The House Ways and Means Committee has finally approved a bill that would attempt to crack down on Chinese currency manipulation, a key cause of America's trade deficit, by threatening China with retaliatory tariffs. Leaving aside the bogeyman of a trade war--which China is unlikely to start as the nation running the trade surplus and thus the nation having something to lose--this raises the obvious question of whether tariffs are a plausible long-term solution to America's trade problems. What would happen, that is, if America reverted to its historical norm (from Independence to after WWII) of being a tariff-protected economy?
The obvious question here is what kind of tariff are we talking about? As I have documented in other articles and in the book Free Trade Doesn't Work, there are any number of valid criticisms of the economics of free trade. There is not one thing wrong with it, but at least half a dozen things, and they get complicated very fast. As a result, the nightmare that haunts criticisms of free trade in this country is this: what if these criticisms imply that America needs a complicated technocratic tariff policy? This seems to be suggested by the complexity of the defects in free trade and by the fact that the nations which have most successfully repudiated free trade actually have complicated technocratic tariff policies. That would spell trouble, as the political difficulties of achieving such a solution in America are no secret. The dangers of a special-interest takeover are not imaginary. Even if America has in the past done a lot more successful picking of winners than laissez faire ideologues are prepared to admit, it's so hard to convince people of this fact that we might as well take the pessimistic assumption that this is not feasible as our baseline, and if it later turns out to be feasible, treat it as gravy.
Billionaire investor Warren Buffett says that one of his criteria for investing in a company is that it must have a business that even a fool can run, because sooner or later a fool will. A similar philosophy should guide our construction of a tariff policy. We need a broad-based policy that can survive imperfect implementation and political meddling, a certain amount of which will be inevitable. We do not need an intricate, brittle, difficult policy that will only create work for bureaucrats, lawyers, and lobbyists. Among other things, any policy too complex for the public to understand will be beyond the reach of democratic accountability, the only ultimate guarantee that a tariff policy will remain aimed at the public good.
One of the great puzzles of American economic history is how the U.S. once succeeded so well under tariff regimes that were not particularly sophisticated. This is where the idea of a so-called "natural strategic tariff" comes in. This idea says that there may be some simple rule for imposing a tariff which will produce the complex policy we need. The simple rule will produce a complex policy by interacting with the existing complexity of the economy. All the complexity will be on the "economy" side, not the "policy" side, so all specific decisions about which industries get protection, how much, and when will be made by the market. No intricate theory, difficult technocratic expertise, or corruptible political decision-making will be required.
There are obviously any number of possible natural strategic tariffs. The one we will look at here (probably the best) is actually the simplest:
A flat tax on all imported goods and services.
Prima facie, this is strategically meaningless because it protects, and thus promotes, domestic production in all industries equally. And if a tariff is going to win the U.S. better jobs, it will do so by winning us strong positions in the sorts of industries (largely but not exclusively high technology) that have the per-man-hour productivity to pay high wages today and have a future in terms of spawning the industries of tomorrow. While a flat tariff would help reduce the deficit, which is extremely important in its own right, it would provide the same incentive for domestic production of computer and potato chips alike, so it would not push our economy towards any industry in particular.
Or would it? The natural strategic tariff is a bet that it would. The key reason is this:
Industries differ in their sensitivity and response to import competition.
Although this is a complex issue, the fundamental dynamic is clear from the obvious fact that a flat tariff would almost certainly trigger the relocation back to the U.S. of some industries but not others. For example, a flat 30 percent tariff (to pluck a number out of thin air) would not cause the relocation of the apparel industry back to the U.S. from abroad. The difference between domestic and foreign labor costs is simply too large for a 30 percent premium to tip the balance in America's favor in an industry based on semi-skilled labor. But a 30 percent tariff quite likely would cause the relocation of high-tech manufacturing like semiconductors. This is the key, as these industries are precisely the ones we should want to relocate. Therefore a flat tariff would, in fact, be strategic.
The exact level at which to set the tariff remains an open question. Thirty percent is suggested here because it is in the historic range of U.S. tariffs and is close to the net disadvantage America's trade currently faces due to America's lack of a VAT. The right level will not be something trivial, like two percent, or prohibitive, like 150 percent. But there is absolutely no reason it shouldn't be 25 or 35 percent, and this flexibility will provide wiggle room for the compromises needed to get the tariff through Congress.
Granted, a natural strategic tariff would be an imperfect policy. But it would be infinitely better than the "free" (on America's part but not on the part of our trading partners) trade we have now, and relatively politics-proof. Above all, it is a policy people are unlikely to support for the wrong reasons (i.e., producer special interests) because it does not single out any specific industries for protection. It thus maximizes the incentive for voters and Congress to evaluate protectionism in terms of whether it would benefit the country as a whole--which is precisely the question they should be asking. It would also create the right balance of special-interest pressures: some interests would favor a higher tariff, others a lower one. This is a prerequisite for fruitful debate, as it means both views will find institutional homes and political patrons.
The tariff's uniformity across industries would avoid the problems that occur when upstream but not downstream industries get tariff protection. For example, if steel-consuming industries do not get a tariff when steel gets one, they will become disadvantaged relative to their foreign competitors by the higher cost of American-made steel. And why should steelworkers be protected from foreign competition at the price of forcing everyone else to pay more for goods containing steel? The only reasonable solution is that steelworkers should pay a tariff-protected price for the goods they buy, too. This logic ultimately means that all goods should be subject to the same tariff.
The natural strategic tariff is more ideologically palatable than most other tariff solutions. Above all, it respects the free market by leaving all specific decisions about which industries a tariff will favor up to the marketplace. It will thus be considerably easier for ideological devotees of free markets to swallow than some scheme in which tariffs are set by a federal agency, leading to that nightmare of free-marketeers: government picking winners.
One obvious objection is simply that a tariff is a tax increase. So it is. But it does not have to be a net tax increase if the revenue it generates is used to fund cuts in other taxes. In order to obtain a "clean" policy debate, in which the tariff is debated purely on its merits as a trade policy, unmuddied by differing opinions about the total level of taxation, any tariff proposal should be packaged with compensating cuts in other taxes.
Another objection to a tariff is that if American industry is granted tariff protection, it will just slumber behind it. Many industries indeed long to shut out foreign competition, reach a lazy detente with domestic rivals, and coast along with high profitability and low innovation. But a flat tariff resists this danger because it does not hand out a blank check of protection: it gives a certain percentage and no more. Any industry that cannot get its costs within striking distance of its foreign competitors will not be saved by it. This discipline, although unpleasant for the losers, is the price we must pay for having a tariff that actually works, rather than one which eliminates the discipline of foreign competition entirely and protects all industries, whether or not their protection is useful to the economy as a whole. And the logical remedy for competitive sloth is stiffened antitrust enforcement.
Another objection to a tariff is that our trading partners would just shrug it off by increasing subsidies to their exporters. This would 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. 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. But other subsidies amount to a give-away from the exporting to the importing nation. While this doesn't prevent them 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.
One final point: a natural strategic tariff would need to include a rebate on reexported goods in order to avoid handicapping American exporters. There would, of course, be any number of other administrative complexities, but this is true of any tax proposal in a complex economy.
Whether a flat tariff is ultimately the best trade policy for America is an open question, but it is worth considering the possibility simply because it sets a baseline, the "least we can do," for a solution. And nothing about it precludes adopting a more complicated approach later. Even if we do not adopt such a policy, knowing that we plausibly could will give us crucial leverage in threatening our trading partners. It is thus an idea that even would-be free traders, who merely want to get America's trading partners to stop interfering with genuinely free trade, should take seriously as a Rooseveltian "big stick" to hold in reserve as our diplomats talk softly to Hu Jintao.
Ian Fletcher is the author of Free Trade Doesn't Work: What Should Replace It and Why (USBIC, 2010, $24.95) An Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933, he was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at ian.fletcher@usbic.net.
We used tariffs since 1791, when ALEXANDER HAMILTON insisted on it.
No one who insists that we should be paid according to our productivity, instead of the tried and true formula of a deal unions did with employers three generations ago is going to get any traction in this political and economic environment.
As die-hard protectionists, we must IGNORE the simple fact that increasing tariffs will drive down the living standards of those ~30% of American who can’t afford higher priced products. We have to REFUTE, even without logic or evidence, the certainty that our trading partners will raise their own tariffs in response to our own actions.
Nevermind that we wrote the rules of the General Agreement on Tariffs and Trade (GATT), and forced them down the rest of the world’s throats! Forget that the evolution of the GATT into the World Trade Organization (WTO) coincided with the greatest reduction in poverty in human history!
We want to get news coverage!
We want to get elected!
< / sarcasm >
And Americans are not living beyond our means! We are waging two wars that we aren't paying for and cutting taxes and not taxing corporations at all...
Publicly fund our political campaigns.
Wanna see banks lend? Remove their licenses to gamble in the marketplace. This is possible? After public campaign financing, SURE!
What else might happen? Good things!
If America wants to be the world's biggest exporter, it can easily be achieved in less than 10 years.
1. Relax the environmental regs., dig dirt and export. The Aussies make a wonderful living doing just that.
2. Encourage foreign companies to invest and develop the export trade - especially Chinese companies to go after the fast expanding Chinese consumer demands. They know the language and the target markets, and have the connections.
"One final point: a natural strategic tariff would need to include a rebate on reexported goods in order to avoid handicapping American exporters"
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So you claim that it would be to expensive for other countries to subsidize exports but at the same time you say the US should do it. What makes you so sure that it wouldn't be too costly for the US to do the same.
Pot meet kettle.
We should also add tariffs on goods coming from countries who don't incorporate social/environmental costs into price of goods.
If China comes up with super new efficient manufacturing process to shave 15% of production costs, then kudos. If they pay $1/hour with no bennies and dump toxic waste in river, then thats a big no-no.
That isn't free trade, its exploitation.
Outsourcing our supply chain overseas has devastated US economy.
By June, 2009, the total number of U.S. investment projects in China had exceeded 57,000 and the value of accumulated U.S. investment in China reached 61 billion dollars. These U.S. companies operating in China REPORT annual profits of at least 80 billion U.S. dollars. The actual profits are of course much higher, as they are hidden with transfer pricing moves. According to the American Chamber of Commerce in China's 2009 White Paper, about 74 percent of American businesses in China made profits and 91 percent chose to stay in China to expand their business. Many of these businesses are enjoying not only whatever industrial policies promulgated by Beijing, but they are also enjoying preferred status, advantaged over the locals.
On the other hand, cumulated Chinese direct investments in the U.S., due to the hostility shown by the American Congress, has been only US$3.1 Billion by June 2009.
The $80 Billion in American profits from China is MANY TIMES that of the profits on China's exports to America ($300 Billion, with profits averaging 1-5%). Protectionism will just jeopardize Americans' ability to make profits from China. It will also kill the fastest growing export market (China) for American exporters.
also whould be some offset or countervail to make up for the differences in labor, safety, environmental regulation
Someone should vet who is paying his salary.
Now here is an economic question that easy to answer. Would even a 50% flat tariff hurt a single consumer if the U.S. PRODUCED all of its own goods and services like it used to? (The answer is NO!) I hope this helps you to see that all free-traders are, at heart, scam artists. If you like losing at Three Card Monte, play the free-trade game.
Another good use for tariff revenue is bolster the social safety nets to assist those who have become un or underemployed as a result of unfair trade, as well as compensate those who have been harmed by IP theft and piracy
Tariffs are a tax that the consumer pays. And it is a bailout to those companies that it protects. More importantly it is a regressive tax and penalizes those with less money more. Finally, they almost always lead to retaliatory tariffs or regulations in return, as was the case with the Smoot-Hawley act in 1929/30. Go back and read a history book to find out how that worked out for us.
Those companies that get protected, tend to spend less money investing back into their company (preferring to invest in senators and congressmen that will keep voting them protection) and ultimately it hollows out the need to innovate. Meanwhile those companies that are competing successfully overseas, having come up with a better mousetrap, get penalized abroad and their products and as a result sell less and never reach their full potential.
In short, the consumer is worse off (by paying higher prices), the companies are worse off (by no longer competing internationally) and the country is worse off (less demand and less consumption tax).
Tariffs? We need less not more. Especially in this time when the poor have less money and need cheaper options not more expensive ones.
Kai
Your speculation that money from within protected companies would go back to congressmen and thus result in less innovation is only that, speculation. And who cares about limiting the potential of a non-US made product or service? Certainly, no one in the US should care. As an American, do I have a vested interest in the success of communist China (which is, by the way, a problem with big US corporations that invest there)?
Geeze, more communists showing up, painted with the face of capitalism and US interests.
1) they were mentioned and dismissed as possibilities. However, there is no shortage of research the empirically demonstrates the economic cost and moral hazards that exist when tariffs are introduced.
2) Your point on industries spending to keep their industry protected as speculation is correct. I was just speculating. Your point on who cares. I care as will most poor people if they have to pay more for products that could be produced more cheaply somewhere else, thus reducing their financial burden.
3) As an American you do not have a vested interest in the success of China and if you feel strongly enough about it, don’t buy their products. That is your choice, however that does not give you the right to limit MY choice to buy their products should I so desire without being forced to protect a domestic industry for which I also have no vested interest. As an American, should you be forced to pay for higher sugar prices because Florida sugar growers have such political clout. Or any product for that matter. How is that fair? By opening the market it provides choice. YOU have the choice to only buy American and if you are that rich and price insensitive please do so. Stop limiting MY choice to feed my family in the most economic efficient way possible.
Not sure about your point about communists and painted faces. Please expound.
Kai
No the problem is processes that were developed by workers over 2 and 3 generations were taken to third world countries without the workers of those generations being compensated. This eroded our standard of living and is in fact the source of the profits reaped by corporations that moved off shore.
Fact is I'm all for keeping those corporations who have engaged in the practice kept out. Were a successful tariff program implemented ... one that indexed the tarif a country pays to the difference between our CPI and theirs(simple eh) ... small and medium sized companies would move into the gap overnight.
No the opposition to common sense comes from idealogues who in the face mounting evidence that Ricardian economics has failed cling to the philosophy like Ptolemaic earth centrist. The second group in opposition are those who believe wrapping the public up in webbing and slowly feeding on them in the way of taxes is a better way to fund government. Both are wrong.
I get your point. It was Ok when we stole ideas during our industrialization but now that other countries are doing it, it is unfair. How one-sided are you?
Regarding lowered standard’s of living, technological innovations have made economies increasingly global, one spin off of that is that unskilled labor (as well as skilled labor) has become commoditized and now must compete at global wage levels. Where there are wage arbitrage opportunities in which there is cheaper wages elsewhere, capital will flow there. You cannot put that genie back in the bottle. The only thing you can do is learn to compete, making your labor more valuable.
Your idea on a CPI-driven tariff system is scary. In addition to being bad economics, it is bad political and social policy. Regardless, it forces the American population to involuntarily pay to keep someone else in business. If you want to keep them in business, YOU pay for their expensive less effective products, do not force me to.
You last paragraph was generalized nonsense so I won’t address it.
Kai
http://www.aflcio.org/issues/jobseconomy/globaleconomy/upload/china_learnfacts.pdf
:...Empty Cargo Containers: Our Leading Export to China.
o Over the decade 1995 - 2005, U.S. merchandise imports from China exceeded U.S.
merchandise exports to China by a cumulative total of more than one trillion dollars. In
the year 2005 alone, China’s total exports grew by 28.4 percent.
o China is now the second leading exporter to the United States behind Canada and exceeds Mexico, the low-wage export platform south of our border. At current growth rates, it will surpass Canada in two years
·o Empty cargo containers are our largest export to China … over 60% of the cargo
containers that come into the U.S. from Asia return empty. We ship empty containers and
raw materials to China. They ship back finished products...: