Happy Monday FRians! Hope you all had a great weekend. As always, Monday’s post by Stephen Hall. Thanks Stephen!!
Once again we are at a topic about which I had very little desire to write, but the current events of the day dictate otherwise. With President Trump putting forth a 25% tariff on steel, the questions abound about the very nature of tariffs themselfs.
Okay, not they are not, and that is the problem. People are espousing opinions right and left upon the impact of the tariff without actually considering what a tariff is or how it actually works.
I do not want to get into at this time the rank stupidity which are the GATT treaties. Neither will I be frightened like a little child by the specter of Smoot-Hawley Tariff Act of 1930 as the sole cause of the Great Depression, as there were many factors, including the stock market crash of ‘29 from a market bubble, the crushing war debt foisted upon Germany by the Treaty of Versailles, or the restricting of the money supply by the newly formed Federal Reserve in contradiction to Keynesian, Monetarist, & Classical economic theory. (The act being an American piece of legislation but the Great Depression was global in scope, the tariff act became a misfortunate scapegoat for a plethora of errors.)
A tariff is a tax. It is that simple. More precisely, it is a tax upon goods imported.
It is not a panacea which will cure all the ills of domestic industry, bring jobs, prosperity, and wealth; nor is it Armageddon which will bring about another great depression, create an economic death spiral from which we can never recover, dooming us to inter-generational poverty.
As Jonathan Hoenig correctly points out, a tariff is distortive; well, in point of fact, all taxes are in some way distortive, some more than others. Distorive means that the tax or policy alters of changes people’s behavior by distorting the true and real costs of the given product or activity. Such distortion always has a negative effect on the economy whether a product is overused or underused.
However, it ought to be noted that sometimes one distortion may counteract the distortion created by another tax or policy, so that no tax or tariff can simply be condemned out of hand because it is alone a distortion on the market, but must be viewed in a broader context.
One of the basic forms of taxation is an excise tax, which is a tax on the production of goods.
One of the earliest taxes imposed by the newly formed federal government was an excise tax on the production of whiskey, which overwhelmingly affected the farmers west of the Appalachian mountains who found it cheaper to ship bottles of whiskey across the mountains for sale than bushels of grain, thus creating the first rebellion in American history over the whiskey tax and for which revenue agents still track down people trying to avoid that tax and licensing fee.
Now, supposing America, hereinafter referred to as “A”, imposed a 5% excise tax upon the production of steel. This would have the distortive effect of making domestic steel 5% more expensive than imported steel, disadvantaging A’s steel industry.
China, hereinafter referred to as “C”, also produces steel, thus gains an advantage from A’s excise tax. A then decides to impose a 5% tariff on imported steel, thus all steel sold in A to the consumers of steel faces a 5% tax whether from the excise tax or the tariff.
In such a scenario, the tariff creates a counter distortion to the excise tax, offering neither manufacturer an advantage in A’s steel market. However, selling A’s steel in Europe, hereinafter referred to as “E”, A’s manufacturers face a 5% excise tax where there is no tax for C’s steel. In such a situation, A could offer a refund or waiver of the excise tax for steel exported.
All of this would have the effect of A taxing the domestic steel market at 5% regardless of the origin of the steel, and no effect on foreign markets. The same thing could also be effected by the imposition of a 5% sales tax on all domestic sales of steel, which superficially appears simpler.
However, as a practical matter, collecting the 5% tax from 100 manufacturers and importers is more efficient than trying to collect the 5% sales tax from 10,000 points of sale at the steel retail level. Efficiency is another criteria for taxes, think of it as the cost of collection, thus the more efficient the tax, the lower the burden upon society.
Now, imagine that instead of an excise tax in A, C creates a steel subsidy of 5% for all steel exported. While this subsidy is a drain upon the economy of C, it does create a competitive advantage for it’s steel manufacturers to produce and sell steel cheaper than A, in A’s own market.
In such a case, A could impose a 5% tariff upon steel from C, thus countering that market distortion. However, E might import the steel from C, and then sell it in A, acting as a middle man in the steel trade.
Which oddly enough is exactly what Holland did when England forbade wine imports from France, they would take the French wine, put their own labels on it, and made a handsome profit selling French wine to the English.
That is where one gets the idea of what general tariff, which is to say a tariff on a specific good regardless of their origin, to prevent this type of circumvention; as opposed to the concept of a general tariff which would apply to all goods equally and not be commodity specific.
As tariffs can be used to counter the distortive effects of an excise tax or a foreign subsidy, some people get the idea to apply them as a means of supporting or protecting the industry of a nation.
Adam Smith proposed and recommended the idea of a modest general tariff to promote the internal trade of a nation. (Key word here being modest, such as the 5% of which I have been using as an example and not the 25% as proposed by President Trump.) The idea being that internal trade provided two jobs in a nation where foreign trade only provided the benefits of one job of the nation and was to be preferred over international trade in making the nation industrially strong.
Much the same effect can be seen in my state’s bidding policy which will prefer in state contractors to out of state contractors so long as the bid is not more than 5% more expensive. So the concept is still active in the United States, even if it is not as overt as it once was, tariffs between states being preempted by the federal government in the Constitution.
Tariffs, because they function as an economic boundary or fence between states, are often seen more as political than they are economic. It is one of the reasons that “commerce” between the states was included as a federal power of the constitution to keep tensions from arising between the several states from issues of tariffs on Connecticut goods or Virginia tobacco.
(One could view certain tolls on bridges between states as a tariff upon persons rather than goods, and it must be noted that one must always pay to get out of New Jersey and never into the state. I think that says something.)
However, there have been some who would use a tariff, just as they use a subsidy, as a form of economic warfare with other nations, what one would label “protectionism”, which is to have high tariffs to keep out foreign competition, or subsidies to promote a nation’s industries.
America subsidizes its agriculture, and politically with the first presidential caucus being in farm territory such subsidy is a political third rail. However, for those who would decry “protectionism” with regards to tariffs, to be consistent they must also decry those farm subsidies as they are also “protectionism”.
One situation is brought to mind where the Japanese, as they were rebuilding their industries after WWII, were dumping television sets on the American market; that is to say they were selling those TVs at prices less than what it cost them to produce them in order to gain market share and drive their American competitors out of business.
They could afford to do this because American TVs were banned in Japanese markets, and they sold their TVs in those markets at highly inflated prices to make up for the money they were losing in American markets.
There were once 25 American TV manufacturers; there are none any more. But, the effect goes beyond just making olde cathode ray tube television sets, those Japanese manufacturers came to dominate the entire consumer electronic production industry.
Of course, the argument is justly made that on the whole, Americans found other productive work while enjoying cheaper televisions so that on the whole the American economy did better while the Japanese economy suffered from their predatory practices. However, that perspective does omit and brush aside those workers and owners directly affected by the policy of allowing such illegal dumping.
The owners of Quasar, or Zenith, or Curtis Mathis had their money invested in their businesses, and such dumping was against the law, but the government chose to ignore the law because it helped a political ally.
An economy is not only about the consumer, but also the producer; not just the housewife buying the product but the worker getting paid to make the product. The very basis of Supply Side economics was that by focusing on the demand for cheap goods at the cost of the companies producing them was not healthy for the whole economy.
Henry Ford when asked why he paid his workers more than the going wage rate answered that he wanted to produce a car which his own workers could afford to buy. Before Ford’s Model T most automobiles were considered a luxury good, not a product for the masses.
In the course of European history several nations became prominent regional and in the age of exploration global powers. The nation of Spain was for all practical purposes the backwater of Europe, a second rate power having little influence upon the rest of Europe.
That is to say until they discovered the New World. The Spanish conquistadors brought back so much gold, copper, and more importantly silver, which was the more common currency, that they immediately vaulted from obscurity to a main player upon the European stage.
It was a time when Europe had faced what might be termed the Muslim Tariff in their trade with the far east. That is to say many military powers along the silk road imposed a toll upon people and goods passing through their territory, kind of like a protection racket. The tolls funded their military, and their military was what empowered them to extract tolls.
A toll is essentially a tariff on goods, or people, passing through a state rather than being imported for sale into that state. The age of exploration was largely a means for merchants to find a way to evade the Muslim Tariff by finding an alternate route to the Silk Road.
With their silver, Spain equipped the largest, most powerful army, built large galleons to carry their treasures from the New World, and thus the largest, most powerful navy in the world.
The other major players of the time were England, France, Holland, and Portugal; where what we now think of as Germany and Italy were largely broken apart into fractious city-states and the former empires of Poland and Lithuania having long fallen from prominence.
Holland and Portugal were both busily building commercial nations, convinced that commerce alone would bring them wealth and power. France was the agricultural breadbasket of Europe, and with it supported one of the largest and most advanced armies dominating the continent. England, while engaged for a hundred years of conflict regarding their holdings in France had of necessity built an economy upon the fledgling industries, because they could not naturally compete with France’s verdent wine fields and cattle pastures.
In their competition for colonial expansion, Portugal and Holland primarily focused upon establishing lucrative trading outposts with the far east, Spain conquered the Aztecs and the Incas, bringing back enormous wealth, while France set upon taming Africa for ivory and jewels, and England was relegated to North America and Australia, which didn’t seem to have much in the way of gold, silver, ivory, or jewels, but had lots of trees and passable farmland.
Then the unthinkable happened, Spain having enough of England’s attitude, decided that they would invade England to show just who was boss of Europe, but the Spanish Armada met with disaster. (One is left to speculate on what could have become of Europe had they succeeded in taking over England and backing up their armed forces with the industrial might of England.)
Thus, as rapidly as Spain had emerged as a leading nation, they fell back into the obscurity of a Second World nation. Many were left to wonder and speculate as to these strange twists of fate, prompting one Scottish philosopher, Adam Smith, to write “An Inquiry into the Causes of the Wealth of Nations” to try to explain what had happened.
He reasoned that the rise and fall of Spain was because the nation had found an enormous treasure trove in the New World, but really had a hollow economy as they did not actually produce significant quantities of goods either cultivated or manufactured.
Why is this relevant to a discussion of tariffs, you ask?
Because one of the arguments presented by the pro-tariff crowd stems from a fear of becoming a nation with a hollow economy like the Spanish, an economy where our nation lacks the actual productive capacity upon which the wealth of a nation is built. It is not merely corporations making profits which builds a nation any more than consumers buying cheap goods, but it is the interplay of productive work and efficient consumption which form an economy.
I cannot say that the current proposed tariff ventures too far into “protectionism” or if the level of the tariff is justified by the levels of the subsidized dumping which is admitted that China is engaged or if the 25% figure is just another of Trumps hyperbolic positional statements to force a better negotiation.
I do know that if your opponent knows you to be so afraid of a negative outcome, like a trade war, then they possess a strategic advantage from your fear. Both the fear of tariffs and the praise of protecting our industries is overblown, reality is somewhere in the middle.
