budget deficits, Buy American, CCP, CHIPS Act, Comparative advantage, Consumer Sovereignty, Content Restrictions, Critical Supply Chains, Domestic Content, Donald Trump, Dumping, Export Markets, Federal Procurement, Foreign Trade, Free trade, George Will, Import Waivers, Joe Biden, Made-In-America Laws, Mercantilism, National Security, Nationalism, Patriotism, Price Competition, Price Preference, Protectionism, Tariffs, Trade Retaliation, Universal Baseline Tariffs, Uyghur Muslims
If there’s one simple lesson in economics that’s hard to get across it’s the destructive nature of protectionism. The economics aren’t hard to explain, but for many, the lessons of protectionist failure just don’t want to sink in. Putting aside matters of national security, the harms of protectionism to the domestic economy are greater than any gains that might inure to protected firms and workers. Shielding home industries and workers from foreign competition is generally not smart nor an act of patriotism, but that sentiment seems fairly common nonetheless.
The Pathology of Protectionism
Jingoistic slogans like “Buy American” are a pitch for voluntary loyalty to American brands. I’m all for voluntary action. Still, that propaganda relies on shaming those who find certain foreign products to have superior attributes or to be more economical. This feeds a psychology of economic insularity and encourages those who favors trade barriers, which is one of the earliest species of failed central planning.
The cognitive resistance to a liberal trade regime might have to do with the concentrated benefits of protectionist measures relative to the more diffuse (but high) costs it imposes on society. Some of the costs of protectionism manifest only with time, which makes the connection to policy less obvious to observers. Or again, obstructing trade and taxing “others” in the hope of helping ourselves may simply inflame nationalist passions.
Both Democrats and Republicans rally around policy measures that tilt the playing field in favor of domestic producers, often severely. And again, this near unanimity exists despite innumerable bouts with the laws of economics. I mean, how many times do you have to be beaten over the head to realize that this is a mistake? Unfortunately, politicians just don’t live in the long-term, they leap to defend powerful interests, and they seldom pay the long-term consequences of their mistakes.
Joe Biden’s “Buy American”
The Biden Administration has pushed a “Made In America” agenda since the President took office, It’s partly a sop to unions for their election support. Much of it had to do with tightening waivers granted under made-in-America laws (dating back to 1933) governing foreign content in goods procured by the federal government. The most recent change by Biden is an increase in the requirement for domestic content to 60% immediately and gradually to 75% from there. Also, “price preferences” will be granted to domestic producers of goods to strengthen supply chains identified as “critical”, including active pharmaceutical ingredients, certain minerals including rare earths and carbon fibers, semiconductors and their advanced packaging, and large capacity batteries such as those used in EVs.
There’s a strong case to be made for developing domestic supplies of certain goods based on national security considerations. That can play a legitimate role where defense goods or even some kinds of civilian infrastructure are involved, but Biden’s order applies much more broadly, including protections for industries that are already heavily subsidized by taxpayers. For example, the CHIPS Act of 2022 included $76 billion of subsidies and tax credits to the semiconductor industry.
George Will describes the cost of protectionism and Biden’s “Buy American”:
“‘Buy American,’ like protectionism generally, can protect some blue-collar jobs — but at a steep price: A Peterson Institute for International Economics study concludes that it costs taxpayers $250,000 annually for each job saved in a protected industry. And lots of white-collar jobs are created for lawyers seeking waivers from the rules. And for accountants tabulating U.S. content in this and that, when, say, an auto component might cross international borders (U.S., Canadian, Mexican) five times before it is ready for installation in a vehicle.”
Biden’s new rules will increase the cost of federal procurement. They will squeeze out contracts with foreign suppliers whose wares are sometimes the most price-competitive or best-suited to a project. This is not a prescription for spending restraint, and it comes at a time when the federal budget is under severe strain. Here’s George Will again:
“This will mean more borrowing, not fewer projects. Federal spending is not constrained by a mere shortage of revenue. So, Biden was promising to increase the deficit. And this policy, which elicited red-and-blue bonhomie in the State of the Union audience, also will give other nations an excuse to retaliate (often doing what they want to do anyway) by penalizing U.S. exporters of manufactured goods. ….. Washington lobbyists for both will prosper.”
Domestic manufacturers who find their contracting status “protected” from foreign competition will face less incentive to perform efficiently. They can relax, rather than improve or even maintain productivity levels, and they’ll feel less pressure to price competitively. Those domestic firms providing goods designated by the government as “critical” will be advantaged by the “price preferences” granted in the rules, leading to a less competitive landscape and higher prices. Thus, Biden’s “Buy American” order is likely to mean higher prices and more federal spending. This is destructive and counter to our national interests.
Donald Trump’s Tariffs
In a recent set of proposals trialed for his presidential election campaign, Donald Trump called for “Universal Baseline Tariffs” on imported goods. In a testament to how far Trump has stumbled down the path of economic ignorance, his campaign mentions “patriotic protectionism” and “mercantilism for the 21st century”. Good God! Trump might be worse than Biden!
This isn’t just about China, though there are some specific sanctions against China in the proposal. After all, these new tariffs would be “universal”. Nevertheless, the Trump campaign took great pains to cloak the tariffs in anti-China rhetoric. Now, I’m very unfavorably disposed to the CCP and to businesses who serve or rely on China and (by implication) the CCP. Certainly, in the case of China, national security may dictate the imposition of certain forms of protectionism, slippery slope though it might be. Nevertheless, that is not what universal tariffs are about.
One destructive consequence of imposing tariffs or import quotas is that foreign governments are usually quick to retaliate with tariffs and quotas of their own. Thus, export markets are shut off to American producers in an escalating trade conflict. That creates serious recession risks or might reinforce other recessionary forces. Lost production for foreign markets and job losses in the affected export industries are the most obvious examples of protectionist harm.
Then consider what happens in protected industries in the U.S. and the negative repercussions in other sectors. The prices charged for protected goods by domestic producers rise for two reasons: more output is demanded of them, and protected firms have less incentive to restrain pricing. Just what the protectionists wanted! In turn, with their new-found, government-granted market power, protected firms will compete more aggressively for workers and other inputs. That puts non-protected firms in a bind, as they’ll be forced to pay higher wages to compete with protected firms for labor. Other inputs may be more costly as well, particularly if they are imported. These distortions lead to reduced output and jobs in non-protected industries. It also means American consumers pay higher prices for both protected and unprotected goods.
Consumers not only lose on price. They also suffer a loss of consumer sovereignty to a government wishing to manipulate their choices. When choices are curtailed, consumers typically lose on other product attributes they value. It also curtails capital inflows to the U.S. from abroad, which can have further negative repercussions for U.S. productivity growth.
When imports constitute a large share of a particular market, it implies that foreign nations have a comparative advantage in producing the good in question. In other words, they sacrifice less to produce the good than we would sacrifice to produce it in the U.S. But if country X has a comparative advantage in producing good X, it means it must have a comparative disadvantage in producing certain other goods, let’s say good Y. (That is, positive tradeoffs in one direction necessarily imply negative tradeoffs in the other.) It makes more economic sense for other countries (country Y, or perhaps the U.S.) to produce good Y, rather than country X, since country Y sacrifices less to do so. And that is why countries engage in trade with each other, or allow their free citizens to do so. It is mutually beneficial. It makes economic sense!
To outlaw or penalize opportunities for mutually beneficial trade will only bring harm to both erstwhile trading partners, though it might well benefit specific interests, including some third parties. Those third parties include opportunistic politicians wishing to leverage nationalist sentiments, their cronies in protected industries, and the bureaucrats, attorneys, and bean counters who manage compliance.
When Is Trade Problematic?
Protectionists often accuse other nations of subsidizing their export industries, giving them unfair advantages or dumping their exports below cost on the U.S. market. There are cases in which this happens, but all such self-interested claims should be approached with a degree of skepticism. There are established channels for filing complaints (and see here) with government agencies and trade organizations, and specific instances often prompt penalties or formal retaliatory actions.
There are frequently claims that foreign producers and even prominent American businesses are beneficiaries of foreign slave labor. A prominent example is the enslavement of Uyghur Muslims in China, who reportedly have been used in the manufacture of goods sold by a number of big-name American companies. This should not be tolerated by these American firms, their customers, or by the U.S. government. Unfortunately, there is a notable lack of responsiveness among many of these parties.
Much less compelling are assertions of slave labor based on low foreign wage rates without actual evidence of compulsion. This is a case of severely misplaced righteousness. Foreign wage rates may be very low by American standards, but they typically provide for a standard of living in the workers’ home country that is better than average. There is no sin in providing jobs to foreign workers at a local wage premium or even a discount, depending on the job. In fact, a foreign wage that is low relative to American wages is often the basis for their comparative advantage in producing certain goods. Under these innocent circumstances, there is no rational argument for producing those goods at much higher cost in the U.S.
Very troublesome are the national security risks that are sometimes attendant to foreign trade. When dealing with a clear adversary nation, there is no easy “free trade” answer. It is not always clear or agreed, however, when international relations have become truly adversarial, and whether trade can be usefully leveraged in diplomacy.
As I noted earlier, protectionism has appeal from a nationalist perspective, but it is seldom a legitimate form of patriotism. It’s not patriotic to limit the choices and sovereignty of the individual, nor to favor certain firms or workers by shielding them from competition while penalizing firms requiring inputs from abroad. We want our domestic industries to be healthy and competitive. Shielding them from competition is the wrong approach.
So much of the “problem” we have with trade is the infatuation with goals tied to jobs and production. Those things are good, but protectionists focus primarily on first-order effects without considering the damaging second-order consequences. And of course, jobs and production are not the ultimate goals of economic activity. In the end, we engage in economic activity in order to consume. We are a rich nation, and we can afford to consume what we like from abroad. It satisfies wants, it brings market discipline, and it leads to foreign investment in the American economy.
Biden and Trump share the misplaced objectives of mercantilism. They are both salesmen in the end, though with strikingly different personas. Salesmen want to sell, and I’m almost tempted to say that their compulsion causes them see trade as a one-way street. Biden is selling his newest “Buy American” rules not only as patriotic, but as a national security imperative. The former is false and the latter is largely false. In fact, obstructions to trade make us weaker. They will also contribute to our fiscal imbalances, and that contributes to monetary and price instability.
Like “Buy American”, Trump’s tariffs are misguided. Apparently, Trump and other protectionists wish to tax the purchases of foreign goods by American consumers and businesses. In fact, they fail to recognize tariffs as the taxes on Americans that they are! And tariffs represent a pointed invitation to foreign trading partners to impose tariffs of their own on American goods. You really can’t maximize anything by foreclosing opportunities for gain, but that’s what protectionism does. It’s astonishing that such a distorted perspective sells so well.