macro homework 110901 – discussion question on trade

(I’m going to start posting up anything I write for classes that seems like a vaguely worthwhile read. I guess I actually started a while back, but I’m about be a lot busier cranking out stuff like this, so I’ll see if they are worth a read for anyone who wants to wade into econ stuff a little more.)

If trade can make everyone better off, why would governments act to restrict trade? Are trade restrictions a good idea? Explain.

Governments usually act to restrict trade for one of a few reasons:

1) To protect infant industries. Developing nations have used trade restrictions to protect the development of native industries from the more efficient competition from the mature industries of other nations. The early US is a prime example of this. In his 1791 “Report on Manufactures,” Alexander Hamilton, discussing the development of industry in the United States, lays out the following argument for using tariffs to shelter infant industries.

     The superiority antecedently enjoyed by nations, who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle, than either of those, which have been mentioned, to the introduction of the same branch into a country, in which it did not before exist. To maintain between the recent establishments of one country and the long matured establishments of another country, a competition upon equal terms, both as to quality and price, is in most cases impracticable. The disparity in the one, or in the other, or in both, must necessarily be so considerable as to forbid a successful rivalship, without the extraordinary aid and protection of government. 1

The merits of this line of argument are still being debated today, with those inclined to a free trade viewpoint arguing that US industry flourished in spite of such tariffs and others arguing that it did so at least in some part because of such policies. 2

This runs contrary to a more pure free-trade viewpoint which would perhaps state that if a nation cannot at any point in time produce a product more efficiently than a potential trading partner, it would be better served by simply importing those goods and finding another set of goods to produce in which it enjoys a comparative advantage. However, the idea of protecting infant industries can be viewed as simply taking a more long run viewpoint. In essence, it is an argument that a less developed nation might find it is at an absolute disadvantage in so many areas that a period of protectionism is required to assure that it does not end up stuck in a rut of being nothing more than an natural resource exporter or a monolithic exporter of perhaps a few crops, etc. In such cases, proponents argue that a period of tariffs, phased out as domestic industries achieve increasing efficiency, creates the capital stock and expertise which lead to more equitable conditions for future trade.

2) Tariffs are more politically expedient to collect than other forms of taxation. Again, the early history of the US gives a clear example of this. Until the early 20th century, tariffs were either the sole or the principle source of revenue for the US government. While consumers of imported goods would see higher prices due to tariffs, this was a hidden cost and was much easier politically than taxes, such as the income tax, which eventually superseded tariffs as the main source of government revenue. (A related tendency today is for municipalities to raise revenue through taxes such as hotel and rental car fees, which are primarily paid by visitors who do not vote in the taxing municipality.)

3) As protection or retaliation against “dumping,” export subsidies or other mercantilist policies. Even today in the era of largely unfettered free trade, the US still uses tariffs against targeted commodities or industries as tools of foreign or trade policy. In 2009, the Obama administration introduced a three-year tariff on car and light truck tires imported from China as retaliation against alleged dumping (or the sale of import products for below the production cost through subsidies from the exporting nation’s government).3 Many critics of such policies would characterize these motives as protecting favored constituents or industries from competition under the rubric of retaliating against unfair practices.

While economists in particular almost uniformly agree that imposing barriers to trade is uniformly a bad thing (according to our text), the “infant industry” argument has a long and relatively well-defended history among economists all the way back to John Stuart Mill. The idea that comparative advantage dictates that any nation which cannot compete in a given industry should simply cede that industry to other nations would have left (and would still leave) many of the world’s leading industrial powers (Germany and the US to name just two who used tariffs under this reasoning) as nations in a weak bargaining position vis a vis nations that achieved industrialization first (such as Britain in the aforementioned case). Without such a policy, many nations that have developed mature and diverse economies would be relegated to simple exporters of raw materials and natural resources. Indeed, newer industrial powerhouses such as China, Japan and Korea all benefitted from various types of trade restrictions and protectionism, with China as the primary example (and notable counterfactual to the largely undisputed gospel of free trade) of an extremely successful economy which uses a wide variety of policies (capital controls, currency manipulation, domestic ownership requirements and outright tariffs) to create a very favorable position for its products in world markets.

Finally, thinking normatively, it is not hard to make the argument that if the goal of a society tilts more towards equity than efficiency, then trade barriers can be seen simply as another tool to manage an economy towards goals of social equity. A great exposition of this line of reasoning was given in a speech by former NY Federal Reserve Chairman Beardsley Ruml in 1946. He was discussing the realization that, in a post gold-standard world of fiat currency, a nation such as the US should look at tax policy (of which tariffs could be considered a part) in the light of societal goals first and foremost. Here is a relevant excerpt:

In general, it may be said that since all taxes have consequences of a social and economic character, the government should look to these consequences in formulating its tax policy. All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.

What Taxes Are Really For

Federal taxes can be made to serve four principal purposes of a social and economic character. These purposes are:

1. As an instrument of fiscal policy to help stabilize the purchasing power of the dollar;

2. To express public policy in the distribution of wealth and of income, as in the case of the progressive income and estate taxes;

3. To express public policy in subsidizing or in penalizing various industries and economic groups;

4. To isolate and assess directly the costs of certain national benefits, such as highways and social security.

In the recent past, we have used our federal tax program consciously for each of these purposes. In serving these purposes, the tax program is a means to an end. The purposes themselves are matters of basic national policy which should be established, in the first instance, independently of any national tax program.

Among the policy questions with which we have to deal are these:

Do we want a dollar with reasonably stable purchasing power over the years?

Do we want greater equality of wealth and of income than would result from economic forces working alone?

Do we want to subsidize certain industries and certain economic groups?

Do we want the beneficiaries of certain federal activities to be aware of what they cost?

These questions are not tax questions; they are questions as to the kind of country we want and the kind of life we want to lead. The tax program should be a means to an agreed end. The tax program should be devised as an instrument, and it should be judged by how well it serves its purpose.

This is an elegant statement which I think can be taken as a wonderful argument for looking beyond possible (or even likely) reductions in efficiency as an iron-clad condemnation of tariffs and other protective trade policies. It’s a lesson which China has learned well and it would be hard to argue that it is serving them terribly poorly overall in the 21st century.

Sources:

1) Alexander Hamilton “Report on Manufactures” 1791 

http://www.constitution.org/ah/rpt_manufactures.doc

2) J. Bradford DeLong “Trade Policy and America’s Standard of Living: An Historical Perspective”

dss.ucsd.edu/~jlbroz/Courses/POLI142B/syllabus/delong.pdf

3) Peter Whoriskey and Anne Kornblut “US to Impose Tariff on Tires From China”

http://www.washingtonpost.com/wp-dyn/content/article/2009/09/11/AR2009091103957.html

2) Beardsley Ruml “Taxes for revenue are obsolete”

http://home.hiwaay.net/~becraft/RUMLTAXES.html

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About theunlikelyeconomist

theunlikelyeconomist is in the midst of the long slog to attain a PhD in economics.
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