Free trade is as advantageous for the giver, that is to say, the country that opens its market, as the receiver, the provider of the goods that are sold. Tariffs damage those who apply them, in the medium to long run, more than those to whom they are applied. Any country that wishes to be rich ought to abolish as many barriers to trade as possible.
As readers of this Substack will know, I am sympathetic to Donald Trump, and excited by his dynamic start to his second term in office. His use of tariffs so far seems to be more political than economic, but if it were to be economic, it would not help American consumers.
This is based on Ricardo's, the great 19th century economist’s, understanding of ‘comparative advantage’. It is not absolute. Thus, even if the US were an efficient producer of goods, it would still be better for it to buy goods from abroad, where its trading partner may be less efficient, as this frees up resources, especially labour, to be used where the US is most efficient. Assuming labour and capital are not infinite, then this will be true of all trade.
Ricardo's example of cloth and wine manufacturing between England and Portugal illustrates the point. On the assumption that it takes 100 hours of English labour to make one unit of cloth and 120 to make one unit of wine, but 90 hours to make cloth in Portugal and 80 hours to make wine, then if England makes cloth and Portugal wine, there will be more cloth and more wine overall than if Portugal continues to produce both, even though it is, in absolute terms, more efficient than England.
Increasing output for the same amount of labour is the essence of improving living standards. So using the national comparative advantage boosts the prosperity of both the English and the Portuguese.
The drawback, of course, is that winemakers in England are put out of business and have to make cloth, while the opposite would happen in Portugal. It would be especially galling for the efficient Portuguese cloth makers, but, nonetheless, overall it would make everyone richer.
Unfortunately, what might happen is that the owners of these businesses lobby their governments to introduce tariffs to protect their industries, which makes everyone poorer.
The concept of ‘comparative advantage’ underpins all the benefits of free trade, as any deviation from it will waste both labour and capital. In the UK, there are regular debates about seasonal labour to pick certain crops. It is argued that the workforce must come from abroad, because British people do not want to do the work, and do it less well.
This is not surprising, in a country with a generous welfare system, people will not work for less than they can receive by doing nothing, and will need a premium for hard physical labour. To be persuaded to replace the itinerant labour, they would need to be paid more. However, that would make the cost of growing of crops that need to be hand-picked too great.
It is an area where the UK does not have a comparative advantage, tariffs on agricultural produce discourage imports and put up costs, thus skewing the market.
The consequence of this is partly in the immigration system. Mass migration into this country has been created because of a desire to keep wages low in certain areas where we have no comparative advantage. Thus, it would be better to import the end product, rather than the labour that produces it.
This shows that tariffs can lead to societal problems, by increasing migration to produce goods inefficiently, as well as bearing an economic cost.
Tariffs also protect the inefficient and incompetent. Free trade leads to the efficient allocation of capital.
In the earlier example, if the English worker took 300 hours to produce a unit of wine against 80 in Portugal, then a tariff that protected the English industry would do so at great cost to consumers. It might help producers, but consumers would pay higher prices for each unit of wine.
This has an ‘opportunity cost’ in that the money then spent on wine cannot be saved, building up the nation's stock of capital, used to buy other goods, or merely used to increase leisure to the comfort of the consumer.
‘Opportunity cost’ is the bedfellow of comparative advantage. Every penny spent on inefficient domestically-produced goods is a penny that cannot be used for anything else. It affects both investment and spending.
Investing is harmed because capital is used inefficiently by the protected business. Its land and buildings could be used for different, more profitable purposes, while its machinery could be sold abroad to the more efficient manufacturer. The allocation of capital is one of the drivers of productivity, that is to say, making more for the same level of inputs, which in turn drives living standards.
Anything which leads to the misallocation of capital is impoverishing, and protectionism is one of the worst culprits.
Tariffs also have a psychological effect on investing, as companies that are protected see no reason to improve their productivity. Thus they do not invest and become steadily less efficient, as their revenues and profits are protected from overseas competition.
This means over time that they would produce a poorer and declining service to consumers than their global competitors.
Capital would also not be built up, as consumers would waste income on buying domestically produced goods that are protected by tariffs. This would reduce the ability of an economy to modernise and innovate, as bank lending or equity capital would be limited by the lack of savings.
Tariffs undermine the concept of competitive advantage, as a high opportunity cost. They discourage investment and make consumers poorer.
Nevertheless, they are popular because producers combine into powerful lobby groups, whereas consumers are individuals who tend not to be organised.
Simplistically, it is popular to say, let us protect our own against ‘unfair’ foreign competition. Fairness then becomes the argument for tariffs. A country may be accused of dumping its products or even deliberately cornering a market to become a monopolist in future.
This is not without some degree of risk, but there is normally a market answer. Initially, the provision of cheap goods will benefit consumers, and all the benefits of free trade will flow. In most markets a government cannot afford to provide subsidies forever, so it is worth taking the low price for as long as it is available and paid for by foreign taxpayers.
This is especially true of goods that require low levels of capital, or have low barriers to entry. The exception can be in areas that have high barriers to entry, because they require significant levels of capital, so are difficult to begin or to resume.
These include steel and rare earth metals, which China has, in recent years, been seeking to monopolise. In these cases there may be an argument for tariffs to prevent a long-term security or monopoly risk, but it does not apply to, for example, electric cars where China also seeks dominance.
This is because the desire for such cars is almost entirely regulation-led, and simply cancelling the rules demanding that people stop buying petrol and diesel engines would end the problem. Tariffs most certainly ought not to be used to protect stupid policy-making,
In defence of Trump, his tariffs so far are political more than economic, seemingly used as a threat to ensure he gets what he wants. They could actually help the United Kingdom. If he were to threaten tariffs unless we removed our own import restrictions on, for example, American cars and agriculture, this would help the UK consumer and hence the economy.
Cars are especially important in this respect. Currently tariffs of up to 10% are applied to American cars with 20% VAT on top. Indeed, we even tax taxation. This serves as a protectionist measure, not just for the domestic market, but also for German car manufacturers. As we are no longer a member of the EU it is hard to see why we wish to increase the profits of Mercedes and BMW.
Letting in cheaper American cars would increase competition for the Germans and reduce prices for British consumers. It could also undermine the policy of zero emissions cars by 2030, because the US will want to carry on selling petrol cars to us. Hence, aggressive action by Trump could save the UK from the folly of its own governing class, obsessed as it is by green theology.
In agricultural matters the same could be true. Many of our tariffs protect continental or Irish production, not the UK. For example, the Irish send us £800 million worth of their beef each year. But why should we continue to subsidise their economy? Why not buy cheaper American beef which, having eaten it on many visits to the US, is almost as good as beef from Somerset?
The argument over chlorinated chicken is nonsense, as a chlorine wash is applied to salad sold in the UK, and it is not for this reason that I am happy to leave salad for the rabbits to eat.
Hence, the current politics of Trumpian tariffs is potentially exciting because it could, but only could, improve our economy. It could force the UK to remove both tariff and regulatory barriers to trade to avoid US penalties. This would not only help reduce prices, but it would take us further from the EU’s regulatory orbit, paradoxically forcing a left-wing government to make more of Brexit opportunities than a Conservative one did.
The economics of free trade are excellent and have been fully understood for over 200 years. While Donald Trump may be making a disastrous decision for the US if he really believes tariffs work economically, he may be in the process of improving living standards for Britain as a by-product of his ‘American First’ policy.
If you have enjoyed this article, then please do share it with your friends.
Your comments would be most welcome. Please click the button to join the conversation. Thank you.
Share this post