Tariff Fantasy

Tariffs are in the air, but like many policies just what they do depends crucially on how they are implemented.

Suppose I were put in charge of implementing a president’s desire for broad tariffs, and I could not just say “don’t do it.” What would I do to implement that desire in the most effective and least damaging way?

First, tariffs are an answer. What’s the question? National security? Increase manufacturing employment? Use our pricing power to make the US better off at the expense of our trading partners? Each one recommends a different strategy, and often a different answer. Policy should not be answers in search of questions.

It doesn’t make sense to charge a tariff on a good that a US business will quickly re-export. Say a shop imports cars from Canada, paints them, then sends them back to Canada. It doesn’t make sense to charge a huge tariff on that imported car. Likewise, suppose a Canadian company buys US cars, paints them, and then sends them back to the US charging 10% more. You want to charge a tariff on the 10%, not the whole value of the US-made car.

Or, say a company imports screws, uses them to assemble a thermostat, which goes in another machine that gets reimported, and back and forth. A lot of goods go back and forth across borders many times on their way to final production. You don’t want to charge a tariff on the same screw 5 times.

So clearly tariffs should be levied on value added, not the total value of the good being imported.

In a bigger picture, surely the President wants to tax net imports, not gross imports. He cares about trade deficit, not the sheer volume of imports and exports, no? If a country buys as much as it sells from the US, don’t we want to leave them alone? If a country buys more from the US than we buy from them, why would we tax their exports, and rob them of the one good way they have to get dollars in order to buy from the US? So tariffs should only start at US imports greater than exports.

One way to do all of this would be to give companies a transferable credit for exporting. If you export $100 worth of goods, you can import $100 free of tariff. And since which company does it makes no difference to the US, they should be able to buy and sell that right. For example, if company A imports cars, sells them to company B, company B paints them and reexports, them, company B can sell its export credit to company A. We love exports, right?

Many imported goods are inputs to other important industries. Steel is used to make cars. If tariffs make steel more expensive, that makes cars more expensive. And steel is used to make airplanes, buildings, aircraft carriers, and a lot of other businesses that employ a lot of Americans, export, as well as being vital for various “strategic” concerns from our industrial policy advocates. If we protect the steel makers, but then have to protect and subsidize the car makers (more), protect and subsidize the shipbuilders (more) and so on, the costs explode. Pretty clearly, we want tariffs on final goods, not industrial inputs.

But not “necessities.” Having just won an election on the price of food, tariffs on food imports and other basic goods are an obviously bad idea. (Removing US agricultural price supports is always a great idea.)

China is imposing export controls on rare earths. Why would we do their geostrategic cold-warring for them by adding our own tariffs? Resources are extracted, not produced. Get them out of the ground and in to the US before trouble breaks out.

Strategically, if the US wants to create a free world trading bloc to compete against the emerging China-Russia-Iran-etc. axis, it doesn’t make much sense to tariff our friends, or those wavering in the middle.

Some of Trump’s tariffs are a negotiating tactic to get other countries to open up. Great. Let’s make a standing offer. Complete free trade is on the table. You make no more trade restrictions than Iowa makes against Illinois, and we’ll do the same. Trade agreements are noxious thousand page managed protection and mercantilism. They need a postcard.

Remember, there is one thing worse than tariffs: quotas. Suppose you own a machine that needs a pressure-relief valve that is only made in Canada. Under a tariff, you pay more but you get it. Under a quota, you’re out of luck. Under a tariff, you can see the economic distortion. Under a quota, the damage can be arbitrarily high.

I’m not a fan of tariffs, but not a catastrophist either. There are so many regulations and taxes raising costs and distorting prices by 20% in the US, one more won’t crater the economy. If they are counterproductive, as most economists believe, we’ll find out soon enough.

Update:

One intriguing idea is the substitution of tariffs for sanctions in geopolitical strategy. This is the first one I’ve heard that softens my economists’ distaste for tariffs (based on long experience rather than just theory). I’m not totally convinced — tariffs beget a domestic constituency for eternal protection (see chicken tax, Jones act), and the overall competence of US geopolitical strategy games is a bit doubtful — but there are interesting arguments here.