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In my March 9th, 2007, column for the Pittsburgh Tribune-Review, I argued that the best policy for the home-country government is to ignore subsidies doled out by foreign governments [2]. You can read my argument beneath the fold.
Ignoring subsidies
In my previous column I concluded that Uncle Sam has no business obstructing American consumers’ ability to buy goods and services from a foreign country — even if that country’s government is accused of subsidizing its producers.
To reach this conclusion, though, I do not deny that foreign governments sometimes subsidize their producers. Nor do I deny that these subsidies are harmful economically.
By directing resources into uses that are not justified by market realities, subsidies make us all poorer. If, for example, Malaysia subsidizes its textile industry, these subsidies direct Malaysian workers and resources into textile production and away from producing goods and services that Malaysians could produce more efficiently.
For this reason I said in my earlier column that even though foreign subsidies typically benefit American consumers, our applause for such benefits should be “somewhat muted.”
Recognizing that subsidies are sand in the gears of the global economy, some people argue that Uncle Sam should use his powers to raise tariffs in order to dissuade foreign governments from imposing subsidies. The idea is that if Washington prevents Americans from buying subsidized imports, foreign governments will have much less incentive to subsidize their industries.
This argument for U.S. tariffs has some appeal. It is based not on the wrongheaded notion that subsidies are bad because they harm American producers, but rather on the correct understanding that subsidies are bad because they reduce the productivity of the global economy — an economy of which Americans are an important part.
Nevertheless, the best and most prudent policy is for Uncle Sam to steadfastly avoid granting protection even when foreign firms are subsidized.
One justification for this policy of unilateral free trade was explored in my previous column: Such subsidies are, in effect, a gift to consumers in America. The chief losers continue to be foreign taxpayers.
Another important reason springs from the fact that subsidies are surprisingly difficult to define and identify. The classic case of a government paying a producer a fixed amount of money per unit of output is straightforward. But beyond this blatant method of subsidizing producers, things quickly get fuzzy and foggy.
Does a government subsidize an industry if it cuts that industry’s taxes?
How about if the government builds a first-rate system of highways, roads and bridges in proximity to the chief firms in an industry?
Is an industry subsidized if it benefits from a government-financed engineering school?
How about if some of the industry’s firms are paid by government to build cutting-edge military equipment?
Are firms that depend upon export markets subsidized if their government provides a top-flight navy to ensure the safety of cargo ships sailing under that country’s flag?
Do governments that use tax revenues to maintain law and order and ensure reliable enforcement of contracts subsidize businesses within their borders?
Answering such questions is surprisingly difficult. And, sad to say, if Uncle Sam commits himself to protecting American producers from foreign competition whenever that competition is subsidized, these producers will exploit the ambiguous nature of subsidies as they petition Washington for protection from competitive pressures. They will too freely and loosely allege that their foreign rivals are subsidized.
Also, because subsidies are indeed often hidden and their nature vague, it is difficult to disprove many allegations of subsidization. Unable solidly to disprove such allegations means that government will err on the side of sympathetic domestic industries that accuse their foreign rivals of enjoying “unfair” advantages.
Predictably, other governments will not sit by idly as Uncle Sam raises tariffs under the pretense of protecting Americans from unfair foreign subsidies. These other governments will retaliate with their own allegations of unfair subsidies — alleging, for example, that Boeing is unfairly subsidized by the many contracts that it receives from the Pentagon.
As always, the losers from such protectionism, especially if it escalates into a trade war, are consumers, both foreign and American.
None of the above is to deny that governments (including our own) dole out unjustified subsidies to various industries within their jurisdictions. And none of the above is to deny that such subsidies are harmful. In this context, however, two facts are important to remember even in cases where there’s no question that a foreign government is unjustifiably subsidizing some of its producers.
First, the principal victims of subsidies will always be taxpayers who are milked to provide the subsidies.
Second, protectionism is itself harmful. Protectionism only piles one harm atop another.
I know of no cases in which a country was impoverished, or even measurably damaged, by its refusal to “retaliate” against alleged instances of foreign subsidies. This fact, combined with the ease of abusing the ability to accuse foreign rivals of being subsidized, counsels strongly in favor of our own government turning a deaf ear to such accusations.