindled, thereby presenting a considerable hindrance to an industrial policy aimed at promoting domestic markets.
A nuanced solution will be indispensable. This could potentially take the form of subsidies, a tool Biden has rightly opted to employ. It may be argued that the taxes required to support these may not be favourably regarded, but tariffs present a larger contribution to tax burdens. To exacerbate this, they are inefficient, impart more strain on those less financially able and are almost guaranteed to incite a counter-reaction.
Indeed, there are absolutely credible reasons for market intervention. However, reverting to the trade methodologies of the 1930s is unequivocally irrational. – Copyright The Financial Times Limited 2024.