There is growing pressure on politicians around the world to place tariffs and other barriers on the free movement of goods. For centuries now, economists have known protectionism a fool’s errand. And yet, somehow we need a reminder as to why.
But before we can understand why protectionism is bad, we have to take a step back and correct a misconception perpetrated by politicians like Donald Trump when talking about the “trade deficit.” Trump frequently refers to the US as “losing” money when other countries buy fewer American products than Americans buy in return. This is flatly untrue.
Countries don’t trade with each other; people and companies do. When a business/person decides to buy something made locally or internationally, they are making that choice in their own interest. No one country is “losing” or “winning.” The fact that the transaction took place means that it was beneficial for all parties involved.
You personally run a trade deficit with your grocery store every time you go shopping. You receive goods in exchange for currency and willingly made this transaction. You didn’t “lose” or “win.”
Deconstructing a Pervasive Myth
Over a hundred years ago, famed Economist Henry George, in Protection or Free Trade deconstructed the argument against free trade quite succinctly. He asks, for example, if you were starting a brand-new city, and you could choose any place on Earth to locate it…where would you place it?
Would you place your city in the middle of a desert to isolate it from shipping lanes and land trade routes? Or would you locate it next to a river or ocean with easy access to trade? The fact that virtually all major cities are located on bodies of water answers this question for us. If trade were harmful, cities would flourish in the isolation of the Sahara Desert. But this clearly doesn’t happen, the most prosperous cities are located along easy trade routes.
But perhaps, you might say, while trade is overall good, one must protect certain key industries with tariffs. This notion also flies in the face of logic. Remember that people and companies trade, not countries. The borders between countries are as arbitrary and man-made as the borders within countries, such as those between towns, cities, provinces…etc. If tariffs of key industries were good for growth, naturally, it would make sense that all government jurisdictions levy tariffs at every level.
For example, Ohio would benefit if it placed tariffs on cars coming from Michigan. Illinois would benefit if it taxed oil imported from Texas. But why stop at state borders? Why not place tariffs on goods coming from other counties? Why stop there, extend the tariffs between cities…etc. Everyone knows that such protectionism would depress growth and benefit no one, yet they fail to extend this same logic to international borders.
This discussion leaves aside the fact that most countries impose reciprocal retaliatory 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 that use their political power for rent-seeking.
Corruption and Taxes
Tariffs open the door to government corruption and rent seeking. Many of the tariffs put in place by President Trump are economically destructive, but prized by vested interest groups. In effect, with tariffs, the government picks the winners and losers in the market. This runs contrary to any notion of free market enterprise.
It is also important to remember that tariffs are taxes. As far as taxes go, tariffs rank near the bottom in terms of tax efficiency and are some of the worst taxes you can impose on a nation. They do not generate significant revenue, they penalize beneficial economic transactions, they also impose significant “dead-weight loss.” Deadweight loss refers to the loss of economic activity beyond the total tax itself (a hidden tax on the tax). Tariffs are also regressive, meaning the burden of the tax falls disproportionately on the poor and middle class.
Another Way
While it is certainly true that free trade causes harm to some groups in some industries, this is because, in any market, there are winners and there are losers. The answer isn’t tariffs or protectionist policies. Instead, the government should create an environment that makes the nation competitive. If the political, economic, and policy structures of a nation are well-designed, prosperity follows.