This time it's (really not) different, Part III

Of infants and reciprocity.

Aluminium and steel are not infant industries in need of support.
Trump does not have anything against which to justly retaliate.
China has not caved in to Trump’s demands.
Even attempting to use tariffs as bargaining chips can too easily result in retaliation, an all-too-convenient slide into general protectionism, or just pointless disruption and self-harm.
It’s just not worth it.

The infant industry argument

One of the arguments in favour of protectionism about which I have previously written is the infant industry argument. John Stuart Mill postulated that supposedly, a young industry in which a nation potentially possesses a strong advantage may not command sufficient initial resources to become competitive and so, warrants temporary protection until it matures to a state competitive enough to survive independently. So Mill believed temporary protective duties, when used “in hopes of naturalising a foreign industry in itself perfectly suitable to the circumstances of the country” may be acceptable.

In the long run, the benefits of gaining such an internationally-competitive industry will supposedly outweigh the costs of the initial support. Adam Smith argued that a country should pursue the present and immediate advantages of buying goods at their lowest “present exchangeable values” via free trade. But surely the possible productive powers of a country are important too. Thus, “it might be worthwhile to incur a loss for a time in order to secure a more than proportionate future gain”. A country’s advantages after all, are dynamic and ever-changing, not static and permanent.

Furthermore, tariff revenue can be used to finance social welfare programs too (e.g. Germany supposedly benefited greatly from its tariffs in centuries past).

Even being a supporter of Smith’s notions of personal liberty, Mill still acknowledged this infant industry argument, a relatively small concession in Mill’s mind but much to the horror of other free-traders, especially the damage that could be inflicted if ‘infants’ didn’t ‘grow up’. Trusting government to “pick winners” has worked poorly in the past (as I’ve written about Argentina). Smith also acknowledged such an infant industry argument (though not in those words) but dismissed it as an unlikely situation.

Retaliation or bargaining

Another argument in favour of tariffs is their use in retaliation or for bargaining. Tariffs can be a bargaining tool to get trade concessions from other trade partners. Bertrand Russell acknowledges the potential power of tariffs in negotiations to reduce foreign tariffs and increase world trade. But, perhaps out of arrogance, if this tactic fails, people are often happy to leave the tariffs in place just to keep foreign goods out, not get domestic goods out, as was the original (and better) intention.

We need to distinguish the intention just to retaliate and gain ‘leverage’, from the intention for an easy and popular transition to protection. Also, is retaliation on free-trade principles worth risking a trade war? There is limited evidence of such retaliation actually working (no, Trump’s tariffs against China haven’t worked, see below) – countries rarely bow to such threats, especially when the political protectionist interests are stronger than the local exporter interests (e.g. the 14th and 15th century Italian condottieri [mercenaries] whose livelihoods depended on war, not peace) and/or national pride is at stake. And you’re just hurting your own economy.

And even if retaliation successfully lower foreign tariffs and increases exports, it'll also increase imports, which may (wrongfully) scare policy-makers into adding more tariffs to reduce imports that resulted from their own successful policy – a popular ‘Mercantilist’ fallacy from which Trump and Co. clearly suffer.

Eventually, the power to negotiate became less important than the freedom to import (as Robert Peel noted in light of the failure of the Corn Laws which placed tariffs on the importation of French corn in the 19th century, as well as the French with respect to their significant tariffs on British manufactured imports). And tariffs can force a country to start producing what it is not apt to produce, resulting in sub-optimal distribution of labour and capital, lower total national output and thus, impaired wealth levels. So often it’s just better to lower tariffs out of own self-interest, independent of any quid pro quo. And this “eventual triumph of universal free trade” will only be hindered by retaliating.

How do these arguments relate to Trump protectionism?

As I’ve written before, steel and aluminium are not infant industries in the US. And even if Trump does want to bring back these older traditional manufacturing industries, they are, by their very nature, lower wage (to compete with the developing countries that can do it just as well) and lower skill jobs than the service, technology and knowledge jobs in which the US should be specialising, bringing lower standards of living with them. And they are highly mechanised and automated now, so their ‘return’ wouldn’t generate a lot of employment anyway.

As Paul Krugman says, attempting to get these old industries back in the US is like running someone over, then attempting to ‘undo’ it by backing over them again. The damage has been done. Entire industries, production facilities and supply chains are now structured around the world based on the assumption that free trade will continue. It’s not simply a matter of bringing jobs back. Reversing this trend – that has been running for decades – will just cause the same disruption all over again but in reverse, as these industries, production facilities and supply chains restructure themselves again (only this time, sub-optimally) to this new protectionist world. Such traditional manufacturing has gone from the US. You won’t bring it back, at least not without significant and destructive disruption.

As for retaliation/bargaining, Trump isn’t retaliating. His claims of great tariffs in Germany and China are wrong. The German taxes Trump refers to as being applied to US exports are sales taxes, to which Germany’s own companies are subject, so it’s not an unfair disadvantage to US exporters. And US companies enjoy an average Chinese tariff of just 3%. So what is he retaliating for? The trade deficit with China? That is not a bad thing either (see previous blog).

What about bargaining? Some have suggested that China has caved in to Trump’s demands and have made numerous concessions to appease him in a recent speech by President Xi Jinping. Unfortunately, either China has already been planning to make these moves for a long time, or they will have minimal impact on the US anyway (according to David Fickling of Bloomberg LP):

·         Opening up financial services and automotive joint ventures. These plans have been under consideration for almost five years and were enshrined in an economic planning document 12 months ago, as well as a Chinese policy announcement last November;

·         Reducing restrictions on foreign investment. Such reviews have been carried out periodically ever since Beijing’s current foreign investment regime was established in 1995. Relaxation of these restrictions generally follows Chinese companies reaching some sort of threshold where they can compete effectively with imports (see infant industry argument above);

·         Strengthening intellectual property protections. This is something the US actually worked very hard to enshrine in the provisions of the Trans Pacific Partnership (TPP), before Trump abandoned it. What was the point? And Xi even referred to it in a financial conference speech last July; and

·         Expanding imports and reducing their current account surplus by for example, reducing tariffs on cars. This is another long-established project as part of China’s ongoing long-term planned transition from an investment-led to a consumption-led economy, which will naturally involve more openness to imports. But even so, China only imports around 5% of its cars, most of which are luxury brands from Europe, not the more affordable ones that would come from the US (which simply can be produced far cheaper in China, not imported). Maybe the US can try to get in on the luxury car market. But they would be competing directly with Germany. Good luck!

I mean, did we really expect China’s reaction to Trump’s tariffs to be: “Oh, okay Mr Trump, we’ll give you what you want. Just please, don’t hurt us”? Far more likely is that China is attempting to trick Washington into declaring victory and abandoning its tariffs – which would actually be a good outcome, given one of the alternatives is all-out trade war.

But even if it turns out that Trump’s bullying of other countries actually does result in countries freeing up their trade policies further (in a real, not superficial and pre-planned way), is it really worth it? Is it worth risking a highly destructive trade war for marginally greater access to a few export markets? What message does this send to other countries? Should they too start making demands (fair or unfair) of the rest of the world, under threat of materially damaging other countries’ (and their own people’s) welfare?

People generally don’t put up with being bullied like this for long before retaliating.