In Defense of Free Trade
There is growing pressure on politicians around the world to place tariffs and other barriers on the free movement of goods, much in the name of “protecting jobs.” For centuries now, economists have known protectionism is a fool’s errand, but for some reason, it’s a lesson that we appear to be forgetting.
The ‘Deficit’
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 (generally) trade with each other, people and companies do. When a business decides to buy something made locally or made abroad, it makes that choice in its own interest. No country is “losing” or “winning” should the business source from abroad. On the contrary, the fact that the transaction took place at all meant 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. The supermarket didn’t “win,” a mutually beneficial transaction merely took place.
On an international scale, it might even be argued that the “deficit” nation is winning in this transaction because it gets useful products in exchange for currency. This currency can easily lose value when more is printed, as is often done during economic recessions, but the imported goods cannot be inflated away.
Deconstructing a Pervasive Myth
Over a hundred years ago, in his book, Protection or Free Trade, famed Economist Henry George, deconstructed the argument against free trade quite succinctly. He begins by asking, 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 trade routes? 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 located along 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 trade routes.
But perhaps, you might say, while trade is overall good, one must protect certain key industries with tariffs, but this notion also defies 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, and provinces. 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.
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 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 abuse their political power for rent-seeking.
With all this said, some tariffs may be acceptable in a Pigouvian sense. For example, should one country levy a carbon tax on manufactured goods, it would make sense to “border adjust” that tax to imported goods so as to ensure a level playing field. To do otherwise could nullify the effect of the carbon tax in the first place.
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, while also imposing 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.
No justification
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 enact policies that encourage growth, innovation, and shared prosperity for all.