This essay explores how protectionism in trade hurts everyone. It appeared in the second and most recent issue of the Vital Center Journal, which you can read by clicking here. Views expressed in this essay are those of the author and do not necessarily represent those of Project Liberal.
At a pivotal juncture in its economic journey, America now risks forgetting the timeless principles that have underscored its success.
Historically a beacon of free trade and open markets, the nation has, since 2013, been increasingly allured by the lofty promises of protectionism. Whether it be the abandoning of the vital Trans-Pacific Partnership trade agreement, the renegotiation of the North American Free Trade Act, the US-China trade war, or the newest wave of economically nationalistic policies, it’s clear that protectionism is once again in vogue.
The new protectionist fervor is built on the old protectionist pitch. It goes something like the following: open trade has offshored our industry and hollowed out our economy, and to reverse this trend, we must once again preference American industries over foreign competitors.
Yet, the truth, as it has been proven in the past and remains to this day, is that protectionist policies, rather than being essential to protect our economy, are one of the greatest threats to it. Tariffs and quotas wreak economic havoc where they are instituted, and their presence promises to suffocate, not enhance the dynamic competitive economy needed for nations to thrive.
Trade is not, as protectionists claim, a game of winners and losers, nor is it to dominate or be dominated, rather, it’s more like a harmonious dance where both parties benefit and where prosperity is mutually enhanced. It also establishes essential ties between nations that de-escalate conflicts, increases cooperation on global problems, and promotes liberty the world over. In other words, trade is not the enemy; it is, in fact, one of our greatest allies.
The Triumph of Free Trade
There was a time when luxuries like coffee, tea, chocolate, and foreign fabrics were reserved for the elite as symbols of status and power. Today, these commodities are casually enjoyed by millions, as modern supermarkets offer goods from all over the world at low prices. Where kings once had jesters and musicians to entertain them, today’s individuals have devices offering music, movies, books, games, and knowledge across cultures and eras.
Entrepreneurs, driven by competition and profit, now scour the globe to reduce production costs, democratizing commodity consumption through lower prices and increased incomes.
Production in such a world is divided amongst billions of independent decision-makers, each pursuing their own interest, leading to the emergence of a highly intricate division of labor. This is quite beautifully illustrated in the essay “I Pencil,” by Leonard Read. Entrepreneurs engaged in international trade through specialization and comparative advantage of resources in different countries lower cost, allowing for the democratization of consumption.
Moreover, by establishing connections between various geographical regions and cultures, trade acts as a basket of knowledge and information about the best manner of using resources, whereby firms in effective competition engage in the innovative process of discovery of various cost-saving methods of organization of production.
This is in stark contrast to the past, where production was organized through inheritance, focused on preservation rather than innovation, and often stifled change. This localized, tradition-bound approach served local needs, with progress and innovation considered exceptions, often looked down upon as causes for disrupting the existing order.
Therefore, it is crucial to understand that the world that we find ourselves in today, especially in America, is one that can trace its prosperity to the wonders of globalized trade and liberalized exchange. And this prosperity was not an accident but rather the product of a break with the long-established methods of organizing production, in which self-reliance and control were valued over free and open markets.
The Protectionist Renaissance
For decades, the enormous propensity for wealth produced by liberalized trade was clear enough to command support from parties all around the political spectrum. But amidst recent economic unsettling, a generation of populist leaders have emerged, eager to pin all manner of problems on trade.
This looming protectionist surge has manifested itself in a variety of policy changes, beginning under the Trump administration, where the so-called “America First” doctrine quickly produced an unsettling acceptance of policies that threatened to tear at the very fabric of the global economy.
The first awful move toward isolation came with the U.S. withdrawal from the Trans-Pacific Partnership (TPP) in 2017. The TPP was a proposed 12-nation trade pact designed to strengthen economic ties between the involved nations by reducing tariffs and fostering trade. It was the pride of the Obama administration and the crown jewel of the effort at a new era of economic globalization. However, the Trump administration viewed the agreement as detrimental to American manufacturing and argued that it would accelerate job losses. However, despite these claims, a study by the U.S. International Trade Commission (USITC, 2016) projected that the TPP would have enhanced the U.S. real GDP by $42.7 billion and created 128,000 full-time jobs by 2032.
Another emblematic policy change was the renegotiation of the North American Free Trade Agreement (NAFTA), resulting in the U.S.-Mexico-Canada Agreement (USMCA). While maintaining the core structure of NAFTA, the USMCA introduced significant changes, especially in the automotive and labor sectors, with the aim of fortifying American industries. This renegotiation was another manifestation of the burgeoning protectionist sentiment within U.S. economic policy.
Furthermore, the U.S.-China trade war marked a dramatic escalation in the country’s protectionist stance. This contentious economic conflict entailed the imposition of punitive tariffs on hundreds of billions of dollars worth of Chinese goods. The Trump administration justified this move as a necessary response to what they deemed were unfair Chinese trade practices.
However, research by the National Bureau of Economic Research indicated that these tariffs resulted in U.S. consumers and importers bearing the brunt of increased costs.
Particularly, the authors found that the United States experienced substantial increases in the prices of intermediates and final goods, dramatic changes to its supply-chain network, reductions in the availability of imported varieties, and the complete pass-through of the tariffs into domestic prices of imported goods.
Protectionism is Negative-Sum
Given that any act of exchange between international participants only takes place if the exchange makes both sides better off, any trade barrier that obstructs these exchanges has by necessity the effect of preventing mutually beneficial transactions. This process is inherently destructive; whether it be as small as propping up local industries with artificial subsidies or as extreme as completely severing trade relations with other nations, the effect is less prosperity for all parties involved.
It is crucial to understand that when a nation erects a trade barrier to promote domestic enterprises over foreign ones, it unintentionally sets in motion several events that create more adverse circumstances for the rest of the economy. This was quite evident in the erection of the Smoot-Hawley tariff, intended to revive the economy in 1929 at the onset of a monetary contraction, which later became the Great Depression.
TheSmoot-Hawley Tariff Act of 1930, named after sponsors Senator Reed Smoot and Representative Willis C. Hawley, was fashioned to shield U.S. businesses and farmers from international competition through imposing high tariffs on imported goods. It was part of a misguided effort at the beginning of the Great Depression that arose because international trade was perceived as a gravity hole that sucked the wealth of the American economy. Thus, it was thought that spending had to be diverted towards local domestic produce which would mitigate unemployment and revive the economy. Although intended to protect domestic industries during the onset of the Great Depression, it proved counterproductive, and hindering recovery.
The Act’s protectionist approach ironically perpetuated deflation by raising import duties to record levels, stifling trade and economic growth. It also disrupted price adjustments needed for recovery, as the raised import prices of crucial intermediate goods used as inputs by American producers led to increased domestic prices, discouraging consumer spending. Far from promoting economic recovery, the Act provoked international retaliation, sparking a global trade war. This retaliation saw U.S. imports nosedive by 41% and exports plummet in response to retaliatory tariffs by other countries respectively between 1929 and 1932, thus undermining any recovery efforts and leading to an absolute decline in output.
The proposed Sanders-Hawley Tariff, built around a similar bipartisan consensus of trade as “bad,” elevates and takes U.S. tariff policy toward China to gargantuan heights, reminiscent only of the historic Smoot-Hawley Tariff Act of 1930. If implemented, the potential implications range from an increased cost of living for American consumers and increased costs for producers to a significant alteration of the U.S.-China trade landscape.
To understand this, it is worth considering the complexity of the economy. Production in modern economies operates in a hierarchical structure. This structure of production in the economy starts with goods produced at the primary stages and ends with the final goods used by consumers. Goods used in the primary stages of the structure of production are created for agriculture, forestry, fishing, mining, oil extraction, and other natural resources.
These inputs form the base of almost every other product or service provided to consumers and thus form a significant component in the inflationary spiral when their demand outpaces supply. A significant amount of rare minerals, which are imported into the United States, form the base of E.V. batteries and are needed as crucial elements needed for the final products of various U.S. firms. The latter will now face uncertainty and increased cost as a result of the proposed plans, thereby hurting U.S. consumers and manufacturers.
The tariff aims to decrease U.S. reliance on Chinese production but fails to recognize that China is only a part of the production process. The U.S. and other countries often ship vital parts to China for cost-effective assembly. Even if the production were shifted to the U.S., it would be very much against comparative advantage in trade and would not generate substantial employment due to the capital-intensive nature of domestic manufacturing as opposed to cheaper labor-intensive production in China. It would also potentially waste capital that could be used more efficiently elsewhere.
The second most effective influencers of prices of other goods are the semi-finished goods and services used as inputs by producers during the middle stages of production to create final goods and services. Given their non-general nature, their production requires specialized knowledge and resources. As demand for semi-finished goods increases due to increased competition among producers of final goods, it exerts inflationary pressures directly on the prices of final goods. When nearly half of the USA’s imports from China consist of these semifinished capital goods, which are used in various stages by multiple producers for their own production process, the implementation of these tariffs are going to get expensive for the U.S., further increasing inflationary pressures, possibly leading to supply shortage, and reducing demand and spending.
In conclusion, the rise of protectionism in America represents a paradox: the more we attempt to “protect” the American economy, the more it will be endangered. Despite this, from the withdrawal from the Trans-Pacific Partnership to the renegotiation of NAFTA and the escalation of the U.S.-China trade war, the trajectory toward economic isolationism and protectionism has been clear. And the evidence has remained clear: these policies will only succeed in making the United States and the rest of the world poorer.