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Wednesday, June 19, 2019

The Poverty of Protectionism and the Impact of Tariffs

The poverty of protectionism is confirmed again.

Image Credit: Official White House Photo by Joyce N. Boghosian [public domain]

The arguments for liberty are richer and belong to a deeper and more credible tradition than the authoritarians’ arguments. Nowhere perhaps is this more obvious than in the area of international trade. We can speak of the poverty of protectionism—even if, no doubt, many of the doctrine’s proponents have much of what hell is paved with. I cannot resist the temptation to quote a consistent authoritarian and defender of slavery before the Civil War, George Fitzhugh, who argued against liberty and free trade:

Admit liberty to be a good, and you leave no room to argue that free trade is an evil—because liberty is free trade.

Protectionism Imposes Net Welfare Losses 

A few days ago, one study of the impact of Chinese-import tariffs on American prices was praised by some protectionist tweeters. Published in November 2018 by a European think tank, the study purported to show that the American tariffs on China were, or would be, mostly paid by Chinese producers instead of by American consumers: Benedikt Zoller-Rydzek and Gabriel Felbermayr, “Who is Paying for the Trade War with China?” The authors estimate that America obtains “net welfare gains.” Studies that reach this conclusion are not frequent.

The tweeter who unearthed the study wrote:

Report from European economists with no axe to grind and no loyalty to the Anglophone paradigm show that 75% of the tax burden of tariffs on China is borne by Chinese firms.

The organization that published the study is the European Network for Economic and Fiscal Policy Research, an association of think tanks often close to European governments—as are most intellectual shops in Europe. But beware of dismissing the study as politically biased. We should try to judge ideas on their merits and, in any event, studies financed by big, far-away, inefficient governments are not necessarily more biased than those sponsored by private donators.

The estimates of Zoller-Rydzek and Felbermayr have little empirical content and, if I understand the study correctly, are based on an extreme model that assumes no American production of the tariffed goods and that these goods can be imported only from China (see Figure 1, p 3). It is a special case of the “optimal tariff” argument, which implicitly relies on omniscient government bureaucrats making complex calculations that are then faithfully incorporated in policies by benevolent-despot politicians.

Consumers Pay the Price 

The authors admitted that the tariffs will have no significant impact on the US trade deficit. They made other interesting observations:

In Figure 4 we show the distribution of US consumer price increases. While for most products the increases are only modest, some consumer good and intermediate input categories are hit hard, with price increases of over 20 percent in some cases. Low-income US households in particular will be affected by this increase, as they spend a considerable share of their income on (cheap) Chinese imports… This will lead to a stronger decline in real income for US low income households.…

As the trade conflict escalates, however, the US administration may not be able to restrict its selection to products with high import elasticities; and US welfare might decrease as more of the tariff incidence falls on US consumers. Moreover, China’s next countervailing duties will be chosen in a similar way, namely in a bid to shift the tariff burden onto US exporters.

A number of recent studies show that American consumers generally pay the full cost of the tariffs through higher prices, as would be expected in standard trade theory. See, for example, Pablo Fajgenbaum et al., “The Return to Protectionism,” NBER, March 2019; Mary Amiti et al., “The Impact of the 2018 Trade War on U.S. Prices and Welfare,” NBER, March 2019; and a short summary of these two studies in “U.S. Consumers Have Borne the Brunt of the Current Trade War,” The NBER Digest, May 2019.

Amiti et al. also summarize their paper in a Liberty Street (Federal Reserve Bank of New York) article: “New China Tariffs Increase Costs to U.S. Households,” May 23, 2019. For a simple illustration of how tariffs work and typically translate into equivalent domestic price increases, see my EconLog post, “A Simple Illustration of Standard Trade Theory” (July 9, 2018).

The Poverty of Protectionism 

The figure below, borrowed from the Amiti et al. NBER paper, shows the impact of the early 2018 washing machine tariff on the CPI index for major appliances. As the latter contains all major appliances, the impact on washing machines prices is of course higher. The authors present a lot of other data and analyses that confirm the impact of US tariffs on US domestic prices. They conclude:

We find that the U.S. tariffs were almost completely passed through into U.S. domestic prices, so that the entire incidence of the tariffs fell on domestic consumers and importers up to now, with no impact so far on the prices received by foreign exporters. We also find that U.S. producers responded to reduced import competition by raising their prices.

Source: Mary Amiti et al., “The Impact of the 2018 Trade War on U.S. Prices and Welfare,” NBER, March 2019 

According to Amiti et al., the total annual cost to consumers of the tariffs imposed by the US government in 2018 (mainly on Chinese imports, but also on steel and aluminum) amounts to $414 per American household. This annual cost would double if the new envisioned tariffs on Chinese imports go ahead. For a “Deplorable” (the stylized supporter of President Trump) who earns the minimum wage, $414 more expenditure represents about one week of work.

Amiti et al.’s results suggest that the tariffs also reduced the variety of products on the American market. This would no doubt please Bernie Sanders, who claimed that there are too many sorts of deodorants and sneakers on the market. Donald Trump, on his side, proposed that parents hit by tariffs could simply buy fewer dolls for their daughters. The poverty of protectionism is confirmed again.

This article is republished with permission from the Library of Economics and Liberty.

  • Pierre Lemieux is an economist affiliated with the Department of Management Sciences at the University of Québec in Outaouais, and a senior fellow at the Montréal Economic Institute.