Tariffs

If Tariffs Are So Bad, Why Are They So Common?

Scott Buchanan4 Comments

Upfront disclaimer: This post is NOT about the most recent salvo of U.S. tariffs – enough apoplectic digital ink is gushing there already. It is about is an underlying question that these tariffs raised in my mind, which is the title of this article.

If there is one thing that nearly all economists, left, right, and center, can agree on, it is that free trade is good (see, for instance, a classic exposition of gains from trade on EcoNomNomNomics) and thus tariffs are bad. The main reason the local producers would need “protection” is because their goods (and services) are more expensive than the imports, and so by definition the consumers will pay more for their stuff. Thus, as is always noted, tariffs are a kind of tax on consumers. And yet…as far as I can tell all or nearly all nations impose tariffs on imported goods. So, what’s up with that?

This is not an area of expertise for me, so I went roaming the web to get some various opinions. The main reason given is to “protect local industry/agriculture”, and by extension, local jobs. We have to drill down deeper to see the reasoning involved.

In some cases, it is a simple, unsavory matter of a local industry having a powerful enough clout either at the business level or the labor level to lobby for special treatment (which costs the rest of the consumers more). But there are other cases where it is argued that it is important for national security to maintain a certain level of domestic production. For instance, historically nations like Japan and Switzerland maintained high tariffs on certain agricultural imports, in order to retain some domestic food production so they would not starve if something happened to interrupt international trade. Ditto for defense-related or other “strategic” production, and so on.

And in many cases, there just seems to be a gut feel that it is more patriotic or economically healthy to promote in-country production. Also, if a certain inefficient industry employs a lot of workers, the medium-term pain of letting that industry fail while resources shift elsewhere may be unacceptable. Economists promise us that the sooner or later those unemployed workers and empty factories will be put to some other, more worthy use, but it can be hard to believe in the “invisible hand” when suddenly you cannot pay your rent and no other jobs are available.

Two other factors came up. One is that for less developed counties without sophisticated internal revenue services, tariffs are a convenient way to collect revenue, and in fact may provide a significant share of government support. If I recall my high school history correctly, the fledgling United States government supported itself largely by tariffs, back in the day.

Another motive is what I would call “smart” tariffs, aimed not at indefinitely protecting inefficient producers, but at promoting improved production. What I have in mind is something I read some years ago, in an article I cannot now lay hands on, describing Korea’s path to industrialization. Protectionism was very much a part of that. The nation’s consumers did forgo short-term cheap consumption, in exchange for the development of domestic production which would in the long-term benefit everyone. I think one example was cigarettes. The government decided that cigarette production was a reasonable place to start industrializing, so they taxed imports to drive the price high enough to justify putting in cigarette-making equipment. After some years, they were happily making cigarettes, employing Koreans and building institutional muscle for the next phases of industrialization.

China has maintained a high degree of protectionism, including capital controls, and has grown and prospered mightily. So, I think that in assessing tariffs, it is essential to look past the immediate effects (which economists can always argue are “bad”, i.e., reduced consumption) to the longer-term impacts. Smart tariffs of the kind that East Asian countries have employed seem to have parlayed short-term consumer pain into long-term societal gains. Non-smart tariffs – -maybe not so much.

Freedom to Trade Internationally

Jeremy Horpedahl1 Comment

How much does the US and our trading partners adhere to the principles of free trade? The Fraser Institute’s Economic Freedom of the World report includes a category that helps to answer this question. Fraser’s measure includes not just tariff rates, but also non-tariff barriers, trade regulations, black market exchange rates, and controls on the movement of capital and people. Each country is assigned a score from 0 to 10, with 10 being the most freedom to trade internationally.

Overall, the US gets a pretty good score, slightly over 8 out of 10, which ranks us as the 53rd most free trading country in the world (data from 2022). That’s pretty good, but clearly not the most open: 52 countries have more trade freedom! Here’s how the US and our 10 largest trading partners look on that measure (I’ve truncated the axis to show roughly the current range of country scores worldwide):

Countries/regions with the highest scores on this measure are Hong Kong and Singapore, and almost every European country scores higher than the US.

What if we just look at tariffs? The US has a slightly higher score at 8.3 out of 10, but our rank on tariffs is slightly lower at 59th most free in the world (this includes not just tariff rates, but also the standard deviation of tariff rates and revenue from the trade sector).

Relative to our largest trading partners, the US does look better on this subcomponent for tariffs, but is still lower than some of our trading partners (note the axis is slightly different than the first chart, to once again roughly show the international range on this measure):

Finally, we might be interested in how much these scores have changed over time. You might sometimes hear that the US has opened up more to trade, while the rest of the world has moved in the opposite direction. This might be true on some margins, but not overall according to the Fraser scores. I use 1990 as the baseline, which is before a lot of the free trade agreements and WTO changes that would happen over the next decade or so (Fraser has no data for Vietnam in 1990, so they are excluded):

Overall, the US and our major European trading partners have reduced the ability of their citizens to trade internationally, while places like China and India have opened up massively to trade. In 1990 China had a mean tariff rate of 40% and India’s was a whopping 79%. Today their tariff rates are still higher than the US: 7.5% in China and 18% in India, compared with 3% in the US. But they are the ones who have massively opened up their economies to international trade, when we consider all aspects of international trade, even if this opening up isn’t as complete as the US. The US ranked as the 12th highest on Fraser’s freedom to trade internationally component in 1990, but is down to 53rd in the most recent data.

Was the US at Our Richest in the 1890s?

Jeremy Horpedahl2 Comments

Donald Trump has repeatedly said that the US was at our “richest” or “wealthiest” in the high-tariff period from 1870-1913, and sometimes he says more specifically in the 1890s. Is this true?

First, in terms of personal income or wealth, this is nowhere near true. I’ve looked at the purchasing power of wages in the 1890s in a prior post, and Ernie Tedeschi recently put together data on average wealth back to the 1880s. As you can probably guess, by these measures Trump is quite clearly wrong.

So what might he mean?

One possibility is tax revenue, since he often says this in the context of tariffs versus an income tax. Broadly this also can’t be true, as federal revenue was just about 3% of GDP in the 1890s, but is around 16% in recent years.

But perhaps it is true in a narrower sense, if we look at taxes collected relative to the country’s spending needs. Trump has referenced the “Great Tariff Debate of 1888” which he summarized as “the debate was: We didn’t know what to do with all of the money we were making. We were so rich.” Indeed, this characterization is not completely wrong. As economic historian and trade expert Doug Irwin has summarized the debate: “The two main political parties agreed that a significant reduction of the budget surplus was an urgent priority. The Republicans and the Democrats also agreed that a large expansion in government expenditures was undesirable.” The difference was just over how to reduce surpluses: do we lower or raise tariffs?

It does seem that in Trump’s mind being “rich” in this period was about budget surpluses. Let’s look at the data (I have truncated the y-axis so you can actually read it without the WW1 deficits distorting the picture, but they were huge: over 200% of revenues!):

It is certainly true that under parts of the high-tariff period, we did collect a lot of revenue from tariffs! In some years, federal surpluses were over 1% of GDP and 30% of revenues collected. But notice that this is not true during Trump’s favored decade, the 1890s. Following the McKinley Tariff of 1890, tariff revenue fell sharply (though probably not likely due to the tariff rates, but due to moving items like sugar to the duty-free list, as Irwin points out). The 1890s were not a decade of being “rich” with tariff revenue and surpluses.

Finally, also notice that during the 1920s the US once again had large budget surpluses. The income tax was still fairly new in the 1920s, but it raised around 40-50% of federal revenue during that decade. By the Trump standard, we (the US federal government) were once again “rich” in the 1920s — this is true even after the tax cuts of the 1920s, which eventually reduced the top rate to 25% from the high of 73% during WW1.

If we define a country as being “rich” when it runs large budget surpluses, the US was indeed rich by this standard in the 1870s and 1880s (though not the 1890s). But it was rich again by this standard in the 1920s. This is just a function of government revenue growing faster than government spending. And the growth of revenue during the 1870s and 1880s was largely driven by a rise in internal revenue — specifically, excise taxes on alcohol and tobacco (these taxes largely didn’t exist before the Civil War).

1890 was the last year of big surpluses in the nineteenth century, and in that year the federal government spent $318 million. Tariff revenue (customs) was just $230 million. There was only a surplus in that year because the federal government also collected $108 million of alcohol excise taxes and $34 million of tobacco excise taxes. In fact, throughout the period 1870-1899, tariff revenues are never enough to cover all of federal spending, though they do hit 80% in a few years (source: Historical Statistics of the US, Tables Ea584-587, Ea588-593, and Ea594-608):

One more thing: in some of these speeches, Trump blames the Great Depression on the switch from tariffs to income taxes. In addition to there really being no theory for why this would be the case, it just doesn’t line up with the facts. The 1890s were plagued by financial crises and recessions. The 1920s (the first decade of experience with the income tax) was a period of growth (a few short downturns) and as we saw above, large budget surpluses. The Great Depression had other causes.

How FRASER Enhances Economic Research and Analysis

Zachary BartschLeave a comment

Most of us know about FRED, the Federal Reserve Economic Data hosted by the Federal Reserve of St. Louis. It provides data and graphs at your fingertips. You can quickly grab a graph for a report or for a online argument. Of course, you can learn from it too. I’ve talked in the past about the Excel and Stata plugins.

But you may not know about the FRED FRASER. From their about page, “FRASER is a digital library of U.S. economic, financial, and banking history—particularly the history of the Federal Reserve System”. It’s a treasure trove of documents. Just as with any library, you’re not meant to read it all. But you can read some of it.

I can’t tell you how many times I’ve read a news story and lamented the lack of citations –  linked or unlinked.  Some journalists seem to do a google search or reddit dive and then summarize their journey. That’s sometimes helpful, but it often provides only surface level content and includes errors – much like AI. The better journalists at least talk to an expert. That is better, but authorities often repeat 2nd hand false claims too. Or, because no one has read the source material, they couch their language in unfalsifiable imprecision that merely implies a false claim.

A topical example would be the oft repeated blanket Trump-tariffs. That part is not up for dispute. Trump has been very clear about his desire for more and broader tariffs. Rather, economic news often refers back to the Smoot-Hawley tariffs of 1930 as an example of tariffs running amuck. While it is true that the 1930 tariffs applied to many items, they weren’t exactly a historical version of what Trump is currently proposing (though those details tend to change).

How do I know? Well, I looked. If you visit FRASER and search for “Smoot-Hawley”, then the tariff of 1930 is the first search result. It’s a congressional document, so it’s not an exciting read. But, you can see with your own eyes the diversity of duties that were placed on various imported goods. Since we often use the example of imported steel and since the foreign acquisition of US Steel was denied, let’s look at metals on page 20 of the 1930 act. But before we do, notice that we can link to particular pages of legislation and reports – nice! Reading the Smoot-Hawley Tariff Act’s original language, we can see the diverse duties on various metals. Here are a few:

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Tariffs: Bad for Revenue

Zachary Bartsch3 Comments

Economists are pretty united against tariffs. There are lots of complicated arguments. Keeping things simple, one reason is that they are bad for welfare. President-elect Trump seems to imply that tariffs can raise a lot of government revenue. But in lieu of what? The Tax Foundation estimates that there is absolutely no way that tariffs can replace all revenue from income taxes. The primary reason that they cite is that imports compose a tiny portion of the potential tax base. There are plenty of goods and services produced domestically that wouldn’t be subject to the tariffs. Any time we add a tax exemption, we’re adding complication, higher compliance costs, and distorting consumption patterns, etc.

For this post I singularly focus on the tax revenue.  In fact, let’s demonstrate what *maximizing* tax revenue looks like under three cases: 1) Closed economy with a tax, 2) Open economy with a tax, & 3) Open economy with a tariff. I’ll use some simple math to demonstrate my point. None of the particulars affect the logic. You’ll reach the same general results with different intercepts, slopes, etc. Let’s start with a domestic demand and domestic supply.

Closed Economy with a Tax

Whenever tax revenue is raised, there is a difference between the price paid by demanders and the price received by suppliers. In a closed economy a tax might be imposed on all goods. In these examples, I treat the tax as some dollar per-unit of output tax. But it’s a short jump to percent of spending taxes, and then another short jump to percent of income taxes. With this in mind, demanders pay more than the suppliers receive by the amount of the tax. Tax revenue is the tax rate times the number of units of output that are subject to the tax. That’s the thing we want to maximize.

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