Midweek Reader: The Folly of Trump’s Tariffs

With stocks plummeting this week upon an announcement of retaliatory tariffs by China in response to a recent spate of steel and aluminum tariffs from the Trump administration, it seems a midweek reader on the situation is appropriate.

  • At the Washington Post, Rick Noack explains how Trump is going into unprecedented territory since the WTO was founded, and why existing trade norms probably can’t stem a trade war. A slice:

    But while China has used the WTO to accuse the United States of unfairly imposing trade restrictions over the last months, Trump does not appear interested in being dragged into the dispute settlement process. In fact, Trump appears to be deliberately undermining the legitimacy of that process by saying that his tariffs plan was based on “national security” concerns. WTO rules mandate that a member state can claim exceptions from its trade obligations if the member’s national security is at stake.

    That reasoning has long been a no-go among WTO member states, because they understand  that triggering trade disputes under a “national security” framework could eventually render the WTO meaningless.

  • Last month at the Chicago TribuneSteve Chapman had a good op-ed showing why Trump’s justification of steel and aluminum tariffs on national security grounds is bogus:

    But putting tariffs on all imports to prevent dependence on China or Russia is like throwing away your library card to avoid bad books. It would make more sense to focus on the guilty countries rather than deploy a sprayer that also soaks the innocent.

    The national security risk is minuscule, though. Imports make up only one-third of the steel we use, and the Pentagon requires less than 3 percent of our domestic output. No enemy has us over a barrel, because we buy steel from 110 different countries.

    Most of what we import comes from allies and friends, including Canada, South Korea and Mexico, which would have no reason to cut us off in a crisis. If China stopped shipping to us, friendlier countries would leap to grab the business.

  • Also at the Washington Post last month, historian Marc-William Palen gives numerous historical examples of how nobody wins in trade wars and how they can threaten our national security by arousing populist resentment of the US abroad. A slice:

    The trade wars that followed the Republican passage of the protectionist Smoot-Hawley Tariff Act of 1930, which raised duties on hundreds of imports, similarly contain illustrative lessons for today. Canada responded with tariff increases of its own, for example, as did Europe.

    In a widely cited study from 1934, political economist Joseph M. Jones Jr. explored Europe’s retaliation. His study provided a warning about the trade wars that can arise when a single nation’s tariff policy “threatens with ruin” specialized industries in other countries, arousing “bitterness” throughout their populations.

  • At Cato’s At LibertyDaniel Ikeson explains how Trump’s tariffs establish a dangerous international precedent that will threaten US interests elsewhere:

    By signing these tariffs into law, President Trump has substantially lowered the bar for discretionary protectionism, inviting governments around the world to erect trade barriers on behalf of favored industries.  Ongoing efforts to dissuade China from continuing to force U.S. technology companies to share source code and trade secrets as the cost of entering the Chinese market will likely end in failure, as Beijing will be unabashed about defending its Cybersecurity Law and National Security Law as measures necessary to protect national security.  That would be especially incendiary, given that the Trump administration is pursuing resolution of these issues through another statute—Section 301 of the Trade act of 1974—which could also lead the president to impose tariffs on China unilaterally.

  • The Independent Institute’s Robert Higgs reminds us that citing trade deficits is misleading:

    In reality, individuals, firms and other organizations, and governments trade with other such entities, some of which are located in the same country and others of which are located in other countries. The location of the trading partners has no economic significance whatsoever. Trading entities enter into exchanges voluntarily, each one in each transaction anticipating a gain from the trade. Hence, in expectational terms, every such trade entails a gain from trade, or in other words an addition to the trader’s wealth.

  • At American Greatness, Henry Olsen tries to give a communitarian justification of protectionism:

    So-called populist movements around the world are gaining strength because their voters no longer feel like valued members of their nations. They do not believe their worth should decline because the owners of capital say so, nor do they think their life dreams or values should be denigrated simply because the most educated have different visions.

    Populists like Trump address this spiritual yearning and fulfill the deepest need every human has, to be valued and to belong to a group that values you. In this, and perhaps in this need alone, all men are truly created equal. Tariffs are simply an economic means to fulfill this spiritual need. Tariff opponents can only win if they first recognize this need and promise a more effective way to fulfill it.

  • At Bleeding Heart Libertarians, Jason Brennan explains why communitarianism cannot justify protectionist policies:

    Second, if tariffs don’t actually succeed in helping these workers, then the symbolic argument falls flat. Imagine an artist said, “I’m so concerned about the plight of people living in tenements, I’m going to do a performance art project where I burn down all their homes and leave them on the street. Sure, that will make them even worse off, but my heart is in the right place, and I thereby express my concern for them.” This artist would be…a contemptible asshole.

  • Finally, given its relevance at the moment, it’s worth revisiting Paul Krugman’s classic essay “Ricardo’s Difficult Idea” which remains the best account of why non-economist intellectuals have a hard understanding free trade:

    (i) At the shallowest level, some intellectuals reject comparative advantage simply out of a desire to be intellectually fashionable. Free trade, they are aware, has some sort of iconic status among economists; so, in a culture that always prizes the avant-garde, attacking that icon is seen as a way to seem daring and unconventional.

    (ii) At a deeper level, comparative advantage is a harder concept than it seems, because like any scientific concept it is actually part of a dense web of linked ideas. A trained economist looks at the simple Ricardian model and sees a story that can be told in a few minutes; but in fact to tell that story so quickly one must presume that one’s audience understands a number of other stories involving how competitive markets work, what determines wages, how the balance of payments adds up, and so on.

Trump’s personal game might work in China

In spite of all the economic and strategic differences between the US and China, personal relationships play an important role in bilateral relations between Washington DC and Beijing.

Trump’s Ambassador to China 

One of the first appointments made by US President Donald Trump was that of Terry Branstad as US Ambassador to China. The key reason was Branstad’s personal rapport with Chinese President Xi Jinping. This began in 1985, when Branstad was Governor of Iowa, while Xi Jinping an official from Hebei was visiting Iowa. In 2011, Branstad visited Beijing, and met with Xi at the Great Hall of the People. In February 2012, when he was vice-president, Xi stopped in Muscatine, Iowa, where he met not just with Branstad but with big industrialists and farmers from the states.

The US President, commenting on the reason for appointing Branstad, stated:

Governor Branstad’s decades of experience in public service and long- time relationship with President Xi Jinping and other Chinese leaders make him the ideal choice to serve as America’s ambassador to China.

During US President’s China visit in November 2017, Branstad, who shares a good rapport with Trump, did the groundwork for the visit. While in recent weeks tensions between both countries have escalated, with Trump imposing tariffs on Chinese goods worth $60 billion, the American president was delighted with the welcome he had received during his trip and had even told the Chinese President: “My feeling towards you is incredibly warm.”

It would be pertinent to point out that Trump’s decision to appoint Branstad as Ambassador to China (December 2016) came as a relief to the Chinese, given the fact that the US President took Taiwanese President Tsai-Ing Wen’s phone call, much to the chagrin of Beijing (since this went against established US policy).

If one were to look beyond the role of personal relationships in the very complex but important Beijing-Washington relationship, China lays a lot of emphasis on experience (educational, professional) in the US. If one were to examine the credentials of some of the top officials in Xi Jinping’s administration, US education as well as experience in dealing with economic issues pertaining to the US, has played a key role in some of the Chinese President’s appointments.

For instance, Liu He, whom Xi Jinping has appointed as a Vice Premier for overseeing the economy and financial sector, is US educated. Liu, who speaks fluent English, obtained a master’s degree in public administration from the Kennedy School of Government (Harvard University) in 1995. Apart from his in-depth understanding of the Chinese economy, Liu has also been involved in important discussions with US leaders.

Another significant appointment by Xi Jinping is that of Yi Gang, who has been named as Governor of the People’s Bank of China (PBOC). Yi obtained a business degree from the Hamline University in St. Paul, Minnesota, and a Ph.D. in economics at the University of Illinois, before moving to Indiana University at Indianapolis as a professor in 1986. He taught later at the Peking University in Beijing, before moving to the PBOC in 1997.

While economic and strategic issues are too complex to be driven by personal relationships or chemistry (though Trump seems to be a keen believer in personal chemistry given the emphasis he lays on individual ties) alone, an in-depth  understanding of the culture, politics, and economics of one’s interloctutors is especially handy. Given the current tensions between both countries over tariffs, this dynamic may prove to be especially useful.

BC’s weekend reads

  1. Pakistan’s ambitious naval delusions
  2. Diplomatic assassinations have a long and tragic history
  3. When tyranny takes hold
  4. Nullification and secession in America (review)
  5. A liberal global trading system without the United States
  6. Floating exchange rates and tariffs

On 19th Century Tariffs & Growth

A few days ago, Pseudoerasmus published a blog piece on Bairoch’s argument that in the 19th century, the countries that had high tariffs also had fast growth.  It is a good piece that summarizes the litterature very well. However, there are some points that Pseudoerasmus eschews that are crucial to assessing the proper role of tariffs on growth. Most of these issues are related to data quality, but one may be the result of poor specification bias. For most of my comments, I will concentrate on Canada. This is because I know Canada best and that it features prominently in the literature for the 19th century as a case where protection did lead to growth. I am unconvinced for many reasons which will be seen below.

Data Quality

Here I will refrain my comments to the Canadian data which I know best. Of all the countries with available income data for the late 19th century, Canada is one of those with the richest data (alongside the UK, US and Australia). This is largely thanks to the work of M.C. Urquhart who recreated the Canadian GNP series fom 1870 to 1926 in collaborative effort with scholars like Marvin McInnis, Frank Lewis, Marion Steele and others.

However, even that data has flaws. For example, me and Michael Hinton have recomputed the GDP deflator to account for the fact that its consumption prices component did not include clothing. Since clothing prices behaved differently than the other prices from 1870 to 1885, this changes the level and trend of Canadian incomes per capita (this paper will be completed this winter, Michael is putting the finishing touch and its his baby).  However, like Morris Altman, our corrections indicate a faster rate of growth for Canada from 1870 to 1913, but in a different manner. For example, there is more growth than believed in the 1870-1879 period (before the introduction of the National Policy which increased protection) and more growth in the 1890-1913 period (the period of the wheat boom and of easing of trade restrictions).

Moreover, the work of Marrilyn Gerriets, Alex Chernoff, Kris Inwood and Jim Irwin (here, here, here, here) that we have a poor image of output in the Atlantic region – the region that would have been adversely affected by protectionism. Basically, the belief is a proper accounting of incomes in the Atlantic provinces would show lower levels and trends that would – at the national aggregated level – alter the pattern of growth.

I also believe that, for Quebec, there are metrological issues in the reporting of agricultural output. The French-Canadians tended to report volume units in manners poorly understood by enumerators but that these units were larger than the Non-French units. However, as time passed, census enumerators caught on and got the measures and corrections right. However, that means that agricultural output from French-Canadians was higher than reported in the earlier census but that it was more accurate in the later censuses. This error will lead to estimating more growth than what actually took place. (I have a paper on this issue that was given a revise and resubmit from Agricultural History). 

Take all of these measurements issue and you have enough doubt in the data underlying the methods that one should feel the need to be careful. In fact, if the sum of these (overall) minor flaws is sufficient to warrant caution, what does it say about Italian, Spanish, Portugese, French, Belgian, Irish or German GDP ( I am not saying they are bad, I am saying that I find Canada’s series to be better in relative terms).

How to measure protection?

The second issue is how to measure protection. Clemens and Williamson offered a measure of import duties revenue over imports volume. That is a shortcut that can be used when it is hard to measure effective protection. But, it may be a dangerous shortcut depending on the structure of protection.

Imagine that I set an import duty so high as to eliminate all entry of the good taxed (like Canada’s 300% import tax on butter today). At that level, there is zero revenue from butter import and zero imports of butter. Thus, the ratio of protection is … zero. But in reality, its a very restrictive regime that is not being measured.

More recent estimates for Canada produced by Ian Keay and Eugene Beaulieu (in separate papers, but Keay’s paper was a conference paper) attempted to measure more accurate indicators of protection and the burden imposed on Canadians. Beaulieu and his co-author found that using a better measure, Canada’s trade policy was 11% more restrictive than believed. Moreover, they found that the welfare loss kept increasing from 1870 to 1890 – reaching a figure equal to roughly 1.5% of GDP (a non-negligible social cost).

It ought to be noted though that alongside Lewis and Harris, Keay has found that the infant industry argument seems to apply to Canada (I am not convinced, notably for the reasons above regarding GDP measurements). However, that was in the case of Canada only and it could have been a simple outlier. Would the argument hold if better trade restriction measures were gathered for all other countries, thus making Canada into a weird exception?

James Buchanan to the rescue

My last argument is about political economy. Was the institutional arrangement of protection a way to curtail government growth? Protection is both a method for helping national industries and for raising revenues. However, the government cannot overprotect at the risk of loosing revenues. It must protect just enough to allow goods to continue entering to earn revenues from imports.  This tension is crucial especially since most 19th century countries did not have uniform general tariffs (like a flat 5% import duty) which would have very wide bases. The duties tended to concern a few goods very heavily relative to other goods. This means very narrow tax bases.

Standard public finance theory mandates wide tax bases with a focus on inelastic sources. However, someone with a public choice perspective (like James Buchanan) will argue that this offers the possibility for the government to grow. Basically, a public choice theorist will argue that the standard public finance viewpoint is that the sheep is tame. Self-interested politicians will exploit this tameness to be elected and this might imply growing government. However, with a narrow and elastic tax base, politicians are heavily constrained. In such a case, governments cannot grow as much.

The protection of the 19th century – identified by many as a source of growth – may thus simply be the symptom of an institutionnal arrangement that was meant to keep governments small. This may have stimulated growth by keeping other sectors of the economy more or less free of government meddling. So, maybe protection was the offspring of the least flawed institutional arrangement that could be adopted given the political economy of the time.

This last argument is the one that I find the most convincing in rebuttal to the Bairoch argument. It means that we are suffering from a poor specification bias: we have identified a symptom of something else as the cause of growth.