Tariffs and Reshoring

Promoted from the diaries by streiff. Promotion does not imply endorsement.

There are a lot of commentaries right now about tariffs and China and how the world is going to melt down if we put a 25% tariff on $200B of imports.  Before we go on let’s consider the scale of that – in 2016 the Federal government collected $3.3T in revenue, the tariff amounts to 1.5% of that number.  I am going to lay out the classical conservative argument for free trade:

Consider the following chain: iron ore -> steel -> brake assembly -> car

At each step value is added, a car is worth more per pound than iron ore or steel.  Brakes are worth far more on your car than in a warehouse.  The basic premise for free trade from the US perspective is that if we can get other countries to smelt iron then we can spend more time assembling cars and do the work that adds a lot of value.  Thus every time we open more trade we are better off as a country.  The story runs a little different for poorer countries, but effectively is along the lines of: Nigeria doesn’t have the capital to buy a lot of cars, but if they mine iron then they can sell it to countries that need brake assemblies for cars.  Thus everybody is better off.

Notice that the argument is really a means to an end, namely lower tariffs allow competitive advantage so that the whole world (including your country) is better off.  If this is truly the case then even if somebody else enacts tariffs you should drop yours so that the world (and therefore your country) grows faster.  However, there is a hidden assumption upon which the entire argument depends.  That hidden assumption is that your economy is labor starved and people who do not work in one industry will be picked up in another.  This has historically been the case, as people left farms they could move into mines or textile mills.  As they left mines they could work on assembly lines, and so on.  That is, the work itself became more valuable (again, per pound a car is worth more than coal used to smelt the iron).  The critical question though is when does this assumption begin breaking down?  If you have mechanized and automated agriculture and mining (we have), outsourced manufacturing, completed most of your infrastructure (highways, water treatment, sewers, transmission grids, electricity production), and are in the process of automating driving then where do your blue collar workers go?

They can’t all become programmers for Apple, or CPAs, so what do they do?  There are a couple options open 1) Low skill services 2) Unemployment.  Why low skill services?  Again, not everyone can become a doctor.  The people who used to work an assembly line might be up for being an auto mechanic or welder, but many will not have the eye to detail that those jobs require (on top of that we don’t have more cars than 10 years ago, so don’t need more mechanics), so they are going to stock shelves, run cash registers, provide janitorial services and so on.  However, notice that these jobs are going to be by nature limited.  When you close down a manufacturing facility it is not as if there are new cash registers that open or new shopping malls.  So now you have a larger potential labor force (low skilled laborers) vying for the same number of jobs.  This is part of why the youth employment numbers have sagged so much. The only way to improve the outlook is to increase the value add of your economy.  You have two ways to do that, build new stuff, or bring the value chain for finished products back into your economy.

“But we are making more stuff all the time!”  Not really.  When is the last time you bought an alarm clock, tape, CD, VHS, or DVD player? How about your last newspaper?  Desktop computer?  As our technology improves we aren’t making all that much more stuff, we are just paying more for improved versions of last year’s stuff.  So, outsourcing our supply line does not necessarily allow us to improve our economy in the same way it did in the 1920’s when the original economic theory was built.

That means we as a nation might very well be better off by integrating our supply line even if it means paying a higher price at the end point.  Consider the car I brought up originally.  If the car originally cost $40k and we imported $20k of parts then the US was able to generate $20k of value.  Let’s say that tariffs add 10% to the price of the car, but we import half as much and manufacture the other half.  Now the price is $44k and we have generated $34k of value.  You might say that the extra $4k shouldn’t count, and so we may take that out, but here is the critical point: unless we took the workers out of positions where they were adding more value we are better off even paying more.  Since we are now at <4% unemployment and the number of jobs open outnumbers those looking for jobs we should acknowledge that all new jobs in the US from here on out are filled by people who would not otherwise be working, and so as a nation we would be $10k wealthier.  Economists, investors, and businesses hate this though for the simple reason that the investor class benefits from the $4k reduction while the $10k in value add goes to workers, your CFO will always make choices that give $4k back to shareholders, even if it means shipping $10k of jobs overseas.

As a conservative I hold that the job of the government is to 1) protect the liberties of its citizens and 2) enact laws that increase the commonwealth.  The concept of low tariffs is a means to accomplish an increased commonwealth as long as those laid off are likely to move to higher value add jobs.  If as a nation we have a choice between lower prices and increased commonwealth we should choose policies that protect the commonwealth.

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