Trumponomics

The new wave of protectionism

Donald Trump’s latest strategy for keeping US businesses from leaving the US, at best, is a risky strategy with questionable benefits, and at worst, will trigger a wave of global protectionism that will leave the entire world unambiguously worse off.

For those unaware, Donald Trump recently managed to keep the air conditioning company, Carrier from shifting all its furnace plant operations to Mexico (some of its operations are still closing/ shifting) by threatening to impose a tariff on anything it might subsequently try to export back to the US. Furthermore, in order to keep it operating in the US, the company received a $7 million tax incentive from the State of Indiana (The West Australian, December 3-4 2016, p.42).

As a general rule, I am opposed to the use of tariffs and subsides. They tend to be anti-competitive tools intended to support inefficient industries, when the wider economy and country would often be better off transitioning out of such industries and into others in which they hold greater advantage. There are, of course, exceptions. In other words, under very specific circumstances, Donald Trump’s strategy may actually pay off for the US.



First is the ‘infant industry argument’ – the idea that certain industries, with temporary support from the government (investments, tariffs, etc.), will be able to invest in new technologies and processes, become more efficient, and eventually stand on their own, generating wealth and benefits for society that outweigh the costs of the initial government support.

There are supposed success stories for this argument, including the US itself, which developed an internationally powerful manufacturing industry in the 19^th century on the back of a significant tariff wall (much to the dismay of British manufacturers who were consequently losing market share), supposedly justifying this protection (at least from the US’s perspective). Furthermore, if the government hadn’t provided this protection, the costs of setting up such an industry may have been too great for any private entity in the young and developing US to bear, and the industry may never have existed in the US.

There are however, just as many (if not more) failures. In Argentina for example, at the start of the 20^th century, the country prospered on the back of its traditional advantage in agricultural exports and reliance on foreign capital and imported technology. But following the shocks to these advantages/ dependencies from WWI and the Great Depression, the government subsequently sought to transition the economy towards a more self-sufficient urban industry-based economy. Unfortunately, Argentina lacked the skilled and educated workforce, and the financial and technological capital to sustain such industries. And its abandonment of export markets and foreign capital hindered its traditional agricultural industries. Consequently (and also as a result of perpetual domestic political turmoil, including six military coups and numerous economic crises), Argentina has declined from one of the top 10 richest countries in the world at the start of the 20^th century (ahead of France, Germany and Italy), with an income per head in line with the OECD, to the 53^rd richest country today with an income per head roughly half that of the OECD.

Consequently, there is great risk in Donald Trump attempting to ‘pick winners’ in the hope that these industries will invest in themselves and eventually become productive enough to pay back these investments in the form of greater economic activity, tax revenue and social harmony. This is especially true because, in a country like the US, with its enormous and developed financial markets, potentially profitable industries such as these should draw the attention of private finance, without the need for government. The fact that these private entities desired to leave the US suggests that the private sector no longer has confidence in its profitability in the US. Why should Donald Trump think that he knows better?



The second argument that may support protectionism as beneficial for the US is the idea that countries of sufficient size and power that are able to influence global price levels just by their existence could potentially impose a tariff on imports that the rest of the world would simply have to bear on the US’s behalf. Because of the US’s bargaining power in the global economy, they may be able to force the rest of the world to pay that tariff without the US having to bear any of it in the form of more expensive import prices. Consequently, the US would benefit via increased government revenue, but at the expense of the rest of the world, who now pays a tax on the goods/ services that they export to the US.

Even Australia could arguably exploit this strategy. Australia accounts for 58% of the global iron ore trade and 65% of its coking coal trade (The Australian, December 3-4 2016, p.28). If Australia were to impose a tax on its iron ore and coking coal exports (export taxes are uncommon but not unheard of), given Australia’s domination of this market, the rest of the world may have to absorb that tax for Australia, resulting in Australia benefitting from greater tax revenue at the world’s expense.

Consequently, market power can allow certain players to break the rules of the game, benefitting at the rest of the world’s expense.

BUT …

These benefits can quickly be undone (and reversed) if the rest of the world retaliates. If other countries start imposing their own taxes on imports from/ exports to the US and Australia, this kind of trade war could very easily cause the entire world collectively (including the US and Australia individually) to be worse off than if they’d all just obeyed the rules of free trade from the start. Even if other countries would have been better off playing by the rules and letting the US or Australia get away with cheating, politics doesn’t always generate rational responses, especially when countries feel cheated (case in point, Brexit and the election of Donald Trump). Keep in mind also that the US may be the biggest economy in the world, but the rest of the world economy combined is over three times bigger than the US and over 50 times bigger than Australia. So with a little cooperation, the rest of the world could surely beat the US in a trade war (and certainly Australia).

Even if it doesn’t escalate to a full trade war, belligerence like this from the US or Australia could (in the space of just a few years) cause other countries to search elsewhere for suppliers and customers that don’t impose such penalties on international trade. Like I said, the US is only 24% of the global economy, so the rest of the world could surely, without too much trouble find alternative import and export markets. Australia certainly, would have to worry about Brazil, a significant iron ore competitor, attracting major miners like BHP and Rio Tinto if Australian operations become uncompetitive.

Consequently, even with the dominant market power the US has (and even Australia in some industries), these advantages aren’t necessarily permanent – especially over the longer term and when such powers exploit their position to everyone else’s disadvantage.



A third example of where protectionism could be justified is to ease the transition of an economy away from one industry, rather than having it disappear rapidly. When an industry employs a great number of people, it may be justified to protect that industry from complete and swift ruin, albeit not indefinitely, thereby giving the industry’s employees sufficient time and support to transition elsewhere, rather than forcing them to do so overnight. Even Adam Smith, the father of modern economics and the poster boy of capitalism, conceded something similar in his famous text, The Wealth of Nations:

“The case in which it may sometimes be a matter of deliberation, how far, or in what manner, it is proper to restore the free importation of foreign goods, after it has been for some time interrupted, is, when particular manufactures, by means of high duties or prohibitions upon all foreign goods which can come into competition with them, have been so far extended as to employ a great multitude of hands. Humanity may in this case require that the freedom of trade should be restored only by slow gradations, and with a good deal of reserve and circumspection. Were those high duties and prohibitions taken away all at once, cheaper foreign goods of the same kind might be poured so fast into the home-market as to deprive all at once many thousands of our people of their ordinary employment and means of subsistence. The disorder which this would occasion might no doubt be very considerable.”

Even though Adam Smith was referring to the only gradual removal of protectionism, not the temporary imposition of protectionism, economies moved and developed at a much slower pace during Smith’s time. Consequently, he may not have foreseen how modern technology and innovation could drive an entire industry to disappear from one country rather rapidly, otherwise he may have extended his above protectionism concession further.

Even so, the key point in this concession is that protectionism is temporary and not intended to keep a declining industry within one country indefinitely. And I am unaware of how permanent Trump intends his strategy to be, or whether he understands how very easy it is for such protectionist measures to get out of control and be extended well beyond their initial intended scope.



Trump’s attempt to save any business or industry that the private sector has already chosen to not save smacks of arrogance. Furthermore, any benefits the US can obtain from protectionism by exploiting its global market power could very easily result in retaliation or a global transition away from the US entirely. And if history is any guide, there is a great risk that such measures will extend well beyond their intended scope, causing widespread economic damage the world over – and even the US is unlikely to be immune.