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A Wonky Letter on the Optimum Tariff

Here’s a open letter to Cafe Hayek commenter Warren Platts:

Mr. Platts:

Commenting on this Cafe Hayek post, you write that “It is a fact of both standard tariff theory, tax incidence theory, and empirical measurements that tariffs INCREASE national net welfare, through the the terms-of-trade gain, that VASTLY outweighs any supposed deadweight losses.”

You here refer to the theory of the optimum tariff.  The first point to note about this theory is that most economists regard it to be a theoretical curiosity rather than a practical guide to policy.  Because the purpose of this tariff is not the protectionism that fuels most political support for tariffs, there’s no reason to trust government to tariff goods ‘optimally.’  In addition, the theory itself breaks down quickly if – as is likely – foreign governments retaliate.

Second, you misunderstand the theory.  The deadweight losses to which you refer arise because, and insofar as, the tariff reduces imports: the greater the tariff-induced reduction in imports, the greater the deadweight losses.  So if and when the terms-of-trade gains from the tariff do “vastly outweigh” its deadweight losses, the tariff-induced reduction of imports must be relatively small.  In the ideal limit, an optimum tariff would cause no reduction of imports and, thus, have no deadweight loss.  But at this limit, the tariff’s protectionist effect is nonexistent.  (More precisely, the protectionist effect here is negative because the result is a greater number of imports.  The very idea of the optimum tariff is to get foreigners to send to ‘us’ a greater amount of imports for each export that we send to ‘them.’)

A third point.  You’re simply incorrect to assert that the net welfare gains from an optimum tariff are large.  My great teacher Leland Yeager did the relevant math to show that the smallness of the estimated net welfare gains from an optimum tariff, even under favorable conditions, is “sobering.”*

For these and other reasons, the assessment of one of the early pioneers of optimum-tariff theory, F.Y. Edgeworth, should be heeded: “Thus the direct use of the theory is likely to be small.  But it is to be feared that its abuse will be considerable.  It affords to unscrupulous advocates of vulgar Protection a particularly specious pretext for introducing the thin edge of the fiscal wedge.”**

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

* Leland B. Yeager, “The Size of Gain from an Optimum Tariff,” Southern Economic Journal, Vol. 31, October 1964, pp. 140-148.  (The quotation is on page 148.)

** Francis Ysidro Edgeworth, “Appreciations of Mathematical Theories,” Economic Journal, Vol. 18, December 1908, pp. 541-56.  (The quotation is on page 555.)