Ports, Prosperity, and Peace

How free trade grows wealth and promotes peace

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Across the globe, there is growing pressure on officials to place tariffs and other restrictions on goods that cross imaginary lines on the map. Like most rules, tariffs and import quotas thrive on the counterintuitive nature of progress; our human proclivity to buy into zero-sum thinking. But for centuries now, economists have understood that protectionism is (mostly) a fool’s errand. Indeed, if our goal is to accelerate and enhance growth, we are best served with low tariffs, if perhaps zero.

Mistaken Logic

Before we can understand why protectionism is counterproductive, we must take a step back and correct a misconception perpetrated by politicians when talking about the “trade deficit.” President Trump, for example, frequently claims that the US is “losing” money when other countries buy fewer American products than Americans buy in return, this is untrue. Generally speaking, countries don’t trade with each other, people and companies within those countries do. Whether a business buys something made locally or abroad, it makes that choice in its interest, no country is “losing” or “winning.” On the contrary, the fact that the transaction took place meant that it was beneficial for all parties, it was a “win-win.”

You run a “trade deficit” with your grocery store every time you buy food. You receive goods in exchange for currency; you willingly make this transaction. The supermarket didn’t “win” and you didn’t “lose,” a mutually beneficial transaction took place. On an international scale, it could even be argued that the “deficit” nation is the “winning” party in this transaction because it gets useful products in exchange for currency. Currency can lose value when more is printed, but imported physical goods cannot be inflated away. Appurtenant to this false depiction of the “trade deficit” is the reality that measuring its magnitude is difficult. A smartphone imported from China may add $350 to the US trade deficit on paper, but because the parts within that phone may have come from other countries, including the destination or “deficit” nation that finally imported it, that $350 figure is misleading.

Protection of Free Trade

Over a hundred years ago, in his book, Protection or Free Trade, famed economist Henry George, succinctly deconstructed the argument against free trade quite. He begins by asking a hypothetical question: if you were starting a brand-new city and could choose any place on Earth to locate it…where would you place it? Would you locate your city in the middle of a desert to isolate it? Or would you locate it next to a river or ocean, with easy access to global trade? The fact that virtually all major cities are situated along bodies of water answers this question. If trade were inherently harmful, cities would flourish best in isolation. But this doesn’t happen, the most prosperous cities are located along trade routes.

That is because, on balance, trade is beneficial and makes us richer. In one of the seminal studies on this issue, researchers Jeffrey Frankel and David Romer, examined data from 63 countries and found “a quantitatively large and robust” positive effect between trade and income. Indeed, they found that “the impact of trade is substantial….increasing the ratio of trade to GDP by one percentage point raises income per person by one-half and two percent.” Trade grows our economies, expands our opportunities, opens our minds to new ideas, and accelerates growth.

Some may concede that while trade is beneficial overall, a country must still protect certain key industries with tariffs. Often, this argument advocates for tariffs protecting “infant industries” from foreign competition, intending to remove them when they “grow up.” There are two problems with this argument. First, it’s politically difficult to remove tariffs once they are in place. Second, this strategy rarely works and often backfires. Much of Latin America employed protectionist policies from the 1940s into the 1980s under the guise of “infant industry” protection. Instead of nurturing successful companies, the tariffs sheltered low-productivity firms from the very competition they needed to become efficient! One study by Luzio and Greenstein found that Brazil’s protection of its electronics industry resulted in an industry that “lagged price/performance practices in international markets by at least three years and as much as five.”

Taxes on Trade

It’s important to understand that tariffs are taxes on trade. Many mistakenly view them as taxes on imports that, outside of retaliatory tariffs from other nations, do not affect exports. Thus, advocates attempt to use tariffs to “correct” the trade imbalance. This doesn’t work. Counterintuitively, tariffs on imports have the same effect as tariffs on exports, in part, because they shift the currency exchange rate to a level where exports fall at roughly the same rate as imports. This concept, known as the Lerner symmetry, is another reason that tariffs are a poor policy tool.

Additionally, many products sold as “exports” require imported components. Placing tariffs on these “imports” can make the finished product intended for export uncompetitive. For example, Handley, Kamal, and Monarch examined Trump’s 2018-2019 tariffs, ostensibly intended to protect American manufacturing jobs, finding that they destroyed jobs and wealth by making American exports less competitive. As summarized by

Brian Albrecht

in his piece on tariffs:

products more exposed to [Trump’s] tariffs on imported inputs experienced significantly lower export growth....On average, exports of unaffected products grew two percentage points faster than affected items. The tariffs intended to protect domestic industries ended up acting as a tax on U.S. exporters…

We don’t need complicate studies to put tariffs to rest. Remember that people and companies trade, not countries. The borders between countries are as arbitrary and man-made as the borders within countries. If tariffs on key industries were good for jobs and growth, naturally, it would make sense that all government jurisdictions levy tariffs at every level. Ohio would benefit if it placed tariffs on cars coming from Michigan. Illinois would benefit if it taxed oil imported from Texas. And why stop at state borders? Why not place tariffs on goods '“imported” from other counties or cities? Everyone knows that such taxes would benefit no one, yet they fail to extend this same logic to international borders.

This entire discussion hand waives a bigger problem: countries tend to reciprocate tariffs. When the US places tariffs on Chinese goods, China responds in kind. This causes economic damage to both sides, benefiting no one, except perhaps a small group of vested interests. With all this said, some tariffs may be acceptable in extremely limited circumstances. In instances of clear “dumping” for example, when one country heavily subsidizes a particular good with the intent to wipe out the competition, tariffs can be justified. They could also be useful in the Pigouvian sense. For example, should one country levy a carbon tax on manufactured goods, it could make sense to “border adjust” that tax to include imported goods to ensure a level playing field for domestic manufacturers.

Finally, remember that tariffs are just taxes by another name. When we examine tariffs against the Canons of Taxation, tariffs are some of the worst taxes a government could impose. They do not generate significant revenue, penalize beneficial economic transactions, and distort economic decisions while imposing significant “dead-weight loss” on the economy. Tariffs are also regressive, meaning the tax burden falls disproportionately on the poorest.

Trade and Peace

While deconstructing the “logic” of protectionism, economist Henry George also had this to say about protectionism: “Protectionism teaches us to do to ourselves in times of peace what our enemies seek to do in times of war.” He illustrates that countries at war try to cut their enemies off trade routes, knowing the disruption imperils their economy and the ability to wage war. Thus, it is ironic that some try to argue that self-imposed tariffs and protectionism are somehow beneficial in times of peace.

George’s realization was prescient. In the latter half of the 20th century, protectionism gradually fell out of favor and free trade/low tariffs were embraced globally. This was accompanied by lower levels of belligerence and inter-state warfare; the more the world traded, the more peaceful it became. A study by Solomon W. Polachek and Carlos Seiglie found that with every doubling of trade volume between nations, the probability of belligerence fell by about 20 percent. This finding is robust and holds across different cultures and political systems. More than any other factor, trade promotes human flourishing and peace on Earth. Tariffs do precisely the opposite. If our goal is a prosperous and bright future, the only tariff we should set begins and ends with “zero.”

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