Tariffs and the return of Made in America!

Trump's tariffs look less and less like an instrument for negotiation, of whatever they would allow to negotiate (some stuff is simply ludicrous, like the discussion on reducing fentanyl entry through Canada), and, at least rhetorically, he is using the language of bringing back manufacturing jobs to the United States. That would actually strengthen his populist credentials. Many trade union types were very happy, contrary to what most media outlets would make you believe, and certainly it should worry Dems.

However, whether this tariffs will bring back manufacturing jobs is far from clear. There have been a lot of jokes about the back-of-the-envelope calculations used to determine the level of the tariffs. At the end of the day, it seems that the actual decision was somewhat arbitrary, and mostly concerned with punishing countries with higher trade surpluses with the US.

I don't think this is clear yet, but average tariffs may go back to the levels of the 1930s, if these stick (which again, nobody knows, since some might negotiate side deals with the Don). And while there is a lot of debate about the effects that they will have in the economy in the short run (inflation, stagflation and so on), there has been little discussion of the historical precedent, and whether tariffs were instrumental for American industrialization, and whether the claim that they will bring back good jobs makes sense. Certainly, on the progressive side that is the common understanding, and a lot of that is associated to Alexander Hamilton, and his followers, less well-known figures like Mathew and Henry Carey, Friedrich List, and later Progressives like Simon Patten, during the Gilded Age. And tariffs were definitely high in the post-bellum period, when the US industrialized (see below, from Douglas Irwin's massive history of US trade policy).

It is certainly true that the bulk of industrialization happened when tariffs where high, even if some industrialization did happen in the ante-bellum period, when tariffs fluctuated quite a bit. The official economic historiography, Taussig, North and Irwin himself, to cite some of the more prominent authors, are somewhat skeptical of its role. Irwin, in particular, is very forceful in his views about the fiscal nature of the ante-bellum tariffs, and even, in terms of intellectual history, the notion that Hamilton was not a protectionist defending import substitution industrialization. I have problems with that interpretation, and I think a reading of Hamilton's Report on Manufactures shows that he is incorrect.

However, it is true that tariffs alone did not cause industrialization. Just as an example, tariffs by the end of the 19th century were higher in Latin America, on average, than in the US, and even though there was some increase in manufacturing in some countries in the region, they remained mostly commodity exporters during this period (see graph below from Coatsworth and Williamson).

So, if not tariffs, what allowed for the industrial boom in the post-bellum period, one may ask. First and foremost, the railroad boom, and the finishing of the transcontinental railroad in 1869,  the "Golden Spike" at Promontory Summit, Utah (I visited, and they do a recreation of the famous photo below), created a national market, that was only possible because of the Federal government. Republican governments in that era had an industrializing project, were protectionist, but more importantly provided subsidized land to railroad corporations, which otherwise would not have been able to finance these massive infrastructure projects. Land grants were central for the expansion of the economy, and suggest that the role of the government was much larger than if one looks simply at the level of spending in this period, which was modest, by modern standards.

In other words, protection did play a role, but it was not sufficient to explain the industrialization boom of the late 19th century. Government support for the expansion of the domestic market was key. I do not expect, and so far that has been the case, that the Trump administration will cut significantly spending. A lot of the money that they will spend, will certainly go to contracts for big corporations. In that sense, American corporations will continue to benefit from government largess, but I doubt jobs will come back in great quantities. Note that manufacturing jobs were constant up to the entry of China in the WTO, and then even when they collapsed in the early 2000s (explaining the Tea Party and Trumpism itself to a great extent), at least for a while, it went hand in hand with the expansion of manufacturing output. Only in the last 15 years, in the aftermath of the Great Recession did manufacturing production stalled, and that was during a period of relative modest government spending growth (the Obama-Trump lackluster recovery).

In my view, and this is admittedly impressionistic, cost of production in the US will remain too high, and alternatives will still be more attractive than moving production back to the US. Also, while I do think that the new Republican coalition is fractious, and some may really want to bring back manufacturing jobs, neither Trump, nor his main backers (mostly wealthy billionaires) are pro-workers or really concerned with bringing back good manufacturing jobs. He is dismantling unions (in the Federal bureaucracy) and has a very pro-business, anti-labor set of policies. Even in immigration that could strengthen labor to some extent, he has not deported more than Biden, at least not yet.

On the critical, progressive side, the most common critique is that tariffs will lead to a collapse of the global economy, like the Smoot-Hawley Tariff of the 1930s, and a significant acceleration of inflation. Perhaps even stagflation. I, obviously, think that fears (or hopes) here are also exaggerated. Smoot-Hawley did not cause, and did not even exacerbate the Depression (even if it did not help either), the latter a view that is probably in the minority these days. And as I noted repeatedly, while tariffs will have a short run effect on inflation, since they will affect the level of prices, they will not lead to persistent inflation, which will come down fast, as did it after the pandemic. The problem will be that workers this time will not have higher wage increases. In other words, tariffs will hurt some people in the economy for sure. But that is a matter for another discussion.

On 'free' and managed trade

In one my last posts I promised to talk about "free trade." As I said the name itself is a misnomer, much like "free market." Not just because it suggests that those that oppose it are somehow against freedom, but mostly because it vaguely indicates that trade and markets are like natural phenomena, which would spring out if only government restrictions were eliminated.

In fact, it is well known, at least since Polanyi's classic, that the key markets in capitalist economies (those for land, labor and money) were slowly created by the interplay of social conflicts articulated through the political process and that their very existence results, in part, from the power of the State. Thus, simplistic and manicheistic views on the relation between the State versus the 'free' market miss the point of how States and markets co-evolved historically.

For example, the Bank of England, created in 1694, obtained the monopoly of money creation only after the Bank Charter Act of 1844, something that resulted from the victory of the City (financial interests) over the country banks (closer to commercial interests). The money issuing monopoly would be impossible without the backing of the government (and its monopoly of violence). The same can be said about international trade transactions. For example, it is well known that the period of the so-called first globalization (1870-1914) saw a significant increase in the volume of world trade. However, several regions actually became more 'protectionist,' i.e. increased the tariffs on trade (see Paul Bairoch for a good discussion on the topic).

In Latin America the higher tariffs allowed government revenue to increase, which, in turn, created the conditions for national armies to reduce domestic conflicts, and centralize administration, provide guarantees for foreign lenders, and fund the construction of railroads and ports. Without tariffs and higher government revenue the integration into world markets would not have been possible.

That does not mean that everybody in Latin America (or in other regions for that matter) did benefit from the increase in international trade during the period [it's worth remembering that in Mexico, towards the end of the period, peasants did revolt against the Porfiriato in the so-called Mexican Revolution of 1910]. It was not 'free' trade that produced growth, but the management of trade to produce commodities for the center (a particular project supported by local elites and international financial and commercial groups) that led to growth (with high levels of inequality).

A more logical discussion, for all these reasons, should not be about 'free' trade versus protectionism, but about what type of managed trade a given society wants, and who benefits from the different trade arrangements. For example, in current discussions about bilateral and multilateral trade agreements the issues of investment and property clauses are essential. The dispute is mostly about those that want to protect the interests of corporations (e.g. property rights, access to foreign courts, elimination of financial regulations forbidding sending profits abroad, etc.), and those that might have alternative interests (e.g. protecting domestic jobs, creating national capacity for industrial innovation, the environment, etc). In fact, for specific cases, like defense or sanitary and phytosanitary rules, it is well established that trade should be regulated, i.e. not 'free' but managed (for discussions of some current problems with the 'free' trade agenda see here and here).

But the problems for the defenders of 'free' trade are not limited to the inconsistencies of their policy positions. In fact, despite the general agreement on 'free' trade by academic (mainstream) economists, the theoretical foundations for their position are very shaky. The basis for the argument harks back to David Ricardo's Principles (and also to the parallel work by Robert Torrens). Ricardo argued that if England and Portugal traded without imposing tariffs it would be mutually beneficial, even if Portugal was better at producing both goods being traded, cloth and wine. The reason is simple. Even if Portuguese workers were more productive than their English counter-parts at producing both goods, they might be better at producing one of them (say wine) and would still benefit from putting all their efforts behind the activity at which they excelled.

In other words, the argument for trade without tariff or other restrictions was based on the the idea that trade is equivalent to access to better technology. The Portuguese could specialize in what they are better technologically, and obtain through trade the things that they do not produce. The English would have also access to better wine. Both would get cloth even if the English were less effective at producing it. The message is: specialization is the wealth of the nations.

However, what is often missed in the discussion is that the Ricardian argument for comparative advantage, as it is the case with all economic models, depends upon certain special assumptions, and that those premises responded to Ricardo's own political views. First, Ricardo assumed that all workers that were employed in wine production in England would find jobs in cloth production, and that all workers in the cloth sector in Portugal would be able to work in the wine sector. Say's Law of Markets, that suggests that general demand crisis do not take place domestically was extended to external markets too. Workers are always employed by definition (not necessarily full employment for Ricardo). Further, Ricardo assumed that capital was immobile, that is, even if it was cheaper to produce from Portugal (given its higher productivity and lower costs) and export to England, English capitalists would prefer to maintain their capital in England and produce in the home country.

Note that if any of those assumptions is violated Ricardo's argument falls apart. In other words, if workers in England and/or in Portugal in the displaced sector cannot find jobs in the other sector, it is unclear that all benefit from 'free' trade. Also, if capitalists can and do move from country to country (interestingly enough Ricardo descended from a family of bankers emigrated from Portugal to Italy, then to the Dutch Republic and finally to England) then in his example the lower costs (absolute advantage) of Portugal would determine that both cloth and wine would be produced there. England would be in a difficult situation importing both goods and condemned to grow at a lower pace, which is exactly the opposite of the historical situation (for an analysis of Anglo-Portuguese trade after the Methuen Treaty of 1703 that allowed Portuguese wine to be exported to England free of taxes and the same for English textiles into Portugal see Sandro Sideri's Trade and Power).

The reasons for Ricardo's special assumptions are very well-known. Ricardo represented financial and industrial interests, and was a harsh critic of the Corn Laws, the tariffs on imported grain imposed after the Napoleonic Wars, that favored the landed and aristocratic classes, defended by his friend Robert Malthus. Ricardo assumed that wages were at the subsistence level, and that tariffs on the importation of grain would lead to the use of more and less productive land in England for their production, increasing the rent accrued by the landowners. For a given output, and fixed wages, the higher rent would necessarily reduce profits, and capital accumulation. In other words, the special assumptions (which Ricardo thought relevant for the particular case of England in that particular historical context) were instrumental in his argument for the elimination of tariffs on grain imports. His was a progressive argument for industrialization and against the agrarian aristocracy (for a discussion of Ricardo's political views see Milgate and Stimson's Ricardian Politics).

Generalizations of the Ricardian argument can only be defended if his assumptions (including that displaced workers do find jobs and there is no capital mobility) are also thought to be generally valid. More modern arguments for 'free' trade rest on the so-called Heckscher-Ohlin-Samuleson (HOS) model, that is fraught with logical problems, and even less defensible than the generalization of Ricardian views, but I'll deal with those in another post.

PS: My paper "What Do Undergrads Really Need to Know About Trade and Finance" might provide a more detailed discussion of some of the issues above. Robert Vienneau has posted here elements of the Sraffian critique of the HOS model.