Monday, March 5, 2018

When Tariffs Made Us Prosperous

By all appearances, the sky will soon be falling because President Trump has decided to impose a 10% tariff on aluminum and a 25% tariff on steel. [1] Whether those turn out to be the right percentages on the right items, time will tell. Your humble servant will abstain from prognostication, since the success of the plan will depend on a variety of factors to which one hopes the administration has applied the proper level of analysis.

But much of the objection to the plan is that it will interfere with the sacrosanct “free trade,” that has become the chief deity of the neo-classical economics pantheon. “Central to the neoliberal discourse on globalization is the conviction that free trade, more than free movements of capital or labor, is the key to global prosperity.” [2]

Alexander Hamilton
Advocates of this so-called “free trade” insist that “that history is on their side. After all, the defenders of free trade ask, isn’t free trade how all the world’s developed countries have become rich?”  

But as University of Cambridge economist Ha-Joon Chang points out, the actual history of capitalism yields a different picture. The truth is,

“…when they were developing countries themselves, virtually all of today’s developed countries did not practice free trade (and laissez-faire industrial policy as its domestic counterpart). Rather, they promoted their national industries through tariffs, subsidies, and other measures. Particularly notable is the fact that the gap between ‘real’ and ‘imagined’ histories of trade policy is the greatest in relation to Britain and the United States, which are conventionally believed to have reached the top of the world’s economic hierarchy by adopting free trade when other countries were stuck with outdated mercantilist policies. These two countries were, in fact, often the pioneers and frequently the most ardent users of interventionist trade and industrial policy measures in their early stages of development.”

Henry Clay
The history of the United States in this regard is particularly instructive. On December 5, 1791, the first U.S. treasury secretary, Alexander Hamilton, presented his Report on Manufactures [3] to the House of Representatives, wherein he argued for the development of manufacturing in the new nation. His recommendations would sound strange to those of us accustomed to hearing free trade advocated as the only sound way to prosperity. Specifically, those recommendations were: (1) protective duties on manufactured goods that could compete with domestic manufactures; (2) prohibitions on the import of manufactured goods also produced in the United States, provided there was sufficient domestic competition for the goods in question; (3) in rare cases, prohibiting the export of materials used in manufacturing to lessen their demand and keep their prices low; (4) subsidies to manufacturing concerns; (5) premiums in a small number of cases “to reward some particular excellence or superiority,” or “some extraordinary exertion or skill” in manufacturing; (6) exemption of some materials used in manufacturing from the imposition of duties; (7) imposing duties on the import of certain materials, for specific reasons, such as the existence of an abundant supply domestically; (8) extension of the same benefits to those who make improvements on inventions as to the inventors themselves; (9) inspection regulations to improve and maintain the quality of manufactured goods; (10) the introduction of bills of exchange which would be made negotiable throughout the United States, and (11) facilitation of the transport of commodities by means of infrastructure improvements. Certainly, Alexander Hamilton was no proponent of free trade.

While Congress did not adopt Hamilton’s idea of subsidies, it did adopt most of his proposal for tariffs. [4] The tariffs themselves were actually moderate. Hamilton didn’t want the tariffs to be so high that it would adversely impact the revenue to be derived from them. Thus, certain protectionist interests switched their allegiance from Hamilton’s Federalists to Jefferson’s Republicans. It seems that free trade ideology was in short supply during the first years of our republic.

Hamilton’s program “was developed in the next generation by Henry Clay, under the name of ‘the American System,’ and implemented under Clay’s disciple and admirer Abraham Lincoln and his successors during the period between the 1860s and the 1940s, when the US became the planet’s leading manufacturing economy behind a high wall of tariffs.” [5]

Friedrich List
“Henry Clay’s ‘American System,’ devised in the burst of nationalism that followed the War of 1812, remains one of the most historically significant examples of a government-sponsored program to harmonize and balance the nation’s agriculture, commerce, and industry. This ‘System’ consisted of three mutually reenforcing parts: a tariff to protect and promote American industry; a national bank to foster commerce; and federal subsidies for roads, canals, and other ‘internal improvements’ to develop profitable markets for agriculture. Funds for these subsidies would be obtained from tariffs and sales of public lands. Clay argued that a vigorously maintained system of sectional economic interdependence would eliminate the chance of renewed subservience to the free-trade, laissez-faire ‘British System.’” [6]

That free-trade British System came into being only when Britain’s international edge in technology allowed it. [7] Still, even with its technological lead, Britain had “policies of industrial promotion until the mid-nineteenth century,” and “had very high tariffs on manufacturing products even as late as the 1820s, some two generations after the start of its Industrial Revolution.” It “was only after 1860 that most tariffs were abolished.” But this policy couldn’t last for long. Its era of free trade came to an end “when Britain finally acknowledged that it had lost its manufacturing eminence and re-introduced tariffs on a large scale in 1932.”

The history of the United States is similar. As Ha-Joon Chang tells us, “It was only after the Second World War, with its industrial supremacy unchallenged, that the U.S. liberalized its trade (although not as unequivocally as Britain did in the mid-nineteenth century) and started championing the cause of free trade….”

But why would a country champion the cause of free trade, when it is clear that it achieved its industrial ascendancy by other means? Dr. Chang quotes the nineteenth century German economist Friedrich List for the answer:

Adam Smith
“‘It is a very common clever device that when anyone has attained the summit of greatness, he kicks away the ladder by which he has climbed up, in order to deprive others of the means of climbing up after him. In this lies the secret of the cosmopolitical doctrine of Adam Smith, and of the cosmopolitical tendencies of his great contemporary William Pitt, and of all his successors in the British Government administrations.

“‘Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her, can do nothing wiser than to throw away these ladders of her greatness, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths of error, and has now for the first time succeeded in discovering the truth.’” 

Of course, instead of hand-wringing about the error of previous protectionist policies, it is, perhaps, even more effective to simply engage in revisionist history, and claim that American economic success was born of a free trade policy from the beginning. The maxim of too many nowadays is: if the truth doesn’t support your case, lie.

Unfortunately, the United States has lost the industrial dominance that it had right after World War II, and we have begun to see some of the ill effects of the free trade dogma. The North American Free Trade Agreement (NAFTA), for example, according to the Economic Policy Institute, a think tank affiliated with organized labor, “caused the loss of some 700,000 jobs as production moved to Mexico.” [8]

“Second, NAFTA strengthened the ability of U.S. employers to force workers to accept lower wages and benefits. As soon as NAFTA became law, corporate managers began telling their workers that their companies intended to move to Mexico unless the workers lowered the cost of their labor. In the midst of collective bargaining negotiations with unions, some companies would even start loading machinery into trucks that they said were bound for Mexico. The same threats were used to fight union organizing efforts. The message was: ‘If you vote in a union, we will move south of the border.’”

Whether the tariffs proposed by Trump will do more harm than good remains to be seen. Protecting one industry while subjecting others to the high winds of free trade can make matters worse for the unprotected companies, particularly those being supplied by the protected companies. The tariffs that have worked for the United States in the past have reflected a more across-the-board approach.

But let us have none of this nonsense that a free trade policy is necessary for American prosperity. History reveals that such is not the case.