Economists overwhelmingly see tariffs as clearly welfare-reducing. Tariffs on imports result in higher prices, fewer imports, less consumption, and more domestic production. In fact, it is the higher prices that solicits and makes profitable the greater domestic production. We don’t get the greater domestic output at the pre-tariff price. We can show graphically that domestic welfare is harmed with either export or import tariffs. The basic economics are very clear.
However, the standard model of international trade makes a huge assumption: Peace. That is, the model assumes that there are secure property rights and no threats of violence. All transactions are consensual. This is where the political scientists, who often don’t understand the model in the first place, say ‘Ah ha!. Silly economists…’ They proceed to argue for tariffs on the grounds of national security and the need for emergency manufacturing capacity. But is an intellectual mistake.
Just as economists have a good idea for how to increase welfare with exchange, we also have good ideas about how to achieve more or fewer quantities transacted in particular markets. This is not a case of economists knowing the ideal answer that happens to be politically impossible. Rather, if it pleases politicians, economists can provide a whole menu of methods to increase US manufacturing, vaccine manufacturing, weapons manufacturing… Heck, we can identify multiple ways to achieve more of just about any good or service. Let the politicians choose from the menu of alternatives.
The problem with tariffs is that they reduce consumer welfare a lot, given some amount of increased production in the protected industry. Importantly, this assumes that the tariffs aren’t hitting inputs to those industries and are only being applied to direct foreign competitors. The below argument is even stronger against imperfectly applied tariffs, like the US tariffs of 2025.
What’s the alternative?
The alternative is a more focused tack. If the government wants more missile or ship production, then what should it do? There’s plenty, but here’s a short list of more effective and less harmful alternatives to tariffs:
- Purchase agreements. This is how the Covid vaccine was rolled out so quickly. The government told producers to make as much as they could and that the government would buy all of it at pre-arranged prices. It’s hard for manufacturers to make sense of the massive capital investments that are necessary unless they know that there will be a market. Advance purchase agreements remove the uncertainty that firms face.
- Targeted Loans. If firms face liquidity constraints, then the government can provide emergency loans to firms who satisfy some criteria for grants or subsidized interest rates. These can be connected to milestone completion, much like video game quest completion. This keeps out nefarious borrowers and grifters. Companies only get the loans if they make progress toward production capacity that the government wants built.
- Regulatory fast-tracks. All of the cash in the world won’t make the environmental studies and community impact studies go away. These kill endeavors because they bring progress to a standstill and place projects into a state of limbo. Any one of multiple regulatory bottlenecks can cause delay or entirely cease the progress of a project. Operation warp speed taught us that these regulatory stumbling blocks are surmountable. In application, the waiver would come in the form of a loan receipt or purchase agreement. If a company has 1) or 2) from above, then they can submit that in lieu of some regulatory compliance.
These are not comprehensive. But we know that they are the types of industrial policies that work and that they are much cheaper than tariffs. But pause, these sound like they cost the government money whereas tariffs provide the government revenue. How in the world can I argue that these are cheaper than tariffs?
The answer is that people always pay. When the government engages in industrial policy like the three methods listed above, they pay for it out of general revenues. Most revenues come from income taxes, which have a wide base and less distortionary effects than do tariffs. The public pays those taxes in ways that don’t substantially disrupt their consumption patterns. Tariffs cause the public to pay for industrial policy through higher prices rather than higher taxes. The public is the one paying in both cases. And economists can persuasively demonstrate that broad-based taxes or income taxes have less welfare loss than narrow tax-bases, such as on imported goods subject to tariffs.
There is a dearth of informed, practical, and vocal work on this topic. Or maybe I’m just paying attention to the wrong people. By far, the best person that I’ve heard on the topic of practical and relatively efficient industrial policy is Noah Smith. He’s a bit glib, but I think that he doesn’t engage in as much lip-service to the various economist factions. He has been the quickest and clearest voice that I’ve heard on this topic. You’ll know that he’s on to something when you find yourself both agreeing and disagreeing with multiple points per interview.
Noah now has a podcast, entitled ‘ECON 102’ that is released semi-monthly or so. I recommend that you give it a try. In particular, if you want to hear more about industrial policy, then try this one from June 2025: China, Tesla, and the Electric Tech Stack Revolution
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