The Nationalist Case Against (Most) Tariffs

President Trump has promised to impose broad-based tariffs as a centerpiece of his second-term economic agenda. Tariffs can indeed be useful in countering economic abuses and advancing foreign policy priorities. However, if Trump goes through with imposing broad-based tariffs for his stated purposes of collecting revenue, stimulating industry, and eliminating the “trade deficit,” they will more likely result in economic contraction, geopolitical reversal, and political defeat than prosperity. Instead of pursuing protectionism, Trump should reform and expand the American network of free trade agreements to advance our economic and geopolitical interests.

I. Six Reasons for Tariffs

The basic rule of thumb is that tariffs harm countries imposing them since, like their citizens, nations are enriched by “buying low and selling high” on the global market. As Milton Friedman put it, tariffs are self-imposed economic sanctions. Nevertheless, there are six valid reasons that a country may choose to impose tariffs.

The first is to collect tax revenue. However, due to the option of buying domestic (albeit at a higher price), tariff receipts have never exceeded 3% of GDP, even during episodes in which imports were taxed at a 60% average rate; during the Gilded Age, the tariff usually raised 1-2% of GDP, a sum dwarfed by state and local property taxes. No modern government could rely on tariffs; even a minarchist state would need a broad-based domestic tax (such as an income tax or value-added tax) to maintain a competitive military. Therefore, the relevant question is not whether tariffs can replace the income tax, but whether they are more or less harmful on the margin. Given the tariff’s narrow and elastic base, which necessitates higher tax rates and more severe economic dislocation for each additional dollar raised than a typical income or (better) consumption tax, it will usually fail on this score.

A second reason, recognized by Adam Smith, is to ensure the domestic availability of supplies vital for national autonomy (that said, this can often also be accomplished through other means like subsidies and stockpiling). However, foreign policy does not always favor protectionism; for instance, free trade within a geopolitical bloc can promote strategic industries and allow a nation to leverage the labor and resources of its allies without requiring socially and politically-divisive mass migration. Furthermore, market access can be used a carrot to build geopolitical as well as economic ties. Even between hostile states, trade in (non-critical) goods might dissuade aggression by increasing the costs of conflict. In the present context, these principles suggest that the US should strongly favor economic integration within our core geopolitical sphere of influence (ie. NAFTA and CAFTA), and secondarily seek trade liberalization with current and potential allies throughout the world, while reducing reliance on Chinese supplies. Even for China and Russia etc., without a regime-change policy (in my view highly inadvisable), there is a strong case for relaxing tariffs on non-critical goods as a carrot for arms-control agreements and other deals to reduce the risk of hot war.

A third reason is retaliation against other countries for their trade barriers or other abuses, such as intellectual property theft and free-riding on “global public goods.” Although the general rule is that tariffs chiefly harm the country imposing them, a moderate import or export tax imposed by a country with market power in the import or export markets respectively of a good can, in the absence of retaliation by its similarly or more powerful trade partners, reduce the price of its imports and raise the price of its exports without choking off trade, on net benefitting that country. Retaliatory tariffs can be used to neutralize any such advantages that other major countries or blocs might gain from protectionism, and secure reciprocal free trade. Retaliation can be useful even when other countries impose tariffs that harm their own citizens in aggregate on behalf of a particular industry, since it can activate a countervailing political interest among that country’s exporters. Finally, a nation large enough to have substantial market power may also be a natural candidate to sponsor global or regional public goods such as collective security, environmental protection, and scientific research, and such a country could impose tariffs to induce its satellites to cooperate in or at least financially support its provision of these goods. In this vein, Trump could impose tariffs to not only secure trade reciprocity but also advance American interests on issues such as controlling migration, securing intellectual property and environmental protection to level the playing field, and ensuring military burden-sharing by allies.

A fourth reason is to counter “dumping,” or predatory pricing by foreign companies (especially when backed by direct or indirect subsidies) trying to attain a monopoly by destroying or deterring domestic competitors. This is a legitimate concern, although “dumping” (defined as foreign firms exporting below either their cost or home-market price) is not always problematic, since consumers can benefit from foreign firms’ miscalculations of demand or loss-leading to expand brand visibility when this does not threaten the viability of competition. That said, conceptually this issue falls under antitrust law more than trade policy per se.

A fifth reason is to promote long-term economic development. As articulated by Alexander Gershenkron and Albert Hirschman (echoing arguments going back to Alexander Hamilton and Friedrich List), if an industry, or ecosystem with multiple synergistic industries, is characterized by rising returns to scale and experience, and capital markets are too shallow or fragmented to provide the requisite patient capital, state intervention can potentially help it attain maturity and global competitiveness. Of course, for this strategy to potentially work, a country must have the institutions, policies, natural resources, and human capital required for a comparative advantage in the targeted industry. Such strong fundamentals helped to minimize the costs and maximize the benefits of tariffs in the Gilded Age, even though they were designed to serve political as much as economic priorities (as is evident in their focus on the less dynamic wool and textile sectors) and rapid growth under moderate tariffs in the 1840s and 1850s suggests that industrial policy was not necessary or beneficial on net. Although the “Infant Industry” or “Big Push” or “Linkages” argument may be valid in principle, in practice there’s good reason to question whether politicians will allocate capital better than even imperfect capital markets, both because of the susceptibility of government programs to bureaucratic and clientelistic waste and abuse and because the private sector attracts far more right-tail talent, especially in America.

Finally, tariffs may advance social objectives. A common example is protecting agriculture for cultural and aesthetic as well as security reasons (as such, ending agricultural protectionism should not necessarily be a condition to free trade in less politically-sensitive sectors). The Stolper-Samuelson theorem also implies that the net effect of global integration with the developing world may be to reduce American unskilled wages, even if returns to other Americans’ skills increase much more. However, while ensuring generally Pareto-optimal long-term benefits from trade or new technology may be imperative for a liberal-republican nation-state, tariffs are usually not the best tool to achieve this; the most effective way to help working-class families would be to cut their taxes, both directly and by reducing taxes on capital investment (which are heavily factored into wages in an internationally-mobile capital market), paid for by taxing a portion of the winners’ surplus from globalization.

In the present American context, the strongest reasons to impose tariffs are the second and third, ie. geopolitics and negotiating expansions of mutual free trade. In my view, the most promising policies would be a new Trans-Pacific Partnership to pry Southeast Asia away from China’s sphere of influence, and a Western Hemisphere free trade agreement that could also elbow out China while addressing issues like migration and drug smuggling. Furthermore, a renegotiated NAFTA could require free speech and media competition to reduce the influence of Canada’s Liberal-aligned CBC (indicated by the age gap in pre-tariff Canadian anti-Trump sentiment), possibly laying the groundwork for Canada’s annexation as political cultures converge over the long-run. That said, although Trump has effectively used the threat of tariffs against Colombia over migration, his disproportionate threats against Canada seem to have backfired on his ambition for ultimate annexation, and undermining the USMCA trade deal that he negotiated during his first term may well harm US credibility in building economic and military partnerships to compete with China.

II. The “Balanced Trade” Fallacy

A commonly-invoked objective that I did not include in this list is reducing the trade or current account (a measure that includes net receipts from foreign investments and services as well as goods) deficit, one of Trump’s stated policy goals. The first reason for this omission is that tariffs are very ineffective for this purpose, since the current account balance is not primarily driven by trade policy, but rather a nation’s sum of consumption and investment (ie. purchase of capital goods such as machinery and building materials) relative to annual production. Tariffs, by reducing the quantity of foreign currency being acquired to buy imported goods, lead ceteris paribus to a strengthening of the dollar, making exports less competitive, ultimately contracting both imports and exports, and not necessarily affecting the trade balance at all; this effect also exists in a single-currency zone, through the mechanism of higher demand for domestic products raising the price level and exporters’ costs. Ultimately, a tariff can only “achieve” a trade balance if it’s set at a level that de facto bans foreign trade and investment.

The second reason is that a trade deficit is not necessarily harmful. For instance, a trade deficit can result from foreign net investment earnings being used to pay for imported goods, an enviable situation, while a trade surplus might result from having to use export earnings to pay foreign creditors (why the current account balance is a better metric than the trade deficit per se). In turn, a current account deficit can result from positive trends, such as a growing economy driving comparatively high investment returns, or negative ones, such as wasteful government spending or emergency crisis borrowing (or all of these, such as in Trump’s first term). Similarly, a current-account surplus can result from a temporary export boom, public frugality, or a dearth of domestic investment opportunities (or all of these factors, such as in Germany since the Millennium, although only the latter two still remain today).

In fact, the basic principle that, ceteris paribus, people will smooth consumption over their (and their children’s) lifetimes, spending against future windfalls or saving for a rainy day, implies that a current account deficit reflects a better economic outlook. This is consistent with the relatively strong performance of the US economy, asset markets (especially technology stocks founded on America’s agglomeration of right-tail talent and relatively pro-entrepreneurial legal framework), and fertility rate compared to the capital-exporting European and Japanese economies. To the extent that our current account deficit has been harmful, it is because it has been partly fueled by wasteful federal spending (with the bias of the tax code against savings reducing compensatory saving to offset higher future taxes per “Ricardian equivalence”); correcting this, rather than levying tariffs a la King Canute vs. the tides, is how Trump could reduce the trade deficit.

Nevertheless, while a current account deficit is far from being inherently harmful, there are certain situations in which capital controls (such as Chile’s encaje system) are warranted to curb it. In particular, flows of volatile foreign “hot money” in the form of short-term debt may increase the vulnerability of a country’s (and the world’s) financial system while imposing currency-driven volatility on liquidity-constrained export businesses. This is the reason that China, following the hot-money-driven 1997 financial crisis in Southeast Asia, maintained capital controls to build up its foreign currency reserves, although it is unclear at best that the yuan is still undervalued. While China’s growth has been impressive (in my view a phenomenon of partial convergence to other East Asian countries with similar human capital), this policy in its full rigor was likely harmful on net, by forcing Chinese savings into low (or even negative) real-yield US assets subject to ongoing political risk instead of both higher-yielding domestic private investment and higher consumption. However, since foreign demand for American assets is relatively stable (partly due to a preference for running international trade through the US financial and legal system), and positively correlated to global market volatility per the “flight to safety” phenomenon, there is little reason for the US to impose capital controls for the sake of economic stability.

Imposing a weak dollar to support American industry would also be perverse; a strong dollar provides Americans with more purchasing power, so trying to increase living standards by making domestic industry more competitive through devaluation would patently be putting the cart before the horse. Furthermore, restricting capital inflows to suppress the dollar would also directly frustrate Trump’s core political imperatives of reducing interest rates and rents. Discouraging foreigners from holding American assets for transactions would also weaken a central tool of US foreign policy leverage. In short, a weak-dollar policy would go directly against “making America great again.”

III. “Exorbitant Privilege” vs. the “Triffin Dilemma”

As noted previously, the dollar, in the form of dollar notes and transaction accounts and other liquid financial instruments furnished by the American financial system and protected by the US legal system and military, is the main medium of global trade. Foreign holdings of banknotes are de facto tribute to the US Treasury in the form of negative-real-yield loans, while holdings of American assets lower the interest rates payable by American borrowers (and also may pay US withholding tax, depending on the applicable reciprocal tax treaty). This permits America to “borrow short and lend long,” our “exorbitant privilege” per the French statesman Valery Giscard d’Estaing, allowing us to boost both our consumption and investment (ie. future consumption), increasing our current account deficit. This unique ability can be seen as a fitting complement to our central role in providing trade-facilitating global public goods, such as safe sea-lanes.

One critique of this status quo, voiced by Trump’s economic advisor Stephen Miran, is based on the so-called “Triffin Dilemma” postulated by the economist Robert Triffin, a scenario in which the country supplying the medium for international trade inevitably becomes unsustainably indebted, leading to a run on the currency. However, the performance of the American economy and investment returns relative to the modest yields payable on US liquid liabilities undermines the notion that our current account deficits are unsustainable, especially after deducting the portion attributable to the federal budget deficit, which Congress could eliminate at any time. That the US still receives “flights to safety” financial inflows, and even still runs a surplus in net foreign investment income, suggests that “exorbitant privilege” is a more accurate description of America’s position than the “Triffin Dilemma.”

While I find the “Triffin Dilemma” unconvincing as a real dilemma for contemporary America, I should note that there is a theoretical scenario in which it could apply. This is the so-called “Dutch Disease” (usually caused by natural resource booms) in which a country that temporarily becomes the provider of the reserve currency and thereby over-develops its financial and service sectors may have been better off in the long-run building experience in other export sectors. Belle époque Britain, in which right-tail talent often favored international finance and imperial administration over industry, may have suffered from “Dutch Disease” in retrospect. However, the City of London lost its prime position due to the economic and geopolitical consequences of two World Wars and a domestic move towards interventionism and socialism, not an inevitable “Triffin Dilemma.” The reserve currency, which assists in financing the American military and increases the cost of hostile aggression, while supporting a high domestic standard of living and economic growth, could help us avoid this fate.

III. Conclusion

In today’s political context, protectionism is often associated with the rise of movements that aim to restore national sovereignty. This association is proper to the extent that a rejection of the “End of History” demands that economic policy ultimately be subordinated to statesmanship. However, the principle of comparative advantage should also have strong appeal to nationalists who recognize the deep foundations of cultural diversity and associated economic specialization. By expanding our free-trade network in concert with domestic deregulation, we can exploit our national edge in energy and globally-competitive manufacturing that incorporates the most advanced inputs as well as in finance and software, while accessing the capital and resources necessary to create millions of blue-collar jobs expanding our infrastructure and urbanism. Furthermore, expanding trade and investment within our sphere of influence would allow us to geopolitically leverage the resources, labor, and skills of other nations against China. If Trump uses tariffs to advance such a vision, rather than chasing the chimera of “balanced trade” or trying to build up uncompetitive industries incompatible with maintaining our high standard of living, then his trade policy can help to “make America great again.”