The US has imposed a 10% tariff on Chinese goods and a 25% levy on Mexican and Canadian goods will come into force in a month. Tariffs on the EU are also in the pipeline at a rate still to be determined. The governments of the targeted countries are planning retaliatory tariffs against the US, which are likely to have a similar effect to punching a lorry that has just run over your foot – brief satisfaction quickly followed by considerable pain.
Regardless of their politics, economists will tell you that trade wars make everyone poorer, indeed it’s just about the only thing you can get economists to agree on, except maybe that rent control is a stupid idea. The arguments are well rehearsed; tariffs result in higher costs for your own consumers and industries that use foreign inputs, they inhibit specialisation and redistribute labour, land and capital away from more efficient to less efficient uses.
So why is Donald Trump’s new administration pushing tariffs so aggressively? It’s clearly not a reaction against the policy of the previous administration, which was itself quite protectionist. Joe Biden’s team, for example, ignored World Trade Organisation rulings in order to retain tariffs on steel, and even increased tariffs on Canadian lumber products.
Trump’s statements on the topic differ from Biden’s in how heavily he leans on his interpretation of American economic history, particularly during period between the end of the American Civil War and the start of World War I. Basically, his argument goes that in this period, the US became a major manufacturing power because it imposed high tariffs on imports. Tariffs, he claims, allowed US industry to develop more quickly than it otherwise could have while providing a source of revenue that largely funded the Federal Government until the introduction of income tax.
In his interview with Joe Rogan in October last year, he even responded positively to the idea of replacing income tax with tariffs. This could be written off as campaign bluster, but once Trump entered the WhiteHouse, it became increasingly clear how deeply this analysis of America’s history would affect his second term.
One of his first acts as President was to rename (or technically re-rename) North America’s highest mountain after William McKinley, whose commitment to tariffs was referenced by Trump in the relevant Executive Order:
Under his leadership, the United States enjoyed rapid economic growth and prosperity, including an expansion of territorial gains for the Nation. President McKinley championed tariffs to protect U.S. manufacturing, boost domestic production, and drive U.S. industrialization and global reach to new heights.
On the one hand, it’s nice when world leaders take an interest in such a fascinating period of economic history. On the other, it’s a pity that Trump has ended up with such a mangled version of what occurred – particularly when it comes to the relationship between tariffs and growth.
To start with, while McKinley was an ardent protectionist in Congress, as President he grew increasingly in favour of ratcheting down America’s tariff wall in exchange for reciprocal arrangements from other countries.
But at a more fundamental level, the whole argument that because the US industrialised in the context of high tariffs, it therefore did so because of tariffs is seriously flawed.
Firstly, as Douglas Irwin has highlighted, in the late 19th century, productivity in tariff-sheltered manufacturing grew much slower than in un-traded sectors like services and utilities which would suggest that the strength of the Gilded Age economy was not primarily dependent on infant industry protection.
But even within the manufacturing sector, industries with lower tariff protections tended to experience more rapid productivity growth than those which were more protected, as Alexander Klein and Christopher Meisner have pointed out in their excellent analysis of American manufacturing output between 1870 and 1909. Industries with higher tariffs faced less competition, and therefore could impose higher prices. However, they were less productive and tended to employ more workers. This last point may seem like a positive but this essentially amounted to a reallocation of workers away from more competitive industries towards firms that could only survive in the context of artificially high prices – the cost of all this was borne by the American consumer.
The US in the late-19th century did have huge economic advantages which helped it become an industrial juggernaut, but these had little to do with tariffs. Among other factors, US industry had access to abundant land, a steady supply of labour from old world immigration, easily accessible natural resources (e.g. iron ore near the Great Lakes or oil in the west), a large and efficient transportation network which could cheaply move them to where they needed and readily available credit which industrialists were able to plough into capital goods.
With this in mind, it seems highly likely that had the US not forced the misallocation of labour and capital through the use of tariffs, it would have become the world’s leading economy sooner, as Klein has argued in a recent interview.
It is true that the US industrialised in the context of high tariffs. It is also true that some 16-year-olds pass their GCSEs in a context of binge drinking. It does not follow that the one led to the other and it certainly doesn’t mean that in middle age you should spend your evenings drinking large quantities of cheap cider in a park to boost your career prospects or that an advanced economy like America’s will benefit from a revival in protectionism.
Unfortunately, it seems that the US is going to have to relearn this lesson the hard way, with both it and the rest of the world bearing the economic consequences.
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