Taxing imports is bad. Tariffs harm the populations that their advocates claim to be helping. This has been well known since at least the early 19th century. But imposing tariffs, especially in the shambolic way Trump did in early April, is even worse than the tariffs themselves.
To see why, imagine two American women, each considering starting a candle-making business. Molly’s idea is to make candles from cheap wax imported from a friend in Congo. Polly plans to make candles from more expensive American wax. Polly’s Great American Candle Company will succeed if cheap imported Congolese wax is taxed. Molly’s Light of Africa will succeed if it isn’t.
You might then think that America is sure to get one new candle company – Polly’s or Molly’s, depending on whether Trump imposes a tariff on Congolese wax. In fact, America may well get no new candle company.
Whatever policy Trump settles on in the coming months, Molly and Polly can’t be sure what he will do in the future, or what his successors will do. This uncertainty might deter both from starting their business, even though they have opposite interests regarding tariffs.
This is the problem of ‘regime uncertainty’. Returns on an investment depend, among other things, on the rules under which the business will operate. If those rules are liable to change in unpredictable ways that might harm the business, people become reluctant to make the investment.
Trump’s fickle tariffs policy has provided a vivid example. But all democratically elected politicians busy themselves with creating regime uncertainty. For example, our new Labour Government has increased employers’ National Insurance contribution from 13.8% to 15% of the employee’s income. Because this tax doesn’t increase workers’ productivity, it makes employing people less profitable. We can expect it to increase unemployment.
But this is merely the obvious problem with the policy. As with Trump’s tariffs, the intervention also causes regime uncertainty. A government that does this will surely make more changes to tax rates, or to the other legal conditions of employment, and these may also spell trouble for profits. The uncertainty deters investment.
That’s why the International Tennis Federation doesn’t change the rules of tennis much or often. If it did, people would be reluctant to make the investment involved in becoming a player. Who wants to put effort into honing skills that could soon be rendered obsolete by a change of rules?
It also explains why stock exchanges have stable rules for the companies that choose to list on them – rules concerning, for example, the content and frequency of earnings reports. Imagine that the Whimsical Stock Exchange of London frequently changed its rules while its rival, the Steady Stock Exchange, did not. All else equal, companies would prefer a Steady listing to a Whimsical one.
Private sector rule-makers provide regime stability because they must attract customers willing to pay for the deal that includes their rules. Once in power, politicians face no such constraint. In fact, they can impose rules on people who are harmed by them.
This can be a successful electoral strategy if the politician convinces enough voters that they will benefit from rules that harm others. Of course, his opponents will compete for power by promising different rules, with different winners and losers. And which rules we get depends on who wins.
Nor is the unpredictability of political competition, even over periods of just a few years, the only source of regime uncertainty. Politicians do not change the rules in one quick burst of activity when they come to power. They keep changing the rules until they lose power, seeking to use legislation to achieve outcomes they believe will be popular with voters. Parliament comprises 650 men and women who devote 170 days a year to changing the law.
The problem of regime uncertainty doesn’t arise from the peculiar moral or intellectual failings of those who come to power. It arises from the power to impose rules on people who don’t like them, and the democratic system by which that power is obtained and held onto.
Click here to subscribe to our daily briefing – the best pieces from CapX and across the web.
CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.
