Tariffs Are Great – If You Like Raising Prices, Undermining Jobs, and Inhibiting Innovation

by Matthew Rooney

Americans — and especially the middle class — are at risk of economic consequences of a protectionist trade policy. The U.S. should look to history for a lesson in the importance of more open global trade.

The United States is embarked on an experiment with protectionism in trade policy that represents a significant change from a policy approach we had followed for nearly a century. We are told that global trade has destroyed American manufacturing and undermined our middle class. We are told that protection will restore America’s prosperity and strength.

In the 1930s, the United States and other industrialized countries raised tariffs across the board, each hoping that by protecting domestic manufacturing they could limit the job losses of the Great Depression and return to prosperity. The result was a series of tariff hikes and retaliatory tariff hikes that wound up choking off world trade. The U.S. and the other wealthy countries of the day were cut off from export markets, which led to a collapse in manufacturing output and only deepened the misery of job loss and depression. Protection only left everyone exposed.

                                              Protection only left everyone exposed.

Learning from past follies

The lesson that generations of American leaders drew from that experience was that more open markets would produce greater wealth. Starting in the mid-1930s, the United States began to negotiate reciprocal tariff-reduction agreements. After 1945, the United States used its unparalleled power to build a global system that reduced tariffs over time and began to create a level regulatory playing field.

The result was the greatest increase in wealth in human history. Across the world, wealthy countries became wealthier and poor countries saw their economies grow and the emergence of a middle class. Successive waves of innovation – jet aircraft, space travel, micro-circuitry, cellular telephony, information technology – spread manufacturing across the world. The wealthy countries – including the United States – produced growing job opportunities even as they lost segments of the manufacturing value chain to poorer countries.

Before we climb off this merry-go-round, we should think carefully. We should be clear in our own minds what we are trying to accomplish, and make sure we are pursuing policies that are likely to get us there. If our goal is to strengthen our middle class, we should understand tariffs and how they affect the middle class in the short, medium, and long term.

The fact is that tariff barriers weaken the middle class. In the short term, they raise consumer prices. In the medium term, they weaken the nation’s manufacturing competitiveness and undermine middle-class jobs. In the long term, they inhibit innovation and the emergence of the next generation of middle-class jobs, weakening our children’s toe-hold in the middle class and sapping the nation’s prosperity over time.

The fact is that tariff barriers weaken the middle class. In the short term, they raise consumer prices. In the medium term, they weaken the nation’s manufacturing competitiveness and undermine middle-class jobs. In the long term, they inhibit innovation and the emergence of the next generation of middle-class jobs, weakening our children’s toe-hold in the middle class and sapping the nation’s prosperity over time.

The explanation of why tariffs have this impact may sound at first blush like some economic “theory” that is speculative and removed from reality. But in fact we are talking about a series of observations of how human beings behave, how they make choices, and how those choices add up to become what we call “the economy.”

Tariffs Raise Prices. When the government imposes a tariff – a tax – on an imported good, that money comes from someone. Although the importer actually pays the money to the government, that cost ends up getting shared among the exporter in the foreign country, the importing company in the U.S., and the consumer. Who pays how much depends on the product in question, what kinds of substitute products are available, and how competitive the market is.

The foreign exporter might reduce their prices a bit to preserve their relationship with a customer or to defend their market share. The American importer might swallow all or some of the cost to avoid losing customers. At least some of the cost falls on the final consumer in the form of a higher price tag.

At the end of the day, the government siphons off some of the benefit of the product in the form of tax revenues and some of the rest is lost as shareholders see the value of their shares fall and consumers pay more for the end product. The overall benefit of the product to the society – whether it is a car or a tomato or a pair of shoes – is reduced and the nation is less prosperous.

Tariffs Undermine Jobs. If tariffs remain in place, these small changes in costs and prices become permanent and begin to spread. Why? Take the example of steel:  The U.S. produces most of the steel we consume, but when we impose a tariff on imported steel, domestic producers of steel see an opportunity to raise their own prices. As a result, the cost of producing things made with steel in the U.S. increases.

This is true in any production chain affected by tariffs:  Shoes become more expensive to produce if we levy a tariff on leather; grocery stores will see their costs increase if we levy tariffs on fresh produce; books and newspapers become costlier to produce if we tax imports of paper. In markets where substitutes are not readily available – avocados in winter, for example, or gasoline – consumers will see prices rise almost in lockstep with the tariff.

In other, more competitive markets – cars, for example, or beer cans – price increases to the consumer may be less noticeable. But in any case, production throughout the value chain will be less profitable, companies are likely to forego expansion or innovation, and the industry’s ability to compete domestically and internationally will begin to suffer. The overall result is downward pressure on wages in those industries and, eventually, lost jobs.

The overall result is downward pressure on wages in those industries and, eventually, lost jobs.

Tariffs Inhibit Innovation. Some companies get a boost from tariffs, of course. Steel producers, for example, are seeing prices for their products rise now that tariffs are blocking foreign competition.

This makes steel production more profitable, opens up headroom for wages, creates additional jobs, and increases the return to shareholders in steel companies. This will tend to attract capital to the steel industry, and young workers will seek training and education to qualify for steel jobs. Talented managers and financial experts will seek out opportunities in steel.

Why is this not a good thing?  Because that increased profitability is illusory:  It only exists because of the presence of the tariff, which is a government policy that could change. And in fact powerful interests in the society – all those producers whose profitability is falling, all those consumers who are paying more, all those workers whose jobs in steel-consuming industries are under threat – are demanding that it be changed, and voting for it to be changed.

Sooner or later, that policy will change and the tariff on imported steel will be eliminated. And the steel industry will be back where it started, struggling to compete in a global marketplace, cutting jobs, and reducing production.

Even more harmful for the society, every day on which those tariffs attract human and capital resources to steel is a day when an innovative new product dies in the crib for lack of investment and lack of workers. Or, worse still for the United States, a day when a potentially promising new industry emerges in China or India or Europe because it finds capital and workers there.

This is the ultimate lesson of our country’s last bold experiment in protectionism:  Tariffs, even more than other forms of taxation or government interference in the marketplace, create dysfunctional incentives that distort costs and prices throughout the economy. They tend to shore up yesterday’s industries at the expense of tomorrow’s industries, an illusion of “protection” from an underlying economic reality that cannot be denied forever.

This is the ultimate lesson of our country’s last bold experiment in protectionism:  Tariffs… create dysfunctional incentives that distort costs and prices throughout the economy.

There is no doubt that that underlying reality in the current circumstances is challenging. Too many people in our country have felt their futures slipping through their fingers as more and more of the manufacturing supply chain has moved offshore, and the innovation that will produce tomorrow’s jobs hasn’t emerged.

But America has always thrived by embracing the industries and jobs of tomorrow, whether it was the radio in the 1930s, jet travel in the 1960s, or information technology in the 1990s. We can do it again in the 2020s, but not if we wall ourselves off from the global economy.

 

Matthew Rooney is the Managing Director, Bush Institute-SMU Economic Growth Initiative at the George W. Bush Institute.

This essay originally appeared  in the new issues of the Catalyst.

 

 

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