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Rigged their way

By Daniel M. Ryan
web posted January 3, 2011

The U.S. economy still has it hard, and the Keynesian approach is more and more questionable. Perhaps inevitably, the resultant economic quagmire has led to an old remedy being revived. With the still-rapid growth of mainland China contrasting more markedly with little in the U.S., and with the peg of the renminbi still grating, the calls for tariffs aren't that surprising.

The main arguments against tariffs, apart from theoretics, are twofold. Firstly, imposing tariffs will cause a trade war, leaving both sides poorer. Secondly, erecting a tariff wall will cause another Great Depression. Smoot-Hawley is adduced for both.

Back in the days when the original free trade agreements were being enacted, those two warnings were taken as settled. Recently, though, there's been some debunking of both. The nub of the debunk notes that foreign trade made up too little of American GDP for a collapse in it to have wreaked major damage. The critique also notes that the Great Depression itself, not Smoot-Hawley, was the probable cause of the early 1930s trade war. That Depression was not caused by blockages to external trade, but by a credit collapse. That's why earlier tariff increases, like Fordney-McCumber, didn't cause any Great Depressions.

Does this debunking imply tariffs are a good idea? Not necessarily. Below, I offer three unintended consequences that tariff advocates haven't dealt with. Taken as a whole, they show a darker side of a tariffed economy.  All three go out of the way to be fair to tariff advocates: they'll come into play even if a heavy U.S. tariff imposition does not spark a trade war and does not accompany a second Great Depression. The only way for the first to be obviated is if exporters to the U.S. largely acquiesce to the tariffization of the world's largest consumer base, albeit grudgingly. The second would be nugatory if tariffs are not imposed to fight off another Depression. Given that foreign trade is a much larger component of the U.S. economy now, and given that there'd be a greater amount of hurt if the U.S. does erect a wall of tariffs, these two concessions are arguable. To be blunt about the matter, U.S. hegemony would be the most likely deterrent to retaliation.

I'm also assuming that other nations don't get the same idea and erect tariff walls of their own. "Good idea; why don't we do it too" makes for a de facto trade war regardless of motives.

I'm also assuming that the resultant price increases borne by the U.S. consumer won't trigger a debt crisis in the household sector. The resultant tumbling of Visa and MasterCard shares would be about as ephemeral as the tumble of BP stock.

Unintended Consequence #1: More Bailouts

Tariff advocates pin their case on the unfair-terms-of-trade argument. Low wage rates in developing countries, and currency manipulation in the case of mainland China, tilt the field against U.S. manufacturing. If both are made up for, they aver, U.S. manufacturing will come roaring back. But what if it doesn't?

A major internal barrier to a manufacturing revival is one not often mentioned: regulatory costs. Even if the U.S. imposes tariffs judged to eliminate any wage differential plus currency component, the differential regulatory burden will still be there. To take a single example: if a tariff on foreign petroleum products was part of the brew, there won't be any refinery revival in the U.S. Why? Because regulations make it all-but impossible for established refiners to add capacity, let alone for new competitors to build new refineries to take on the established players. A Wall Street Journal article estimates the total costs of federal regulatory compliance, not including state-regulatory costs, to be more than $1.75 trillion. A tariff will do nothing to eliminate any red tape.

It will, on the other hand, increase pressure for corporate bailouts. That's because Lee Iacocca, the "father of bailouts," set an important precedent. In addition to the arguments which amount to Chrysler being too big to fail, he added one that will be eventually echoed: Chrysler was hobbled by regulations imposed in the '70s that contributed to the company's demise. Consequently, the U.S. government owed Chrysler a bailout to mitigate the damage done by those regulations.

If the manufacturing sector gets enough clout to have tariffs enacted, they will have enough clout to try this argument on for size. They'll also have enough clout to win some, as do the bankers today. There will be occasion to try, as tariffs will mean price increases for consumers. That ol' budget can only stretch so far.

Needless to say, any U.S. business that imports its raw materials or intermediate products will be squeezed. This kind of business has a more prima facie claim to a "reciprocity" bailout, or to a compensatory subsidy.

Unintended Consequence #2: Lonely City On A Hill

I'm assuming that other trade-linked nations will not enact retaliatory tariffs, or emulative tariffs – no "if it's good for the Americans, it'll be good for us too." There won't be any retaliatory economic policy of any consequence, likely caused by deference to U.S. status as a hyperpower.

That assumption does not rule out diplomatic retaliation, nor does it rule out a net turning away from America by the rest of the world.

Fact is, a lot of the interest in America comes from interest in securing Yankee dollars from Yankee customers. When that's no longer practicable because of Yankee tariffs, then there'll be far less interest in watching America. Hope for gains from trade makes the hopers well-disposed to America: it makes little sense to hate the customer base. On the contrary, it makes a lot of sense to get to know and like them.  

Should tariffs be imposed, it's these foreigners that will be left high and dry. The ones who never liked the U.S. will be saying, "I told you so." Electoral politics in those nations will change accordingly, as will policy. That same country which a tariff regime is primarily aimed at will be the one to benefit accordingly.

The competitive advantage of nations is a lofty subject, but it does have its gritty side. To be blunt, mainland China has a competitive advantage when it comes to international bribery. Doing business through bribery is generally held to be un-American, but it is not un-Chinese. Needless to say, it's not un-developing-world either. This advantage, the PRC has already been exploiting. It's an edge that can be built on if the PRC government continues its shift to a more consumer-oriented economy. Taken far enough, China will be the market to court. If so, then there'll be a lot more interest in getting to know and even like the Mainland. America's econo-diplomatic advantage will become the PRC's.

America will probably continue to be the city on the hill, but it'll get lonelier. Other countries will not fail to notice that imposing tariffs will necessitate the U.S. government extricating itself from at least two treaties. Again, other national governments may emulate. A drop-out from NATO is unlikely, but other treaty zones may shrink – especially if the country to watch becomes mainland China.

Unintended Consequence #3: Meet The New Class…

The main enabling trope of the current ruling class contrasts them from the old boys, the ones who went to the best prep schools and purportedly didn't have to earn their way. Needless to say, the current ruling class can be elbowed aside too. Who better than a group of manufacturers? "We make things; we create real values. We don't shuffle paper with one hand and bleed the people through the Federal Reserve with the other. We ain't predatory lawyers; we're the victims of them."

There are no inevitabilities in history, but a tariff regime spawning a new ruling class has strong odds in its favour. Any businessperson who benefits from the tariffs is going to know full well that his or her prosperity is linked to D.C. Consequently, there's going to be a lot more interest in the workings of federal politics. Some may wade in to protect their government-granted competitive advantage. Others may wade in out of a sense of responsibility, seeing their tariff privilege as something that has to be paid back through public service. Most likely, it won't be businesspeople who go into politics directly. Instead, it'll be the son, the cousin, the classmate who lacks a heart for business.

How do I know this? Because that's how it panned out in Canada. Canadian business was protected by a tariff wall for more than a century until 1988. That same era saw the politico-economic dominance of the Canadian Establishment. There was some intermixture with the military class, but not much. Confined to Anglophiles, that intermixing didn't stick. On the other hand, there were solid interlinks between largely tariff-shielded business and government. One of Canada's more prominent Prime Ministers, Pierre Trudeau, was the only son of a Québec lawyer-businessman who made a tidy fortune with a chain of service stations.

Some Americans would be comfortable with a new ruling class that hails from the factory set, seeing it as preferable to the Wall Street - Washington – Big Media –Big Lawyer loop. Others will be bothered, some of them out of principle. A ruling class rooted in manufacturing would be more patriotic and heartfelt, but it would also be more inclined to paste up-and-comers as "un-American."

No Easy Way Out

Tariffs many not be the horror that free-traders describe, but they are far from being a panacea or even a betterment. One indirect consequence would be an increasing resort to subvention – foreign aid – to make up for loss of U.S. standing on the world stage. The current symbolic-analyst crew won't go quietly; they may well roll with the punch by shifting from globalization to U.N.-style internationalism. The PRC economy will take one in the chin, but the PRC itself will benefit indirectly.

There is the possibility that the PRC economy will be flat knocked out. That eventuality, though, would trigger the same depression scenario I ruled out: it would trigger a made-in-China credit crisis. What good a "productive" loan if the goods can't be sold at a profit? ESR

Daniel M. Ryan is currently watching the gold market. He can be reached at danielmryan@primus.ca.

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