BUILDING TRADE WALLS: Holding China at Bay?

Trade is the mother of money. ~ Thomas Draxe (1613) 

Unfettered production and consumption of foreign-made goods – aka, “free-trade” – is so old school. Just ask Donald Trump.

Should we hop back to the old days of high tariffs, big customs duties and large quotas on foreign imports to make our country great again? Should we remember what the world was like after our Congress passed the Smoot-Hawley Tariff Act in 1930? Here’s a hint, it wasn’t that good.

Most economists and historians agree this Act, which significantly raised US tariffs to a level not seen in over the previous century on more than 20,000 types of imported goods, not only exacerbated the Great Depression but harmed the public’s economic prosperity due to higher prices. The Smoot-Hawley tariffs were ignominiously rescinded within five years after our major trading partners retaliated with their own increased tariffs on US exports.

But here we are with a president who is ready to roll the free-trade clock backwards by building “protective” tariff walls, not just his physical wall across our Mexican border.

International trade has been a quarrelsome series of policy debates (and much more) for at least the past 250 years. From an economic perspective, these disputes were formalized when Adam Smith stated in 1776 that free trade (trade not encumbered by tariffs or other protective barriers) was the basis of the wealth of nations. In the early 19th century David Ricardo, another British political economist, provided a notional rationale – his theory of comparative advantage – for determining which goods and services should be produced (and traded) to allow each trading nation to benefit from the trading. Unsurprisingly, these debates have continued and, as trade has greatly expanded, have become more consequential.

In our current age of globalization, there's a lot of international trade. It can be argued that the first "early modern age of globalization" in the West began in the 17th and 18th centuries (although inter-regional trade occurred since ancient times) with the development of the Portuguese, Spanish, Dutch and British empires. This early globalization certainly gained importance with the resultant increase in international trade, although its benefits were exclusively realized by the conquering Europeans.

Since the end of World War II the doctrine of trade liberalization – lowering or eliminating import tariffs, quotas and subsidies – has been publicly praised and followed by the majority of (already-developed) Western nations. These nations, with the strong support of many economists, have genuflected at the altar of free-trade. The creation of the World Bank, the International Monetary Fund and the General Agreement on Tariffs and Trade (the predecessor of the World Trade Organization - WTO) by 1950 was predicated on expanding post-war international free-trade across the planet. Virtually all contemporary nations have comported with this vision – that freer trade benefits everyone.

The WTO states that total world merchandise exports were $16.0 trillion in 2016, more than a 150% increase since 2000. The WTO now has 159 member countries, with 24 countries negotiating their WTO membership.

For more than 60 years US exports and imports have followed a bumpy but long-term increase as a share of our real (inflation-adjusted) GDP. This increase has happened as tariffs have been reduced and overall trade has grown.

The US and China are now the world’s largest traders. US exports represented 11.9% of our 2016 GDP, $1.45 trillion (T). Chinese exports represented 19.6% of its 2016 GDP, $2.10T. Germany wears the crown as the most intensive trading nation because its sizeable exports (ranked third-highest) represent an amazing 46.1% of its GDP. That’s a lot of Porsches, BMWs and Mercedes.

Let’s now consider China, the world’s largest exporting nation and Mr. Trump’s proclaimed nemesis. One analyst diplomatically characterizes the shifting US international trade priorities as a “protectionist crouch.” Others perceive it as a retreat from the leadership the US has provided for decades in the international economic community. Predictably, China sees Trump’s change in US policy as an opportunity and is very willing to assume more leadership in the world economy. Beijing is presenting itself as a benign alternative to the US in the international policy sphere. China’s rising geo-political influence has been caused by several reasons; the largest is its export-driven economic growth. Mr. Trump’s priority of building tariff walls specifically to protect domestic manufacturing jobs is simply policy icing on China’s expanding geo-political cake. For perspective, just 7.7% of the US labor force was in manufacturing in 2016.

China’s growth from a poor, “lesser-developed country” 40 years ago began when Deng Xiaoping took power in 1978 and instituted significant economic reforms. China’s much heralded growth and development has been founded on government-led economic planning, large state-owned and subsidized enterprises in strategic industries, direct state control of capital markets, restrictive rules for any foreign manufacturer wanting to operate in China, and little concern for the traditional guidelines of free trade. Despite such centralized planning and obstructive trade policies, China gained membership into the WTO in 2001. China’s growth hasn’t relied very much on Adam Smith’s “invisible hand” of competitive market forces for its economic progress; it’s a centrally-planned economy with a dose of market interaction around the edges. The Communist Party of China describes its economic system as a “socialist market economy.”

China’s development into a more modern, industrialized economy via restrictive, non-free trade policy has an interesting parallel in US history. This history exposes the myth that we have always practiced free-trade throughout our economic development.

Several years after winning the Revolutionary War and freed from British control, Alexander Hamilton successfully argued before the first US Congress that our new nation should be protected from established, more developed countries like Britain, France and Spain. He coined the compelling phrase “infant industries” to claim that strong tariff protection was needed for our new nation. Congress agreed with his request. Domestic industries that benefited from tariff security included textiles and iron, and later steel. Some specialists believe this early, vigorous trade protectionism of our nascent industries allowed the American economy to be one of the fastest growing throughout the 19th century and into the early 20th century.

With this trade protection, revenues from US tariffs (also called customs duties) were a very large part of the federal government’s total revenues for over a century. Using high tariffs thus served two purposes, they helped protect our infant industries from foreign imports and they provided revenue to our federal government. It wasn’t until the 1913 passage of the 16th Amendment which legalized the federal government’s use of a personal and corporate income tax that customs duties’ fiscal importance began to wither.

The table below shows that customs duties accounted for at least 81% of the government’s total direct revenues from 1792 through 1850. Even in 1900, more than 100 years after protectionist tariffs were initiated by our government, customs duties accounted for over one-third of the government’s revenue. Notice the significant bump in federal customs duty revenues in 1930 because of passage of the Smoot-Hawley Tariff Act.

US Federal Government Revenue, 1792-1950 (millions $)

Year	Customs Duties & Fee Revenue	Total Direct Revenue (TDR)	Customs Duties Percent of TDR
1950	$407.0	$39,443.0	1%
1930*	$561.0	$4,830.2	12%
1920	$294.2	$7,380.4	4%
1900	$238.2	$669.6	35%
1850	$39.7	$49.1	81%
1800	$9.1	$11.1	82%
1792	$3.4	$3.7	92%

Source: usgovernmentrevenue.com *Smoot-Hawley Tariff Act passed.

Trade protectionism was very much alive and well during the initial industrialized growth of the US in the late 18th and the 19th century. This long period of US non-free trade policy is forgotten by most modern economists and politicians. Why should they remember; it’s now the age of globalization.

Many people say that the development of the US into the world’s macroeconomic power was because of a straight free-trade hit. But it’s not a hit, it’s a myth. It’s a myth that we’ve always used free-trade policies to achieve our greatness. We didn’t, as explained above. Ah, what a difference a century or so of growth based on protective “infant industries” tariffs followed by decades of freer-trade as a fully-developed nation makes.

For the past 65 years the US and many other nations have largely adhered to the free-trade faith of reducing tariffs on many goods and services. Significant and broadly beneficial bilateral and multilateral trade agreements have been implemented by the US with other trading partners. US free trade agreements include 20 bilateral free-trade agreements, the Tokyo Round, the Uruguay Round and the North American Free Trade Agreement (NAFTA). That is not to say that the US, or any nation, allows all foreign products to be imported with no tariff. Nope. The US International Trade Commission states that many agricultural products like sugar, cotton and vegetables, as well as live foxes, umbrellas, and nuclear reactors are subject to import tariffs.

It’s a different world now. Or is it? Is our blinkered, zero-sum micro-man leader Donald Trump returning to our forgotten olden days of uniformly high tariffs to battle specifically with China on the international trade stage? It seems so.

China has the second largest GDP in the world and, like the US, is a member of the Group of Twenty (G-20) nations. Nevertheless, its GDP per capita is $8,123 and not high enough to be ranked in the top 50 nations. Its investment- and export-led economic growth over the past 30 years has been impressive. Equally notable, the Chinese government had extensively raised literacy and life-expectancy levels, and reduced poverty. In 2017 its GDP growth slowed to 6.5%, the 16th highest in the world according to the World Bank. The US GDP growth for the last quarter of 2017 was 2.6%, less than half the Chinese growth rate.

As a candidate, Mr. Trump denounced the “false song of globalism.” In his first week as president, he canceled US participation in the Trans-Pacific Partnership (TPP), a large regional trade deal with Japan, New Zealand and nine other pacific-rim countries that was initiated in 2005 to contain China. Mr. Trump has publically criticized Canada, China, Germany, Mexico and South Korea for exporting more to the US than they import from us. He is renegotiating trade pacts with Canada, Mexico and Europe to get a better deal for American workers. Mr. Trump has expressed a strong preference for bilateral trade agreements rather than larger, multilateral ones like NAFTA and the TPP.

Last month his administration decided to impose tariffs on imported washing machines and solar cells and modules from China, Malaysia and South Korea to help domestic firms’ workers. The tariffs’ overall effect on the US solar power industry will be to raise consumer prices of solar panels and also reduce employment by thousands of US workers. Also, the Trump administration started an investigation into claims that China has infringed on American intellectual property that could occasion investment restrictions or further tariffs.

On February 16, the Commerce Department recommended that the president impose substantial tariffs or quotas on imported steel and aluminum from China, Brazil, India, Hong Kong, Russia, South Korea, Venezuela and Vietnam to save American jobs. US auto makers complained that such trade restrictions will increase their costs and raise vehicle prices.

Mr. Trump dismissed objections to these trade measures, saying that the United States was considering tariffs, quotas or both. “You may have a higher price, but you have jobs.”

This quote typifies the president’s myopic view of raising tariffs on specific goods. The consequent price increases will directly affect millions of consumers (in this case of steel- and aluminum-using products like cars and trucks); the possible benefits are aimed at far, far fewer workers. Mr. Trump’s interest in building tariff walls scorns the historically high likelihood of other nations retaliating against these US tariffs with ones of their own, and filing formal complaints before the WTO.

In fact, America’s direct options for punishing China’s huge, worldwide increase in steel and aluminum exports are fairly limited. Why? Because the Obama administration already imposed a series of restrictions on Chinese steel imports in previous years; only 2% of American steel imports came straight from China in 2015. So, it may be media-worthy politics that possibly saves jobs (depending on how they’re counted), but ultimately it’s bad economics for consumers as prices will rise.

Protectionist tariffs certainly can serve useful economic purposes for developing nations, as they did for infant industries in the US well over a century and a half ago, and as they have more recently for Japan, South Korea and other Asian Tiger nations. But it’s been a very long time since we’ve been a nation of infant industries, despite the claims of domestic manufacturers. Erecting high tariffs to shield established industries (like US aluminum, steel, consumer appliances and agricultural products) in already-developed countries like ours at best only provides narrow, micro benefits and causes economic pain for the general consuming public.

Politically, the President’s retreat from our nation’s half-century record of trade liberalization seems to have boomeranged internationally and instead has provided China with an opening to fill the policy vacuum Mr. Trump created. Perhaps he recognized his mistake in building new trade walls – a very faint hope –when he offered a slightly different tune about trade at the January 26 Davos meeting saying, “America first does not mean America alone” and “America is open for business.” Did the listeners believe him? Doubtful, very doubtful. Just ask the Chinese, Canadian, Mexican and South Korean leaders whose businesses will be subject to higher US tariffs.

Mr. Trump’s foray into the dark, high-tariff past may provide ephemeral, slender benefits that will be paid by the consuming public’s much broader pain from higher-prices. If, somehow, we millions of consumers were to gain influence comparable to that of far narrower private interests, public decision-makers like our occluded president might support of our interests of broad choices and fair, low prices. Politicians like Mr. Trump always support these consumer interests in their campaign speeches but disdain them once elected to office. That’s why Thomas Draxe’s 405-year old quote remains relevant.