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One topic that I was thinking about lately is regarding tariffs and some sort of hidden cognitive dissonance behind the whole policy. It seems to be a clash of different type of worldviews, one being the so called industrial policy, which is a policy where a nation creates favorable environment to grow domestic behemoths and grow their domestic economy. There are multiple examples of countries employing this type of policy such as South Korea, China or even Japan back in the day.
On the other side of the spectrum you have standard economic theory in favor of free trade. It has formidable range of theories for why this is ultimately the best policy, the most important one being the concept of comparative advantage.
Now to get back to the cognitive dissonance stuff, there is one huge question. If you are in the latter camp where you oppose tariffs and trade regulations - why are these people not against retaliatory tariffs? From this standpoint it seems as if you are shooting yourselves in the foot. If USA imposes tariffs on some goods like steel, then you can actually take advantage of that in free trade framework: buy state subsidized steel from USA to build your own infrastructure and factories for cheap, and then use this advantage to sell things you produce back. And even if USA decides for some broad tariff regime, it still enables you to use this advantage to sell goods to other countries. Under this framework the only country punished should be USA and the rest of the free trade world should be winners.
The other side of the cognitive dissonance is that in fact at least during last few decades a lot of economists are actually pro industrial policy. You can easily find articles like these where protective measures are praised. The same goes for EU, which explicitly aims to subsidize certain industries.
I think that the most interesting example here is China, which especially subsidies the basic production capacities: energy, steel, concrete, basic chemicals etc. These basic commodities tend to "supercharge" the rest of the economy, mostly as they are hard to transport and thus create at least local monopolies. It also benefits and/or suffers from so called double marginalization problem, as costs of goods at the bottom of supply chain propagate positively/negatively throughout the rest of the economy. Moreover creating complete supply chain in certain place increases intangible "know how". You can then have experts on the whole supply chain working collaboratively with each other to produce superior goods cheaper. Think of Detroit being the old car hub or Silicon Valley as a hub for software or Hollywood for entertainment industry.
To be frank I am leaning more into industrial policy side now, especially since COVID-19. Noah Smith has an article defending such a policy for national security reasons. But in the end with how complicated the supply chains are, this becomes almost an impossible conundrum. Just take chip production issue: you have to have mining facilities for pure silicon and other valuable minerals. Then you have to have companies designing new chips in research labs. Then you have companies capable of producing highly sophisticated lithographs capable of producing high-end chips, such as ASML in Netherlands. Then you have to have companies capable of producing said chips such as TSMC in Taiwan. The whole system is very fragile and even one of the chains in the links proves security risk. The same goes for pharmaceutics or other technologies.
Isn't that basic game theory? A retaliation might hurt you, but it beats the alternative in the hypothetical pay-off matrix where you meekly accept unilateral tariffs. At the very least, it dissuades future trading partners from considering tariffs when you have a reputation for tit-for-tat.
I would agree, but only in case when tariffs actually have some impact on targeted nation. Again, the free trade doctrine would mean that tariffs are bad just for the country enacting them. There is no game theory where you have two players and one just shoots himself in his foot. The other player either does not care, or maybe he can use the now injured other player to take advantage of. He should definitely not "retaliate" by shooting his own foot. It does not make sense.
So even if adopting this game theory framework - if tariffs are so universally bad, why interrupt your enemy when he is making a mistake? And if tariffs are so effective that they help the enemy player at your own cost, then tariffs are actually useful and good at least in some case and we can have honest discussion who is benefiting and who is losing given certain trade framework. That is the core of the cognitive dissonance I am talking about.
No, if your opponent shoots himself in the foot (and splatters blood on you, which is irritating and expensive), you respond by shooting him in the kidney and try to dodge the blood spray.
When the US put tariffs on Chinese steel and aluminum, the Chinese put tariffs on American soy beans, which directly hurt the republican heart land and didn't really hurt their own farmers all that much - Brazil was still selling soy beans after all.
Effectivity, this is a step beyond the standard prisoners dilemma. You can choose where you defect, and the gain/loss can be very asymmetrical. It also can be more than monetary gain/loss, since the payoff might be in geopolitical position or voter opinion instead of trade balance.
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I'm no economist, but my understanding is that tariffs harm both parties. If, likely due to ideological reasons, someone makes a mutually negative sum decision, then you're justified in punishing them.
So they're not just shooting themselves in the foot, the spread from the shotgun is hurting the other party too. They're making a mistake that hurts you too, and you'd very much prefer they didn't do that, even if you're agnostic on whether you want them better or worse off.
Sure, but then the question is how and why. Details matter in this case as reasons may bring more light into the whole issue of tariffs.
Moreover this to me seems quite a different statement: any country that refuses to trade with us under any circumstances except of condition of absolute free trade, is harming us and we will retaliate. This is quite a statement, especially when it then comes to oxymoron of mandatory "free" trade. You would probably not deal like that with an individual.
Also there is more to this type of thinking. In this framework Trump is then also right regarding VAT/Sales tax. If country A has sales tax of 20% and uses this tax for instance to provide free health care, then it is using taxes on foreign goods to artificially bring benefits to its domestic workers. Country B with sales tax of 0% is thus "harmed", right?
This is why details matter.
A VAT applies equally to foreign and domestic goods. It is not similar to a tariff.
Whether applying a retaliatory tariff (harming both sides) in order to kick the first side into dropping their tariff is a quantitative question that can easily differ from one situation to the next. It is not amenable to a reductio like "any country that refuses to trade with us under condition of absolute free trade is harming us and we will retaliate".
It is similar to tariff, as VAT on foreign goods is used to subsidize domestic production. Revenue from VAT is used to subsidize domestic infrastructure, healthcare and other benefits for domestic workers and companies, or they can even provide direct subsidies. None of these are available for factories or workers from foreign manufacturers who get nothing from VAT imposed on goods they produce. So in the end domestic producers reap more advantage compared to what they pay as a tax.
Okay, so what are these quantities and what are costs or benefits to that? If retaliatory tariffs are beneficial then under what conditions? What if these conditions are met when you are the one enacting the tariff as first mover - should you do it?
It's the subsidy to domestic production that's the issue here, not the VAT for raising revenue. The VAT falls on domestic and foreign producers equally. An income tax is no different from a VAT in this respect.
The cost to the retaliating entity of the foreign tariff, and hence the benefit of getting rid of it. The cost to the retaliating entity of the retaliatory tariff. The chance of success, and how long it would take.
Under the assumptions in this discussion (that a tariff harms both sides), the conditions cannot be met enacting the tariff as a first mover.
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Furthermore, despite obvious structural problems the USA is economically much healthier than the EU, Canada & Mexico.
So from a leverage / bargaining position tariffs make a certain sort of sense; we are much more well placed to absorb the hit and bounce back. It’s like a Mexican standoff where one person has a Kevlar vest and the other person has the shakes from alcohol withdrawal.
It’s completely in line with the “Daddy’s home” / “My house my rules” vibe that sustains the MAGA movement. Trump has been entirely consistent in his sentiment that the USA has been taken for a ride by its supposed closest allies and partners, and it’s time to play our hand. He’s been saying it for like thirty years, it’s his most deeply help political belief as far as I can tell.
We are stronger than Canada, Mexico, the EU, China, and Japan. We are not strong enough to pick a fight with all of them at the same time! The only sane trade policy for industrialization is to encourage trade within the Americas, with our friends, with whom we exert outsized influence as opposed to the EU and the Pacific. Free trade has very clearly worked in this context as evidenced by the comparative economic success of the US. The extent to which it hasn’t is the extent to which we should fuck with it (not much) which I was under the impression that we already resolved under Trump 1.
How much has Canada actually taken advantage of the US?
At the end of the day, the US will not be a net exporter and have the strongest currency in the world.
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