As the saying goes, “History does not repeat itself, but it rhymes.” After a long exile, tariffs are back. But the greatest economists in history would be wary of imposing taxes to address a trade imbalance. Adam Smith, the father of economics, railed against their distorting effect on trade, which he saw as essential for national prosperity. David Ricardo developed the theory of comparative advantage, which shows that nations should specialize and then trade, which would lead to even greater prosperity. Paul Samuelson further enhanced our understanding of international trade by pointing out that there are those who benefit more, and others who benefit less, when a nation specializes, even if the economy gains overall. In sum, selling more, rather than importing less, is one of the lessons to draw from history’s greatest economists.
As the saying goes, “History does not repeat itself, but it rhymes.”
After a long exile, tariffs are back, and they’re being levied on billions of dollars of traded goods, ranging from steel and aluminum to Harley-Davidson motorcycles. They’re part of a trade war between the U.S. and China, and between the U.S. and the EU (although a conversation this week between President Donald Trump and Jean-Claude Juncker, president of the European Commission, may ease some of those tensions — we will see).
Tariffs are taxes imposed by a country that make imports more expensive. The U.S. enacted this recent round of tariffs as a response to its trade deficit (when a country buys more from abroad than it sells). The idea is to make foreign products less desirable and thus protect domestic industry.
But the greatest economists in history would be wary of imposing taxes to address a trade imbalance. The better way to reduce a trade deficit is to export more, not to reduce imports by making them more expensive.
Using tariffs to improve a country’s trade position was essentially what Britain rejected over a century ago. The argument was won due to the work of two great economists, Adam Smith, the father of economics, and David Ricardo, the father of international trade. When the UK repealed the Corn Laws, a piece of protectionist legislation, in 1846, it marked an era of greater opening for Britain, then the dominant trader in the world.
What the Great Economists Thought About Tariffs
Unlike many economists, Smith had the chance to put his theories into action. As the commissioner of customs for Scotland, he advocated removing all trade barriers, which was qualified only by the need to raise revenue for what he considered to be the proper purposes of governing a country, such as providing roads. He supported levying duties on imports and exports at a moderate level, but not so high that smuggling would be profitable.
True to Smith’s beliefs about government policies not distorting the market, he would set duties to be equal for different producers and importers, so that one group or one country would not have an advantage over another. For instance, he saw the inequity of exempting the product of private brewing and distilling (which was imbibed by the rich) from excise duty while taxing the preferred tipples of the poor.
So, if tariffs were necessary, they should treat all traders and trading nations the same, so as to not distort the “invisible hand” (his most notable contribution in The Wealth of Nations) of the market allocating what producers should make.
Later economists deviated from Adam Smith in developing new lines of inquiry, but retained his insights. Inspired by The Wealth of Nations, David Ricardo developed the theory of comparative advantage, which shows that nations should specialize and then trade, which led to greater prosperity.
In the 20th century, great economists such as Paul Samuelson further enhanced our understanding of international trade by pointing out that there are those who benefit more, and others who benefit less, when a nation specializes, even if the economy gains overall. Thus, his work highlights the distributional impact of trade and points to ways of helping the losers of globalization.
Even as our understanding of the issues around trade has evolved, the central tenets laid out by the great economists from two centuries ago remain. Tariffs are a protectionist measure that is inefficient and also distortionary if higher taxes on some imports mean they become less competitive relative to others.
Looking Ahead
Countries have often used protectionism to foster home industries until they are able to compete with established firms. This was the case for the United States in the 19th century when competing against Britain, and is still the case for China in a number of sectors.
China in particular is not as open to trade as the U.S. and EU, which has been a perennial complaint of Western businesses, and so far China has been measured in its tit-for-tat responses to each round of American tariffs. The U.S. is threatening to levy tariffs on nearly all Chinese exports, some $500 billion, unless the U.S.-China trade position improves. China won’t easily be able to retaliate in a like fashion since it doesn’t import half a trillion dollars of goods from the U.S. But China could choose to mirror the U.S. in imposing investment restrictions, which would be very damaging as they would distort the supply chains and the operational decisions of multinational companies. This would not be easily reversed, unlike tariffs, which can be levied one day and removed the next. There are some signs that investment has been affected by trade tensions. China scuppered U.S. tech company Qualcomm’s bid for Dutch chipmaker NXP even though the global deal had been approved by U.S. and EU regulators.
Further distorting trade, which partly comes about through companies investing in supply/distribution chains and conducting M&A across national borders, would be something that the great economists would oppose. After all, there is consensus among them that international trade benefits an economy.
The great economists would likely say that there are better ways to improve a country’s trade position, such as opening up the global market for services trade. This would disproportionately benefit the U.S. as the biggest exporter of services worldwide, competing well even with trade barriers in place. If China opened up more of its services sector, as it is already warily looking to do, then that could increase U.S. exports to China and reduce the trade deficit, for one. The UK, the second biggest exporter, and other advanced economies such as the EU and Japan would also see an improvement in their trade position, as the bulk of these advanced economies comprises services. Even accounting for the fact that services are not always traded (for example, restaurants), the EU has pointed to the potential to sell more services that would better reflect what it produces. For example, the economy of the EU is 70% services, while services make up just a quarter of exports.
In sum, selling more, rather than importing less (and thus consuming less or producing with more-expensive components), is one of the lessons to draw from history’s greatest economists.
They argued for the opening up of markets around the world so that countries could sell more of what they produce — which would bring about greater prosperity. Their insights continue to underpin economics today. Politics, however, are another matter.
