The Economic Impact of a “Border Tax”

There’s been a lot of talk about President Trump’s proposal to tax imported goods coming through our southern border that has led to a debate about the benefits of trade […]

There’s been a lot of talk about President Trump’s proposal to tax imported goods coming through our southern border that has led to a debate about the benefits of trade (specifically “free trade” agreements) and the real costs of protectionist policies (“border taxes,” aka tariffs, as well as quotas, etc., are all specific types of “protectionist” policies). I hope the following, adapted from my book The Common Sense behind Basic Economics (used copies now available here at Amazon for as low $16, an absolute steal! Ha!) helps to explain why trade benefits everyone, and how tariffs, taxes, etc. on imported goods rarely benefit the intended beneficiaries (us).

However, there are a couple of caveats that I did not explicitly discuss in the book.  First, there is a difference between trade in general and free trade.  If trade in general is beneficial, free trade is generally even better, but it works best if it’s truly free.  It may not be helpful to enter a “free trade agreement” when the trading partner then manipulates its currency or alters other domestic policies that undercut the intention of the agreement and benefit one country over another.  Also, political leaders interested in obtaining better trade agreements may use protectionist policies as temporary leverage in the negotiation process.  I suspect, and hope, that the new President (known for his negotiation skills) is currently pushing for a “border tax” as a means to achieve the latter.

This first snippet is on the Theory of Comparative Advantage, describing the benefits to all countries from trade:

The Theory of Comparative Advantage helps to explain how this works
and how all countries benefit from trade. Yes, all countries, even those
that are trumped by other countries in virtually every skill and are less
productive in every industry (poor Burundi), can still benefit from trading
with the rest of the world. What makes this benefit beneficial is the
fact that countries gain when they specialize in a service or producing a
good that they are “most good” at compared to others. Basically, countries
have to focus on what is most productive for them.

To get better insight in to why we all benefit from trade you’ll have to buy the book (did I mention it’s deeply discounted on Amazon right now?).

But now for the good stuff.  This next section gets into the weeds to better explain tariffs and quotas…just keep in mind those caveats (and forgive the formatting and randomly-placed numbers, it’s from the publisher’s pre-published draft).

PROTECTIONISM VS. OPEN BORDERS
Although free trade benefits the world on the whole, some particular
business sectors, and those employed within them, may be harmed by
free trade. Everyone has seen the impacts on employees of a company
who decides to move its manufacturing abroad. When Americans lose
jobs to other countries, the pressure is on for legislators and government
administrators to make some changes.
Well, never fear, our elected leaders have a number of tricks up their
sleeves to “help” those impacted by free trade (a.k.a. voters). Good or
bad, all of these tricks impede free trade. One of the most popular impediments
is a system of taxes on imported goods, or tariffs, ostensibly to
teach those efficient overseas producers a lesson and to protect our domestic
producers. Unfortunately, Americans pay when prices on those
goods rise, and so do the economies of the countries from whence they
come.
Import quotas and other barriers and subsidies are also effective at
controlling imports and exports, but in the end, all barriers effectively
reduce competition and efficiency both at home and abroad. Why does
this happen? Well, let’s go back to an example.
Suppose the latest and greatest smart phone is produced by Samsung
Electronics in South Korea and sold in the U.S. for 500 dollars. (We all
know that the phone is really made in China, but indulge me here.)
Suppose a manufacturer in Michigan makes a good phone that costs 100
dollars more than the Samsung, with a retail price of 600 dollars, but still
lacks the quality of the Samsung. So the two senators from Michigan get
together and say to their peers in the Senate: “Hey, this is crap. We want
American jobs and manufacturing to prosper, so let’s put a tariff of 21
percent on those phones from Korea.”
So now, the 605 dollars phone from Samsung is more expensive than
the American phone. Well, the Senators were right and people now buy
less of the Samsung phone, more of the American phone, and the produc
tion facilities in Michigan boom, jobs increase, and more money stays in
the American economy, for this particular transaction.
[19.20] However, the reality is that no one really wins. Now that it’s more
expensive to purchase a smart phone similar to the desirable Samsung,
fewer people will buy it. “I was cool with spending five c-notes on a
phone, but six? Nah, I need that money for some new kicks,” you might
say. Those who do buy, have to spend more, reducing the money they
might have used to purchase other goods or to save. Many will actually
choose the lesser-quality Michigan-produced phone, so they will spend
more and get less. Consumers lose. (I’m sure someone will think that I’m
bashing American producers here, but that’s not my intention. Clearly, if
we wanted to, we could make the best products in the world, but comparative
advantage prevents us.)
[19.21] On the other hand, one might argue that the Michigan producer gains
and the increased economic output are good for the local and national
economy. Because of the tariff they receive the higher price and can add
more to the bottom line. Yes, this particular manufacturer, and its employees,
will gain from the tariff. Clearly, this is why so many domestic
manufacturers are strong advocates (campaign donors) for trade barriers
that affect the competition. If you simply refuse to think past this local
benefit, you might miss the full economic impact. There are always economic
repercussions that extend beyond those directly and initially affected.
[19.22] First, Samsung is going to take a hit. Who cares? They’re not
Americans. We have to look out for number one first, right? Think deeper.
Koreans like to buy American products too. But when Samsung has to
shrink production and lay off employees, South Koreans can’t afford to
buy as much from us as they wanted. Perhaps one of those employees
was saving for a Harley-Davidson Fat Boy, but now can’t afford one. On
the whole, Harley sales to South Korea will fall, which may push total
Harley sales down, decreasing production. If the Harley-Davidson manufacturing
facility in York, Pennsylvania has to lay off employees, their
local economy suffers. The negative impact may not be as dramatic as the
positive one in Michigan, but Harley-Davidson is only one of many others
that will suffer. In the end, did the senators from Michigan hurt or
help our country?
[19.23] What about the additional revenues that the government gains from
the tariff? That’s good for us, right? Well, not really. Although the
government does gain, the gain is really just a transfer of money from
consumers to Uncle Sam. The net benefit to the economy is nil, zero, zip,
zilch, nada. Uncle Sam basically just found a back door to your wallet.
And what does he do with his money? Well, most likely he is going to
have to give some to help subsidize the economy through welfare benefits
or other economic support due to the local economic effects from the
tariff.
Besides the transfer of dollars to Uncle Sam, higher consumer costs, [19.24]
and decreases in American exports, tariffs also have the net effect of
incentivizing inefficiency. That manufacturer from Michigan who is having
a hard time competing with Samsung now has no reason to improve
its products or find a way to reduce its costs. Why would they? They’re
making cash money.
Quotas Can BeWorse [19.25]
Some legislators know a little bit about this, so they instead advocate [19.26]
for quotas on imported goods. Our favorite Michigan senators might ask
for a limit on the number of Samsung phones that are imported, so consumers
that want a similar phone, have no choice but to go with the
Michigan producer. Well, they might have chosen the worst of the bad
options.
Quotas have two effects. First, at least with a tariff Uncle Sam was the [19.27]
one ripping off consumers, which would ostensibly be used in America
for Americans somehow. But when a quota is enacted, we might as well
just send a check to foreign countries. Samsung isn’t going to stop selling
phones just because they aren’t being sold here. They’re taking their ball
and going to another court. Europeans might be perfectly happy buying
the new phones at the price Samsung wants. And given our increasingly
connected and globalized world, we all know how to get a product that
isn’t sold here in the U.S. if we want to. Since Samsung still has a comparative
advantage over our Michigan manufacturer, many of us still want it
more than the Michigan phone, no matter what price it’s sold for, so we
look for it on eBay, Amazon, and some other foreign companies, who will
be more than happy to ship us a phone. Except their price is going to be
higher than it would have been if it was imported directly to American
retailers. Why shouldn’t they profit off our government’s folly? And the
ripple effect extends from there. Americans lose doubly this time.
As you can see, with free trade, the most efficient goods are produced [19.28]
and the most efficient manufacturers are rewarded by consumers, while
with tariffs, quotas, and other trade barriers our scarce resources are
moved to those who do not have a comparative advantage and are less
efficient. Again, you don’t have to take my word for it. Do a quick search
on Google Scholar and you’ll find numerous studies showing the net cost
to society from trade barriers.
Are There Good Reasons for Either? [19.29]
With so much evidence proving that trade barriers decrease efficiency, [19.30]
why do we still have them? There are some good arguments and rational
reasons that go beyond the politicians need to help his precinct’s voters
(or give the perception that he or she is helping them). Our nation’s
security is, and always will be, the most important issue to most
Americans. If those Michigan senators can’t ensure that Detroit’s residents
can get their daily Starbucks Caramel Macchiato without fear of
getting hit by an incoming missile from North Korea, there’s going to be
hell to pay.
[19.31] It’s hard to argue against manufacturing our military’s equipment
here in the U.S. If the Taliban, Al Qaeda, or Islamic State somehow finds a
cheap way to make the MRAPs (Mine Resistant, Ambush Protected vehicles)
that our military personnel need, would it be wise to buy from
them? At this point, I’d recommend a quota and/or tariff that pretty
much pushes them out of the market (combined with a missile up their
manufacturing facility’s backside).
[19.32] The only problem is that companies, and politicians, are really good at
making this argument for whatever product they want. The case of the
cell phone? Hey, if a foreign corporation makes the phone, can they then
sell the technological know-how to our enemies that allows them the
ability to tap into it? Compelling as it may be, we have to resist the
temptation to restrict all of our imports in the name of security.
[19.33] Security will always be number one, but there are a few other arguments
to be made for protectionist practices that you budding economists
need to look out for. Sometimes a country wants to diversify the number
of successful industries within its border and also help the ones that are
budding, but just need a little extra push. So they “temporarily” restrict
outside competition, hoping to incubate and diversify. The problem is
that there is no way to ensure that these industries will be successful in
the long-term if they aren’t compelled by the forces of competition that
make other industries better. What happens when barriers are removed
and these companies aren’t ready to compete?
[19.34] Human rights advocates are often critical of the low wages that employees
receive in other countries, such as China and India. They argue
that we should implement protectionist trade barriers to “punish” these
companies into compliance. I won’t get into all of the logical fallacies of
this argument, but what if we didn’t buy from a Chinese company that
was employing former subsistence farmers in their factories? Those employees
would either lose income altogether or go back to the lower
paying farming gig they once had, while Americans pay higher prices for
goods and transfer resources to less efficient production. No one gains.
[19.35] Absolute free trade has never existed on a world scale. Countries have
always found a way to get in the way of their own progress, sometimes
with justifiable and rational reasons. However, this hasn’t stopped numerous
attempts to make trade just a little freer through trade agreements
like NAFTA, LAFTA, the WTO, and the European Union. Plug any
of these acronyms into your favorite search engine and you’ll find thousands
of both scathing reviews and unfiltered admiration. I only hope
you now know just a little more to read them all with your own critical
eye.