THE BLOG
04/21/2011 08:17 am ET | Updated Jun 21, 2011

Answering Objections to a Tariff

It's only fair to answer some of the objections to the idea of an import tariff that I and others, like possible presidential candidate Donald Trump, have recently proposed.

One common objection is simply that our trading partners would just shrug it off by increasing subsidies to their exporters.

They are constantly alert to threats against their trading position: China, for example, was recently reported in China Daily as increasing export rebates on 3,800 items "to maintain growth."

This would, obviously, force us into an endless game of matching these moves on a country-by-country, industry-by-industry, and even product-by-product basis.

However, such subsidies by our trading partners would be restrained by the fact that they would be very expensive in the face of an American tariff. Right now, these subsidies are relatively affordable only because they don't have to climb an American tariff wall. But if they did, their cost would increase dramatically.

They can't afford to play that game forever, as it's cheaper for us to raise a tariff (which brings in money) than for them to raise a subsidy (which costs money).

Currency manipulation is probably the only subsidy that is affordable over prolonged periods of time (and even then problematic in the end), as it involves buying foreign assets and debt, thus accumulating wealth rather than just expenditures.

While this doesn't prevent foreign subsidies absolutely, it does tend to set a limit. This is all we need, especially as we have no hope of eliminating or countervailing all foreign subsidies no matter what we do, tariff or no tariff.

The same goes for the objection that our trading partners would just devalue their currencies. As I have previously written, we can end foreign currency manipulation at any time simply by restricting or taxing foreigners' ability to lend us debt and buy our assets. We would need to raise our own savings rate if we did this (or face rising interest rates), but we need to do this anyway.

Another objection is that any tariff large enough to mean anything would impose a sudden shock on the U.S. and world economies, which would tip them into recession as other shocks, like the 1973-4 oil shock, have done.

This is a legitimate concern, as economies do not adapt well when the rules governing them change faster than the economy itself can keep up with.

Example: if a 25 percent tariff suddenly makes it economically rational to manufacture disk drives in Colorado rather than Kyushu, this doesn't make plants sprout in Colorado overnight. So until the U.S. and Japanese economies adapt to the newly implied distribution of industries between them, they will be out of balance and thus underperform.

But phasing in a tariff over five years or so would mitigate this. Think gradual.

Another objection is that a tariff would trigger a downward spiral of retaliation and counter-retaliation with our trading partners, resulting in an uncontrolled collapse of global trade.

But this oft-bandied doomsday scenario is unlikely. Above all, our trading partners know that they are the ones with the huge trade surpluses to lose, not us. Foreign nations would probably raise their tariffs somewhat, but there is no reason to expect the process to get out of control.

Indeed, there is an opposite possibility. Suppose we tell foreign nations that our tariff increase is in retaliation for their own various trade barriers. (This is, of course, largely true.) And suppose we then threaten to raise our tariff even higher if they don't open up, but offer to drop it back down somewhat if they do.

Then our trading partners may even reduce their barriers in response to our imposing a tariff! Our imposing a tariff could, paradoxically, further the cause of global trade openness, not retard it. But it would be a much healthier openness than what we have now.

We can call this alternative "managed open trade." It is not the same thing as free trade. Fully elaborated, it would be based on the internationally shared twin goals of zero tariffs and zero deficits.

These goals would be shared, despite the reality of international rivalry and the absence of a sovereign to enforce them, because every nation would know that a) other nations would retaliate in response to excessive surpluses inflicted upon them, and b) the alternative is the system breaking down for everyone, including themselves.

This substitute for free trade would spare a lot of ideological sacred cows, as it would come fairly close to free trade if it worked. Many people who think they are defending free trade are actually defending covertly managed trade with zero tariffs, anyway.

But it would depend upon our ability to credibly threaten a tariff if our bluff were called. It would therefore depend upon our having viable contingency plans to function with a tariff.

Therefore even free traders thinking through how to save as much of free trade as they can should take the option of a tariff seriously.

By the way: they're running out of time.