TARIFFS: A MIXED STORY

Must Include Non-Tariff Trade Barriers

President Trump has re-introduced the raising of tariffs into the global economic dialogue after 75 years of their gradual decline. This has raised a ruckus among economists, journalists, and some segments of the business community while labor has cheered.

Tariffs have an interesting history. All of the countries who have industrialized and become rich, have done so by dint of tariffs and other trade barriers beginning at the opening of the 19th century. Interestingly, Britain, which in the 1840s was by far the leading industrial economy, began abandoning tariffs at that time supposing that it could lower the cost of labor thereby making it extra competitive in world markets.

In roughly the same time frame, the U.S. began raising them. A key item on which tariffs were raised was steel. Abe Lincoln is often cited as having said of tariffs on steel: “I don’t know much about tariffs but I know that when I import steel, I get the steel and the exporter gets the money. But with a tariff, I get the steel and the money stays in America.” In fact, it is doubtful that Lincoln actually said this. But it is true that by the 1890s, the United States was the world’s low cost producer of steel. As the world moved into the 20th century and then into World War I, the United States became the global low cost maker of most manufactured goods.

The Smoot-Hawley tariff increase of 1930 has been blamed by many economists for triggering the Great Depression. However, award winning UC Berkeley professor Barry Eichengreen says not so. In fact, it had little or no impact on the Great Depression.

In the wake of World War II, the world outside the U.S. was largely a basket case and American policy focused on the recovery and rebuilding of the global economy and especially of the economies of Europe and Japan. A combination of the mistaken notion that Smoot Hawley had, in fact, been a major cause of the war, and of the economic theory that free trade would reduce the chances of more war while also stimulating economic recovery took hold. The International Monetary Fund was created along with General Agreement on Tariffs and Trade while the dollar was allowed to be very strong and over-valued long after Europe and Japan had recovered.

In 1971 the fixed rate currency system faltered. Under the system, the dollar was fixed to gold at $35 per ounce and all other currencies were fixed to the dollar at a predetermined rate. The yen for example was fixed at 360 per dollar. The D Mark was almost 4 D Marks per dollar. But by 1971 these values were far far out of kilter. The U.S. was beginning to run trade deficits. Worse, other countries were entitled swap any excess dollars they might have for gold from Fort Knox. Suddenly the gold was rushing out of Fort Knox and the value of the dollar was in question which in turn put into question the whole Bretton Woods system adopted in 1944 as the main pillar of the post war economic system.

As President Nixon was elected President in 1968, he found himself facing an increasingly unviable system. By 1971 the dollar situation was acute and Secretary of the Treasury John Connally announced to a group of Europeans that the Nixon administration was halting the fixed rate dollar system and letting the value of the dollar be determined by the daily fluctuations of the market, He famously announced that “the dollar is our currency but it is now your problem.” With that the floating rate system of today was adopted. Although it somewhat reduced the U.S. trade deficit for a while, it was not the panacea Connally supposed and hoped it would be. For one thing, countries could now buy and sell the dollar on the open market and they could influence the value of the dollar by doing so. Another factor was and is that exchange rates are not the only determinates of exchange. Japan, for instance, has very low tariffs and the yen fluctuates in value according to the exchange markets. It also has no oil, few raw materials, and relatively poor resources for farming. Yet it has a chronic and large trade surplus and is a leader in industries like autos, ships, electronics, and steel.

Japan has pursued a weak yen policy by keeping interest rates low and by intervening in currency markets whenever the yen appeared to getting too strong. In addition, Japan has built its economy in such a way as to encourage the “buy Japan” attitude of much of its nationalistic population. The Keiretsu structure of its industry ties corporations into large groups such as the Mitsubishi group, the Mitsui group, and the Sumitomo group. These groups buy and sell to the large range of corporations in their groups. They are not very open to competing groups and certainly not to foreign intruders.

Thus can a country have very low tariffs and nevertheless be extremely difficult for foreign exporters to penetrate at the same time. Tariffs are only one way, and a rather crude way for countries to protect their markets.

Finally, tariffs can be harmful to the domestic economy by raising prices unnecessarily for its citizens. If America were in a trade war, the Fed might very well feel compelled to raise interest rates at a time when economic growth is already weak.

This is not to say that tariffs cannot be useful. They can prevent penetration of key U.S. markets by strategic competitors, and they can give U.S. entrepreneurs shelter from predatory actions by countries trying to undermine U.S. leadership. A good example is that of the Bush Jr. administration in its dealings with China.

Robert Zoellock was the Trade Representative in the Bush administration and he was dedicated to making nice with China. He famously said that “we want China to be a responsible stake holder in the global, free market system.” China was following a policy with the slogan “made in China 2025”. It was not interested in being a “responsible shareholder”. It was focused on catching up with the U.S. and the other advanced countries and ultimately in being top dog itself.

My conclusion from all this is that tariffs can be a useful tool if used carefully and strategically, but they can be very harmful if used carelessly as part of a macho attitude based on pride rather than substance.