A Tariff Would, Too, Fix Our Trade Mess

Ian Fletcher 

I and my employer, the Coalition for a Prosperous America, are unabashed protectionists.  I have written previously about how, for example, a flat tariff on all U.S. imports may well be the key to solving the ongoing trade crisis that is depleting our national wealth and gutting our industries. 

We at CPA believe that a genuine national debate on trade issues will eventually draw public opinion our way.  So it is only fair to answer some of the reasonable-but-mistaken objections raised to our position.

One obvious objection is simply that a tariff is a tax increase. So it is. But it does not have to be a net tax increase if the revenue it generates is used to fund cuts in other taxes. So in order to obtain a “clean” policy debate, in which the tariff is debated purely on its merits as a trade policy, unmuddied by partisan opinions about the total level of taxation, any tariff proposal should be packaged with precisely compensating cuts in other taxes. 

A related concern is that a tariff is a tax on consumption. This is generally better than a tax on income because it rewards saving and avoids penalizing work. Unfortunately, consumption taxes also reduce the progressivity of the tax system because the poor consume, rather than save, a higher percentage of their incomes. So any tax rebate financed by the tariff should also be designed to leave the overall progressivity of the tax system unchanged. 

Another objection to a tariff is that if American industry is granted tariff protection, industry will just slumber behind it. Some industries indeed long to shut out foreign competition, reach a lazy detente with domestic rivals, then coast along with high profitability and low innovation. 

But a flat  tariff—say, 30% on all imported goods and services—would resist this danger because it would not hand out a blank check of protection: it would give a certain percentage and no more. Any industry that could not get its costs within striking distance of its foreign competitors will not be saved by it. 

This discipline, although unpleasant for the losers, is the price we would have to pay for a tariff that actually worked, rather than one which eliminated the discipline of foreign competition entirely and protected all industries, whether or not their protection was useful to the economy as a whole.

What kind of industries are worth protecting? The kind of high value, high wage, high technology industries that have a future.  The whole point of protectionism is to capture better jobs; there’s no point capturing junk jobs or jobs whose capture will cost consumers more than they are worth.

A flat tariff would avoid the danger of getting stuck with a tariff policy that made sense when it was adopted but gradually became an outdated captive of special interests over time. Although it would be a fixed policy, it would not be fixed in its effects, but would automatically adapt to the evolution of industries over time. 

In 1900, for example, such a tariff would have protected the American garment industry from foreign (then mostly European) competition. It wouldn’t do that today, as a 30% cost advantage isn’t enough to protect an industry whose production cost consists mostly in cheap  unskilled labor.  But it is enough to protect high-value, high-skill industries whose production cost is mainly capital, know-how, and skilled labor.  These industries are what we need.

Next issue: it is sometimes objected that protectionism stifles competition. As a result, if a tariff is imposed, antitrust policy will become even more important than it already is. But luckily, there is a compensating benefit: rivalry between domestic firms actually appears to be a more potent competitive force than rivalry with foreign ones. As Michael Porter of Harvard Business School observes in The Competitive Advantage of Nations:

Domestic rivalry not only creates pressures to innovate but to innovate in ways that upgrade the competitive advantages of a nation’s firms. The presence of domestic rivals nullifies the types of advantage that come simply from being in the nation, such as factor costs, access to or preference in the home market, a local supplier base, and costs of importing that must be borne by foreign firms…This forces a nation’s firms to seek higher-order and ultimately more sustainable sources of competitive advantage. (Emphasis in the original.)

So replacing foreign rivalry with strong domestic rivalry is probably a net plus. Japan’s ferociously competitive (and protected) automobile and consumer electronics industries illustrate this well.

Another issue is that if a tariff gives companies back market share and lets them raise prices, they may just harvest profits, rather than reinvesting them in long-term growth. (This was, in fact, a problem with one of America’s largest recent protectionist undertakings: the Voluntary Restraint Agreement with Japan on automobiles.)  Good trade policy requires not only the “carrot” of tariffs and subsidies, but also the “stick” of measures to prevent companies from merely taking out added revenues as profit, rather than investing them in long-term upgrading of their capabilities. 

Does this mean that a tariff should be accompanied by agreements on investment levels? No; the needed investment may be in another industry anyway. The solution here probably lies in creating generalized incentives for investment. Since increased investment is a good thing even if we leave trade out of the picture, and already the object of tax incentives supported across the ideological spectrum, this should not be too hard to swallow politically.