Exogeneity & Economic Growth: Why America Needs Tariffs

black swan

The Case for Tariffs

President Trump promised to put America first when it comes to foreign trade. Most conservatives think this is a good thing: why should we let Japan manipulate its currency with impunity? Why does the U.S. government allow China to dump below-cost goods into the American market, killing local industries? These concerns are reasonable.

And yet many libertarians, and establishment Republicans, are unwilling to take action. They fear that by imposing tariffs, or simply enshrining reciprocity in our trade deals, we will start a trade war. Strong words. They claim that American exports, such as beef or bourbon, will suffer if we tax Chinese semiconductors. Beyond that, they argue international free trade is always good, reciting the mantra trade is not zero sumeveryone wins.

Of course, reality is more complex than slogans. Modern scholarship, from Michael Porter and Daniel Kahneman to Benoit Mandelbrot and Nassim Taleb, has completely debunked the presumptions underpinning classical, liberal economics. We now know that free trade is domain-specific: it only applies when certain preconditions are met. There are a number of technical reasons for this, but the main point is that not all industries are of equal value—some are better long-term investments than others.

Businessmen understand this; economists do not.

How Does the Economy Grow? Exogeneity

To understand why some industries are better than others, let’s revisit how economies grow. Economic growth occurs when—and only when—either more stuff is made or better stuff is made.

For example, America’s economy grows when it produces more cars or bushels of wheat, or better cars and more nutritious wheat in the same time period. This applies to all products, whether goods or services. This point is rather obvious, and axiomatic.

Now the question becomes: how do we make more stuff? There are two options. First, we could work harder: want more wheat? Plant more fields. More legal research? Work overtime. More bobbleheads? Build another factory. This is the archaic growth paradigm, and it boils down to the maxim: more input, more output.increasing productivity leads to economic growth infographic

Historically, growth this way was fueled by conquest, slavery, or immigration. Why? Because economic and population growth were synonymous. The problem with archaic growth is for you to get rich, someone else must become poor. Profit is zero sum.

The second way to make more stuff is to increase productivity; that is, make more stuff in the same amount of time. This is the industrial growth paradigm. This is how countries get rich. Why? Because it snaps the link between population and production.

Take Britain at the dawn of the Industrial Revolution. In centuries prior, if Britain needed more cloth, it needed more weavers. It was that simple. But then something changed: in 1785 a man named Edmund Cartwright invented something called the power loom, which made British weavers 40-times more efficient. Within a few years, textile mills across Britain employed power looms, and churned out more cloth than the rest of Europe combined. This generated exponential economic growth and unprecedented material wealth.

The significance of the power loom cannot be overstated: not only did it usher in the industrial age, it also changed how people thought about economic growth. It switched the paradigm from one that was population-driven to one that was productivity-driven. This continues to be true today.

The question shifts for a final time: how do we improve productivity? In the short run there are many options. We could drink more coffee, organize our labor more efficiently (think Henry Ford), or we could trade with more efficient producers. These work, but only to a point: we can only do things so efficiently with our current technology before we hit a ceiling. For example: no matter how freely the Dutch traded, their textile mills could not compete with Britain’s until they also used power looms. At this point it should be obvious: technology drives long-run productivity, and therefore economic growth.

Better technology is also how we make better stuff. Televisions are a good example. The first TVs were chunky boxes that emitted grainy, monochromatic pictures. Today, TVs are thin, elegant, and can produce more colors than we can imagine. Even if we were no faster at manufacturing TVs than we were in the 1930s, the improvement in quality would still have expanded our economy. Both quantity and quality are elements of economic growth.

The key takeaway here is that long-run economic growth is a predicate of technological growth—which is exogenous to economic models.  It cannot be predicted, all we can do is increase the likelihood that innovation will take place.

This is the signal. Everything else—be it free trade or immigration—is noise.

Why Do Tariffs Work?

Given that long-term economic growth depends upon technological growth, it goes without saying that more inventive countries have distinct advantages—advantages that translate into wealth. History proves this: creativity is why the West dominated the global economy for centuries. It is why Britain ushered in the modern era. And it is why America became an economic powerhouse.

The data also confirm this: over the last few decades, almost all of America’s economic growth was generated by our advanced industries—technologically advanced manufacturing, information technologies, pharmaceuticals etc. Collectively, these industries employ just 9 percent of America’s workforce, but file 85 percent of all patents, provide 90 percent of private sector research dollars, and employ 80 percent of all engineers. This is where economic growth happens. It is easy to see why: the invention of the personal computer improved America’s economic efficiency across all industries.

My point: not all industries are of equal value. This is why free trade fails, and tariffs win.

Free trade theory lacks a time-horizon: it stipulates that if America can make more money today by exporting beef in exchange for cheap IT services from the Philippines, that’s a good deal. But it neglects a key fact: ranching is not a growth industry; IT services are. By offshoring our advanced industries, we forgo future growth.

A good example is trade with Mexico. After the North American Free Trade Agreement took effect in 1994, U.S. corn exports surged, as did our imports of automobiles. Trouble is, automobile manufacturing is much more likely to benefit from disruptive technology than is growing corn—under NAFTA, the preponderance of long-run benefits went to Mexico, not the United States.

Again, the hard data reflect this: in 2016 America ran an $83 billion trade deficit in advanced technology products. We offshored their production—along with the opportunity to generate new discoveries. As a result, we’ve increased the likelihood that the “next big thing” will be invented in Japan, China, or India, as opposed to the United States. Proof of this can be found in patent filings: America is filing fewer patents per capita, and fewer as a percentage of the world total, because we are now importing research from abroad.

America Needs a Tariff to Protect our Advanced Industries

A competent trade policy would prevent America’s cutting-edge industries from relocating to different countries, and concentrate advanced industries domestically. We must preserve, and sharpen, our cutting edge. Tariffs are the least-intrusive way to do this: they are a completely avoidable tax that create a strong incentive for businesses to build their new laboratory, factory, or industrial park in America. Not China. Not India. Not Mexico. America. This benefits everyone in the long run.

And beyond the dry economic reasons justifying tariffs, they are also critical to our national security. No matter how you cut it, President Trump is right on tariffs.

This article was first published on American Greatness.

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About Spencer P Morrison 82 Articles
JD candidate, writer, and independent intellectual with a focus on applied philosophy, empirical history, and practical economics.Author of "America Betrayed" and Editor-In-Chief of the National Economics Editorial.

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