Debunking the Tariff Myth

The trade war between America and China has the world buzzing about tariffs once again. Donald Trump has threatened to levy tariffs on every Chinese product sold in America. As a result, economic analysts have started debating whether the tariffs would hurt China or whether they would hurt America itself. Many sophisticated economic arguments are being thrown around.

The basic arguments for tariffs have been debunked by economists as old as Adam Smith! However, there are many new arguments which are being relayed on social media in order to change public opinion. In this article, we will conduct a critical analysis of some of these arguments.

The Trade Deficit Argument

Proponents of the trade deficit argument believe that tariffs are generally not good. They believe that free trade is good and necessary. However, that is the case only until the trade is balanced.

Hence, if a country is persistently running deficits against another country, tariffs may be justified so that the trade can be brought back into balance. This is because if the trade isn’t balanced, the country does not have enough foreign exchange from exports to pay for its imports. As a result, currency devaluation becomes a necessity. This adversely impacts the local economy over the long term.

The problem with this approach is that the true meaning of balanced trade is distorted. It is true that a country must pay for its imports with its exports. Hence, overall trade needs to be balanced. However, it is not true that trade needs to be balanced for every country.

For instance country A could run a persistent trade deficit with country B. This trade deficit would be offset if country A ran a persistent surplus with country C. In this case, if we look at the relationship between country A and country B, it might appear that country A is persistently losing money. However, that may not be the case since country A is buying the best and cheapest products from country B. At the same time, it is exporting its products to country C where it gets the best price for the product. This is consistent with the theory of competitive advantage.

For instance, most countries will have a trade deficit with nations like Saudi Arabia since they import oil from Saudi and sell very little in return. That does not mean that tariffs need to be laid on Saudi Arabia. The bottom line is that trade needs to be balanced overall and not for every country.

The “Nascent Industry” Argument

Another argument in favour of tariffs assumes that tariffs must only be allowed for a small period of time. They should only be allowed until a particular nascent industry matures. After that, the tariffs should be removed. The argument is based on the principle that newer industries need some nurturing and that it is the government’s responsibility to provide such support.

However, the problem with this approach is that a time-frame for such nurturing in never put forward. Therefore, once the proposal is put into legislation, taxpayers are forced to subsidize the efforts of such nascent industries indefinitely. This may not be the right thing to do. For instance, if an industry can become profitable in 5 years, it would make sense for the taxpayers to subsidize its workings in the initial years. However, if subsidies have to be provided for 50 years, that might not make much sense.

Also, if any nascent industry is likely to become profitable in a few years, private investors will be more than happy to invest money in the same. For instance, companies like Uber, Lyft, Airbnb, and even Facebook have lost money for the first few years during their operation.

However, as long as the long term cash flows from a company remain positive, private individuals are willing to invest money. Hence, there is no actual reason for the government to intervene and impose tariffs on imported products. The free market has proved that it is more than capable of taking care of these issues.

National Security Argument

National security is one of the most commonly used argument for levying tariffs. This argument is currently being used by the Trump government in order to incentivize the sale of products made by inefficient domestic producers.

The idea behind the national security argument is that some industries need to be kept in domestic hands even though the price of goods is higher. This is often said for products like steel which have application during a war.

However, this argument is incorrect because if a war were to break out, it wouldn’t happen suddenly. There would be a build-up to the war, and private individuals would be able to anticipate a steel shortage. Therefore, they will be willing to stockpile steel so that they can sell it to the government. They will not be willing to do this because of patriotism but because of the pure unbridled self-interest.

The World War-2 has already shown that when manufacturing war goods becomes more profitable, most entrepreneurs start manufacturing war goods automatically. They don’t need the government to force them to make more money!

The bottom line is that the idea of tariffs is as old as economics itself.

It is a known fact that tariffs do nothing but harm the economy.

However, over time, economists try to sell old wine in a new bottle. They try to explain how this time the situation is different and why tariffs will actually help. However, the reality is that tariffs have never really helped in the past, and it is unlikely that they will help in the future.

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