Montreal, December 2, 2007 • No 244

  

THE RATIONAL ARGUMENTATOR

 

Gennady Stolyarov II is a science fiction novelist and philosophical essayist, and is Editor-in-Chief of The Rational Argumentator. He lives in Chicago.
 
 

WHY TARIFFS HURT DOMESTIC INDUSTRIES*
 

by Gennady Stolyarov II
 

          In reality, so-called “protective” tariffs protect no one. They actually harm the domestic industries that they are intended to help. Indeed, in the long run, everybody loses when the free market is restricted and when individuals and companies are not permitted the liberty to exchange goods and services throughout the world.
 

          Let us consider a hypothetical tariff leveled on, say, steel. The steel industry in the United States might lobby for such a tariff and has done so in the past using the argument that the tariff will protect it from foreign (often state-subsidized) competitors that will “dump” steel on the American market at prices that domestic steel producers can’t possibly match. The tariff, the steel industry representatives might argue, will tax the foreign imports sufficiently to raise their price to a comparable level to the price charged by domestic firms.

          Of course, just implementing and enforcing the tariff and arranging the administrative machinery for it can be sufficiently costly to taxpayers – including the very owners and employees of the firms that lobbied for the tariff – as to outweigh any possible benefits. But let us assume that the tariff has been successfully put into place and has raised the price that Americans pay for imported steel. What happens then? And who are some of the American consumers that must now pay higher prices?

          It turns out that the steel tariff would raise costs for American domestic firms – particularly those that use steel as an input. Manufacturers of automobiles, industrial equipment, tools, building materials, and many other products would be faced with far smaller profits – just because the tariff has raised their input costs. Thus, these firms become less competitive relative to other firms abroad that might not have to deal with the same artificially high steel prices. The government-imposed steel tariff actually hampers the profitability and competitiveness of many more domestic industries than it helps.

          Consider how these firms might respond to an opportunity to move their operations abroad where steel tariffs are lower or don’t exist. Surely, such an action would lower their input costs and enable them to function more effectively. Tariffs imposed to “protect” domestic firms actually give many domestic firms a strong incentive to move outside the country!

          But even the steel industry would lose in the long run due to steel tariffs. On the face of it, it might seem that the steel industry has been benefited by the “protection” from competition that the tariffs afford. But consider what it takes to produce steel in mass. A steel manufacturer would need to own a lot of specialized machines that include components made of… you guessed it – steel! By hurting the domestic industries that use steel as an input, steel tariffs make it less likely for those firms to develop new products that make it easier and less costly to manufacture steel! Thus, the domestic steel industry is deprived of the ability to benefit from innovations that would have occurred in the absence of the tariff.
 

"Instead of supporting measures that achieve the opposite of their intended effects, why not abolish all “protective” tariffs, give temporary aid to any workers who lose their jobs as a result, and let domestic industries restructure themselves to become as productive and efficient as they possibly can be in free and open competition?"


          Furthermore, the tariff gives the domestic steel industry an effective guarantee of certain levels of revenue – at least in the short run. The steel industry will receive this revenue irrespective of what it does and of whether it innovates or stagnates, cuts costs or decides to leave them as they are. With the artificially high barriers to entry created by the steel tariffs, there exist tremendous incentives for what economists call X-inefficiency – the tendency of firm managers to slack off in their efforts to maximize profit and instead try to lead an easier life by relying on the guarantees of protection offered by the government’s tariff. The result of X-inefficiency will be that the domestic steel firms’ cost structures will actually drift upward over time, leading them to lose any productive edge they might have had. Indeed, all historical evidence shows that industries can seldom, if ever, be “weaned off” of government protection once it starts. Rather, inefficiencies take hold that permanently cripple the “protected” industry’s ability to compete with foreign producers or domestic producers whom the government does not aid.

          Now let us assume the worst-case scenario offered by advocates of “protective” tariffs. That is, let us say that a domestic industry is entirely driven out of business by competition abroad. On net, even this change would be beneficial to domestic industries in general, and even, in the long run, to the specific workers displaced by the decline of one particular industry.

          If it is truly the case that a certain firm or industry has been displaced by free, open competition, then this means that another firm or industry has a comparative advantage over the displaced competitor. If the firm with a comparative advantage in producing product A focuses on producing just A while the displaced competitor – who might have a comparative advantage in producing B instead – focuses on producing just B, a mathematical analysis can show that both firms can be made better off than if this specialization did not take place. Furthermore, this can still be the case when one competitor has an absolute advantage over the other in all areas. So even if a foreign firm F can produce both goods A and B at lower cost than a domestic firm D, it would still be advantageous for F to specialize in producing A and D to specialize in producing B, so long as F can produce A more effectively than it can produce B.

          So a displaced domestic industry needs only to shift its focus on producing something else. Once the shift is in place and the workers and managers have been re-trained, everyone is better off than they would have been if the tariff had remained in place. There is no need to fear for the fate of the displaced workers during the transition, as it is possible to give such workers aid in place of the tariff. Many economic analyses have shown that an outright cash grant of several hundred thousand dollars to each displaced worker would generate less overall economic waste than maintaining any given protective tariff.

          So instead of supporting measures that achieve the opposite of their intended effects, why not abolish all “protective” tariffs, give temporary aid to any workers who lose their jobs as a result, and let domestic industries restructure themselves to become as productive and efficient as they possibly can be in free and open competition? Everybody – both in the United States and abroad – will be better off as a result.

 

* This article was originally published on GrasstopsUSA.com.
 

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