Drunk On Reason

I will try to keep this post short and to the point. However, brevity often comes with a cost and the cost, in this case, is to gloss over details and forgo certain aspects of the discussion. That being said, I will attempt to cover key elements as well as those that are, to my exasperation, left out of most conversations about tariffs. Keep in mind that the examples used to illustrate points are meant as simplified versions of reality – not the reality itself – to aid us in analyzing this hot topic of the current administration.

Firstly, let’s quickly review what a tariff is. Simply speaking, a tariff is a government-designated amount of money that an importer (someone bringing goods into a country) pays to the government when they bring a product into the country. Take this example:

1. The U.S. government imposes a 30% tariff on all shoes imported from China
2. You are a businessman who imports shoes into the US from China
3. Each pair of shoes costs $30 before the tariff

In the above scenario, you pay $30 for the manufacturing and shipping cost plus $9 (%30 of $30) to the U.S. government for each pair of shoes. So, the total cost comes down to $39 for each pair of shoes imported by you from China to the U.S. That is all a tariff is. Obviously, the higher the rate of tariff, the more it will cost the importer.

Why Do Governments Impose Tariffs?

There are effectively two reasons, one is innocuous and well-intentioned but rather stupid, the other malicious and insidious but longer-lasting. The former reason is to incentivize manufacturing within the country that is imposing tariffs and create more jobs. To demonstrate the logic of this argument, let’s go back to our earlier example but add some conditions to it. In addition to all the points from 1-3, we have:

1. Each pair of identical shoes made in the U.S. costs $35
2. The retail store wishes to make a %20 profit on each pair of shoes sold

Now, without tariffs, each pair of shoes imported from China are sold at $36 ($30 cost of manufacturing and shipping into the U.S. plus $6 of profit). The same pair of shoes made in the U.S. will sell for $42 ($35 cost of manufacturing plus $7 of profit). The end consumer will obviously prefer the cheaper option and buy the pair made in China. But consider what happens when our hypothetical tariffs are taken into account. Now, each pair of Chinese-made shoes costs the end consumer $46.8 ($39 cost of import plus $7.8 profit) whereas a pair of the American-made shoes still costs the same $42, making the American shoes more favourable to the consumers. This will, the proponents of tariffs argue, cause the importers to either abandon or limit importing shoes from China and instead invest in making shoes in the U.S. Brilliant idea right? Not so fast!

Firstly, as the above example shows, the end product ends up being more expensive for the American consumer. This almost always causes at least temporary inflation. If a U.S. made product is cheaper to make, then people would buy it in the first place without a need for tariffs to energize its production. 

Free Trade

Before we proceed further, let me introduce an economic concept called opportunity cost. Opportunity cost refers to when an agent (me and you) engages in an economic activity (e.g., growing tomatoes) which results in him not being able to engage in other activities. Think of it in terms of individuals. Imagine you had to procure all the necessities of your life by producing them yourself. You would have to then grow your own vegetables and fruits (many cannot be grown in the same ecological environment), raise your own cattle and chickens (and/or fish, pigs, etc.), grow cotton and manufacture other clothing materials and then weave and sew your own clothes, find or manufacture the right building materials such as wood, cement, chalk, etc. to create a dwelling for yourself, and protect yourself from threats from nature and man alike. All of this and you would have only managed to live primitively with no access to any of the comforts of the 19th century, let alone the 21st. 

But instead, you strike upon a brilliant idea. You become infatuated with your godlike insight to improve everyone’s life and go to your neighbors to enlighten them about it. Here is the revolutionary idea you stumbled upon: You are very good at growing vegetables, but you are quite clumsy when it comes to everything else. Your animals in the farms mostly fall ill or die and do not produce much milk or meat. Your wood-procuring skills are quite shabby and your clothes barely cover your genitalia since you don’t have the knowledge to grow, sew, or weave anything. But you notice  one of your neighbors who is quite well-dressed but on the verge of death for lack of good nutrition. Another who lives in a solid cabin that can withstand an average storm but his butthole is as exposed to the world as a young man’s heart to his lover (a ghastly scene in your opinion). And another neighbor is a fuckwit by all accounts, no proper house, no proper clothing, not even decent food. He is considered lazy and inept by all. So, you tell your neighbors, what if you, instead of wasting all of your time on accumulating all the necessities of your life, just focused on growing vegetables for everyone and, in exchange, you received adequate clothing from your cloth-savvy neighbor and a well-structured house from your other one. For now, you don’t quite pay attention to your last neighbor. (In fact, even if you were better than your neighbors in all the activities in absolute terms, you would still be better off specializing in growing vegetables and trading with your neighbors for other goods but I will not get into that now)

This creates free trade among all of the neighbors. Each neighbor focuses on what they are good at and they specialize in it. This will, as you can see, result in essentially everyone being better off. By saving valuable time that each neighbor would have to spend on all the other activities to sustain themselves, they can now only allocate time to perfecting what they are good at and as a result, grow higher quality food, weather-oriented clothes, and more durable houses. Now all parties have better food, clothing, and shelter than they did on their own. However, something more interesting starts to happen. Your last neighbor, who all this time had trouble producing anything of value to anyone, wants to join the trade. So, he starts procuring all his necessities through his neighbors. (In exchange, perhaps he engages in prostitution. This hypothetical neighborhood of ours turns out to be pretty progressive). After some time, since our last neighbor has quite a lot of free time on his hands and is quite tired of prostitution (not for any ethical reasons, but perhaps because that might be an uninteresting profession on its own), he starts experimenting with putting wood pieces together. He then is able to make an axle and a wheel alongside a wooden bed to create a rudimentary carriage. As it turns out, our last neighbor was anything but a fuckwit. His talent was simply in making crafts, it was only that he did not have the bandwidth before to engage in such activities. 

We can extrapolate from our example and think of these neighbors as importers and exporters (or as countries). Different countries (and different regions within a country) are skillful at creating different goods and services. By “skillful” I mean more efficient. It means that if India can make a pen and it ends up costing $2 and the same pen manufactured in the U.S. costs $10, then making that pen in America is less efficient than in India. What ends up happening in a free trade world, just like our hypothetical neighborhood, is that countries will export goods and services they are more efficient at producing and import the ones they are less efficient at producing. So, Germany could manufacture and export cars and import pens from India, operating systems from the U.S., and shoes from China. (It is also worth noting that it is not just the monetary cost, but quality that plays a role in efficiency). 

But what happens if a country is not efficient at producing anything in comparison to other countries (it costs more to produce the goods being imported into the country than if they are made at home)? This is the equivalent of our last neighbor. This last neighbor, incidentally, is much like the U.S. and other developed nations. What this will result in is the best thing that has ever befallen on us as a species; innovation. Once your country can procure all its goods and services from outside of the country, it will have no choice but to innovate in order to stay competitive. (If it can’t innovate, then it won’t be able to create jobs. If it can’t create jobs, the labor cost drops and the goods and services become cheaper to make in that country causing it to become more efficient in producing those goods and services. I told you there was a lot more I’d have to gloss over). In fact, this is what exactly has  happened in developed nations like the U.S. Take a look at the largest corporations in America. Companies like Google, Microsoft, Meta, Amazon, and Apple are at the forefront of innovation. What’s more, their U.S. service sector is a lot larger than their U.S. manufacturing sector. This is because America has steadily moved from a manufacturing economy to a service economy. By delegating manufacturing of most of our goods to other countries, just like our last neighbor, we have been able to free up our time, energy, and resources to focus on innovation in the service industry and it has not only created many millions of jobs and entire new industries, but those created jobs have been high-paying, not to mention the mere presence of those high paying jobs will drive up wages for all sectors of the economy. (If more people are driven into high-paying tech jobs for instance, there will be fewer people doing anything else, hence raising wages for everyone). 

What About the Tariffs?

Imagine that our neighbors are sovereign nations again. As you recall, you were the neighbor who was good at growing vegetables. Let’s say you are operating within the U.S. And let’s say your clothes-making neighbor is now operating out of Vietnam. The U.S. government claims that the nation as a whole needs to bring in more jobs into the country so it imposes tariffs on all clothing made in Vietnam so as to make it more expensive to import. But just like our neighbors, what it will do is artificially make manufacturing more inefficient. Now a sector of the economy will have to abandon what it is doing (which almost by definition must be more efficient) in order to make clothes (and be more inefficient). This will force the country to be in a state like our neighborhood where you would not only have to grow your own vegetables which you excel at, but would now have to make clothes which costs you more to make and takes up valuable time that you could have spent growing more or better quality vegetables (opportunity cost) . Furthermore, the new jobs will tend to be low-paying jobs since engaging in less efficient jobs will pay less. Now if the government decides to impose tariffs on virtually all goods and services in order to stimulate fake job growth in the country, then we would end up in a situation like the initial condition of our neighborhood where everything would have to be made at home, something practically ridiculous and economically comical. (Just take a look at “economically independent” nations like Cuba, North Korea, and Iran. Even they are far from anything self-sufficient). 

This is the true damage of tariffs; the immense cost to productivity and innovation. Forcing Americans to produce goods and services they can obtain for cheaper from other nations means forcing software developers and engineers to work in factories for lower wages. Remember that the unemployment rate averages less than 4% in the U.S. and if we create millions of other jobs forcefully because of government meddling in free trade, then in some extreme cases and out of necessity, we would have to relinquish many of our more innovative enterprises so that some moron in Washington D.C. can claim that he made a “wrong” right.

The second reason for tariffs, is corruption. Think of it this way; Imagine you create mattresses in the U.S. You can produce your products quite efficiently and have a decent business, selling each queen-sized mattress at $600. Now, say, a company from Thailand finds an innovative way to manufacture mattresses that ends up costing less. Perhaps the mattresses use special kinds of straw and rubber that the country has an abundance of and can be obtained cheaply. The Thai company is able to sell each mattress at the price of $300. A retail store that used to buy from you, now buys from this Thail company, and the end cost, plus shipping, may be $400 a mattress. Now, the price has dropped and the quality may have increased too. This is clearly good for the consumers but not you. So, since you can’t outperform your new competitor fairly, you lobby the politicians to come to aid with tariffs and couch your demands in populist words like “saving American jobs” and “Independence from foreign products.” (Or if you feel especially cute, you could throw a “these countries are ripping us apart without having to pay for anything” in there too). If you could have your way, the tariffs will be implemented and the consumers will have to pay more for the same (or worse quality) mattresses. What you have done is you have rigged the system and cheated in the free-market. In a truly capitalist society, businesses compete for consumers with their products and services only, not through finding backdoors and asking Big Brother for handouts and favors. 

There is a lot more to be said about tariffs, including how blanket tariffs cause corruption, how with free-trade countries tend to make enough products domestically to maintain a high-employment rate as well as import many goods and services from abroad (regardless of their innovation rate), how trade-deficit is a childish idea to make policies based on, how most monopolies could not last under free-trade, and why free trade almost always leaves everyone better off. I also saved you (and myself) the trouble of going over numerous statistics about how free trade immensely benefits countries involved. There are a myriad of data points out there. Compare countries with more free trade like the EU nations, Singapore, Taiwan, Japan, South Korea, Canada, the U.S., and other nations with the likes of Cuba, North Korea, Iran, India before the 1990s, China before the 1980s, and come to your own conclusions. To be clear, free trade is by no means a panacea for all or even most economic ills but it is quite a powerful tool to drive a country forward.