Let's Talk Tariffs
Thinking through a new trade-reform proposal. Links on trade, industrial policy, the loss of trust, and the role of the uncanny.
There’s been a lot of heated debate about American Compass’s proposal of a 10% global tariff. The Twitter exchanges have been, shall we say, spicy.
Rather than getting into some grand argument about “free trade” versus “protectionism,” I thought it would be a useful exercise to think through the American Compass proposal on its own terms and work through some of the political and policy issues involved in it.
(Spoiler alert: This analysis is not going to come to any conclusion about whether a global tariff would be a good idea or not. I just want to raise some variables to consider. No hot take here! But I feel like the market for hot takes on trade is pretty saturated at the moment.)
First of all, I think much of analysis of American Compass’s proposal has missed its inner logic. It’s not simply a proposal for a 10% global tariff. Instead, it’s a bit more sophisticated. Here’s the text of the proposal:
Legislation should direct the Department of Commerce to impose a simple, uniform tariff on all imports, beginning at 10%. For any year that America continues to run a trade deficit, the tariff would increase by five percentage points for the following year. For any year when trade is in balance or surplus, the tariff can decline by five points the following year.
What American Compass is proposing here is a thermostatic tariff. Trade deficits ratchet up the global tariff; surpluses cause it to fall. This is more dynamic than conventional tariff regimes. One of the points that could be made on behalf of a thermostatic tariff order is that it could perhaps prevent global trade balances from becoming too lopsided. For instance, Michael Pettis (along with some others) has argued that the massive trade surpluses run by the People’s Republic of China have distorted both the global marketplace and the PRC’s own economy. A thermostatic tariff regime could hypothetically be one way of counteracting the destabilizing risks of massive surpluses or deficits in the global trading market.
This kind of thermostatic tariff regime may be somewhat compatible with Ricardian comparative advantage. The point of a thermostatic tariff is not to minimize imports or to create some absolute autarkic self-sufficiency. It’s to have a balance between exports and imports. If one country can export shoes to the world while importing the raw materials to make those shoes, so much the better under a thermostatic tariff regime. A global thermostatic tariff is indifferent to bilateral deficits or surpluses with any particular trading partners; its focus is a nation’s balance of trade with the globe as a whole.
Unlike some other tariff programs, a thermostatic tariff might also be to some extent globally scalable. Some tariff regimes risk a retaliatory spiral—where Country A puts a tariff on Import X, so Country B puts an even higher tariff on Import Y, and so on and so forth. The dynamic with a thermostatic tariff might be different. Each operating under some thermostatic tariff regime, multiple countries could trade with each other. If one country started to generate considerable deficits, it would start to ratchet up the tariff until some new balance of trade was found. Different trading partners might have different “equilibrium” tariffs. For one country, 10% might be enough for it to maintain a trade equilibrium. Another country might have a 15% or a 5% equilibrium tariff.
The dynamic nature of the thermostatic tariff regime would mean a rethinking of what “parity” means in global trade. Many policy discussions about trade today assume that “parity” means equivalent tariff rates between countries; a thermostatic regime might instead focus on getting each trading partner into some trade equilibrium and then adjust tariff rates to promote that equilibrium.
In debates about trade, it’s worth remembering that perhaps the central motivation for a “free trade” regime in the aftermath of World War II was political—not economic. Policymakers believed that trade between nations would be a way of lowering the risks of global conflict. In the 1840s, J.S. Mill anticipated this argument in Principles of Political Economy: “The great extent and rapid increase of international trade, in being the principal guarantee of the peace of the world, is the great permanent security for the uninterrupted progress of the ideas, the institutions, and the character of the human race.” In his memoirs, FDR’s Secretary of State Cordell Hull (and one of the principal architects of the “postwar international order”) built upon Mill’s argument to say that “unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with war.”
To some extent, this was a utopian vision. Nevertheless, there is a major geopolitical component to trade agreements. During the Cold War, the US used trade policies to help solidify an anti-Soviet bloc, and trade remains an important way of building networks of international support.
This suggests that any assessment of a trade regime should also consider its diplomatic and geopolitical effects. In that respect, then, the potential for a thermostatic tariff regime to be globally scalable could be a point in its favor.
I reached out to Oren Cass, the head of American Compass, about this proposal, and he said that the global tariff would be only a “baseline”: “higher tariffs would also be appropriate for nations without [Most Favored Nation] status and in particular cases where we want to target national security issues or dumping or whatever else.” This suggests that the thermostatic tariff would also be compatible with other efforts to tweak trade policy for the sake of national security and international alliances. The United States could put in place additional protections for key strategic goods as well as to disrupt trading patterns that could endanger national security. (It’s also worth remembering that the “free trade” of the postwar order did not include “free trade” with the Soviet Union. Geopolitical demands had priority over some abstract economic dogma.)
One possible tweak for a thermostatic regime would be to introduce some tolerance into the measure (just as a thermostat might only turn on the heat after it detects a whole-degree drop in the ambient temperature). Theoretically, a nation could continually toggle between a 5% and 0% tariff as it bobs around a trade equilibrium. That introduces some perhaps-unnecessary uncertainty. Putting in place some thermostatic tolerance could help stabilize a tariff rate from year to year. For instance, the thermostatic tariff might not increase until the trade deficit hit 1% of GDP, or it might not ratchet down until a trade surplus hit 1% of GDP. (There are also more complex calculations that could be done to create some zone of tolerance, but I’ll offer that simple example for now.) Because it’s often more disruptive to raise taxes than cut them, the thermostatic tolerance might not even have to be symmetrical around zero: hitting a 1% GDP deficit might be required to ratchet up the tariff, but a 0.5% GDP surplus might be enough to lower the tariff.
I’ll note in passing that nations seem able to run modest trade deficits relatively indefinitely and still flourish. Here’s a chart made by the St. Louis Fed showing that the U.S. ran trade deficits under 2% of GDP throughout much of the 19th century and still rose in power:
(Sidenote: I’m note sure I agree with the decision to create an “average” from 1970-2018. The trade paradigm from 1970 to 2000 was very different than the post-2000 paradigm, and deficits over the past 20 years have been significantly higher than the average in the 19th century. At a certain threshold, trade deficits—like other deficits—may be more of a strategic challenge.)
One possible wrinkle for a global thermostatic tariff is that it de facto favors local supply chains over international ones. To its proponents, this might be a feature rather than a bug, but it does introduce some potential complications.
For countries that are net exporters of goods that rely on global supply chains, ratcheting up a global tariff could risk being counterproductive by raising the costs of components for exportable goods. Let’s look at the fictional example of Hersheystan. It exports chocolate to the world but also needs to import cocoa beans. Due to a hearty appetite for Taiwanese microchips, its trade deficit has ballooned, so the global tariff has gone up 5%. But this means that cocoa beans have become more expensive—which could in turn hurt its exports for chocolate (exports that could be used to reduce the trade deficit). Theoretically, Hersheystan could counteract the risks of this import price hike by growing its own cocoa beans (though its climate might not be ideal for that) or by relying more on some non-chocolate form of export. Maybe policymakers could devise subsidy programs to compensate for tariffs on strategic imports. Maybe the consequences of those increased tariffs on imported components would all come out in the wash. Nevertheless, there could be some disruptive potential here.
And that brings me to a political issue. I think there would be considerable political pressures to exempt certain goods from a global tariff. Energy might be the most prominent general example here. A lot of manufacturing is very energy-intensive, and energy costs are often at the forefront of voters’ minds. Thus, there could be major political pressure not to raise tariffs on—say—oil imports if the trade deficit increased. Again, those tariffs might encourage some countries to produce more energy at home, and none other than Charles Krauthammer was open to import fees on oil in the 1980s in order to keep enough oil production in the U.S. However, many countries do not have the same energy resources as the United States, and I think even many American policymakers could push back against tariffs on energy.
How this would turn out remains unclear, but I think the reality of those political pressures should be recognized. The potential for political pressures does not necessarily disqualify the idea of a thermostatic tariff—political interests have thoroughly shaped the current status quo on global trade. If the risk of political influence disqualified an economic policy, there would be no economic policies at all. But in gaming out a global tariff, that’s a variable that needs to be considered.
A related policy question would be what to do with the fees accumulated through a global tariff. There are a variety of options. Those sums could be bundled into the general federal budget, though I have doubts about the efficiency of that. Another option would be to shift some of the tariff money into a “trade calibration fund” (TCF) that would give a sliding-scale tax credit based on income. The point of TCF money would be to help compensate for the higher prices lower-income consumers might face on imported goods as a result of tariffs. It would be important to keep the TCF targeted in order to minimize inflationary risks. Tariff money could also be used for investments in infrastructure, basic research, and other big-picture efforts to improve the economic efficiency of the United States. It goes without saying that what to do with tariff funding could become a major political football.
A question lurking in the back of these debates is the People’s Republic of China. While the United States runs trade deficits with many other nations, the growing influence of the PRC on the American economy is a major motivating force for many proponents of trade reform. The goods trade deficit of the PRC was close to $400 billion in 2022—far and away the biggest bilateral trade deficit that year. More focused reforms on trade with the PRC (something that American Compass has also discussed) could perhaps help address those economic concerns more directly.
Some links on trade, industrial policy, and other issues.
At the brand-new magazine of ideas FUSION, Samuel Gregg makes a realist’s case for trade:
Trade liberalization may not lead inexorably to universal peace. But it does promote very particular and tangible goods for countries, not the least among which is the fact that the wealthier a country becomes, the stronger and more influential its place in world affairs. Protectionism, by contrast, gradually weakens a country by 1) rendering it less competitive; 2) diminishing the pace and scale of economic growth; 3) encouraging legislators and citizens to be less attentive to the willingness of other people in far-off lands to work harder or be more entrepreneurial than them; and 4) making its citizens more subject to the whims of domestic special interests seeking privileges for which everyone else pays.
“Is industrial policy making a comeback?” The Council on Foreign Relations wants to know.
To its supporters, a new U.S. industrial policy is essential to respond to China’s state-led development, secure a supply of critical materials and products, and develop technologies that could preserve the planet. They point to the use of industrial policy not only in China, but also in countries such as Germany, Japan, and South Korea, as well as its historical use in the United States. To critics, such a policy inevitably distorts the free market and rewards companies not for the quality of their products and services but for their skill at lobbying lawmakers. President Donald Trump upended the Republican Party’s traditional stance on economic policy by imposing new barriers to trade, while President Joe Biden has overseen the passage of major industrial policy legislation, including the CHIPS and Science Act and the Inflation Reduction Act.
A conversation between Erica York and Oren Cass on trade policy.
National Security Advisor Jake Sullivan on “de-risking” trade (from April of this year).
Charles Fain Lehman on how demographic change impacts arguments for “reparations.”
A report from the American Enterprise Institute looks at the decline of institutional trust in the United States:
A nationally representative survey conducted by the Survey Center on American Life finds that a growing number of Americans are distrustful of scientific and medical experts. This distrust cuts across demographic lines but is especially acute among Republicans and evangelical Christians. This phenomenon poses significant challenges to democratic debate and public policymaking across a wide range of scientific, technological, and medical issues, including climate change, public health, and artificial intelligence (AI).
Lincoln Michel delves into the role of the uncanny for horror. (Hey, gotta have some Halloween content.)
In case you missed them, some recent pieces of mine:
On the roles of culture and economics for a political “realignment.”
Defending the human during the digital revolution.
Mike Pence looks back on Reagan’s legacy.
New thinking on immigration (and the minimum wage) from some Republican senators.
How RFK could impact the 2024 presidential race.
The “guns and butter” tension at the heart of Biden’s foreign policy.
Hey, what’s going on in the House anyway?
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