Broken Compass

by Don Boudreaux on January 29, 2023

in Balance of Payments, Myths and Fallacies, Trade

Here’s a letter to a long-time correspondent:

Mr. W__:

Thanks for sharing with me American Compass’s Policy Brief endorsing a global tariff. Alas, I don’t share your enthusiasm for that document. It’s deeply flawed both factually and economically.

Forget that, contrary to the Brief’s assertion, an increase in the U.S. trade deficit does not necessarily increase Americans’ indebtedness. (When you pay $1,000 for a car repair, you are not thereby thrust $1,000 further into debt if your mechanic – rather than buying $1,000 of what you sell – either pockets the cash indefinitely or spends it on an out-of-town trip.) Overlook the Brief’s mistake of equating a fall in U.S. manufacturing employment with a fall in U.S. manufacturing output. (The former has been falling for more than 40 years while the latter has been rising. Real U.S. manufacturing output is today only 5.7 percent lower than the all-time high which it hit just before the Great Recession and 179 percent higher than it was when the St. Louis Fed began gathering data on manufacturing output in January 1972.)

Instead focus on this passage from the Brief’s final paragraph:

Even very large tariffs have barely detectable short-term effects on consumer prices, and every dollar of tariffs can go toward reducing other taxes or costs that families face. In practice, much of the tariff ’s cost will be borne by foreign producers who must cut price to compete in our market, which economists found to be the case when President Trump imposed tariffs on China.

This passage alone reveals that the author of the Brief is ignorant of the most basic of economic realities. The reason is plain: Tariffs protect domestic producers only if and to the extent that tariffs raise the prices that domestic consumers must pay. The very point of a protective tariff is to raise the prices that consumers must pay for imports, for only by artificially raising the prices of imports will consumers be incited to instead purchase domestically produced substitute goods. Any tariff whose “cost will be borne by foreign producers” and thus cause that tariff to have “barely detectable” effects on consumer prices is a tariff that doesn’t do what the author of the Brief wants it to do – namely, protect domestic producers from foreign competition.

The fact that American Compass peddles its scheme for a “global tariff” by claiming that such a tariff will divert consumer demand to domestically produced substitutes for imports without raising the prices that consumers pay for imports is proof as solid as proof gets that all of American Compass’s trade-policy proposals should be ignored.

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

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