Protect This: Why You Can't Stop the Outside World

On a recent episode of 60 Minutes, Steve Croft interviewed an Ohio factory executive about (what else?) Barack Obama and Hillary Clinton.

The exec was concerned about the "trade deficit" with China, as he felt it was responsible for the depressed state of the economy in Ohio, the widespread job loss and wage reduction throughout the state, and the generally poor quality of life.  According to him, China could hire workers for one-fortieth of the cost of his employees, so the Chinese were easily able to offer the same products his plant made, but for far less money - which meant that many industries like his throughout Ohio were being forced to shut down.

His solution: "[W]e need some tariffs or something."

Let me first stipulate: I am not indicting the American working man.  Like most economic fallacies, the ideas of protectionism seem perfectly commonsensical at first blush.  A series of duties, quotas and taxes on importing would stop foreign products from out-competing domestic ones, ensuring a ripe market for our own manufacturing and (more importantly) protecting jobs for those working in our manufacturing sector.

And anyway, such stuff is only fair, since those foreigners (the Chinese for example) are imposing quotas and tariffs on our products and taking all our manufacturing sector jobs through outsourcing -- so we ought to give them a taste of their own medicine, to induce them to open up their markets and quit undercutting us.

Certainly these ideas sound attractive to beleaguered factory owners and, especially, to trade unions.  Unfortunately, they are all economic fallacies.

Sucking the Blood

The idea that foreign companies will be somehow penalized by these tariffs is utterly false. Like all corporate taxes, the cost of these duties will simply be passed on to the consumer.

Consider this example: A Chinese manufacturer can produce a television for the retail price of $500, and the best American manufacturer can produce an equivalent one for no less than $600. Very sensibly he believes, a protectionist suggests that the government enact a $100 tariff on the importation of TVs from China in order to "even the playing field."

However, the Chinese manufacturer is not punished by this tariff in any way; he's not the one paying it.  The American consumer who wishes to purchase a TV pays the tax.

Think about it: prior to the tariff, the consumer had a choice among different TVs at his local electronics store.  Assuming he went to the store with $600 - and assuming that all other things were equal with regard to TV quality - he could leave with a Chinese TV and $100, or an American TV and no dollars.

After the tariff is imposed, he can only leave with a TV, Chinese or American, and zero dollars.  Note that he is $100 poorer, not the Chinese TV manufacturer who still makes the same profit over his cost regardless.  All that's happened here is that the tariff has transferred $100 to the government from the wallet of the citizen, in the name of "leveling the playing field."

And what if we raise the tariff so high that the American TV is actually cheaper, and outsells the Chinese manufacturer to the point of forcing him to leave the market?  Well, then we're creating a monopoly, or at least oligopoly, and we know how well those have worked in the past. And, like all monopolies, as soon as the government protection disappears, so will the monopoly.  The moment we drop the tariff, the Chinese manufacturer will be back, because he knows that there's money to be made in the American market.

Self-Destruct Sequence

How about the American TV manufacturer in the previous example?  Has he really benefited?  Well, arguably yes - he's the classic example of a special interest gaining a benefit for himself at the expense of everyone else.  But we (and he) should understand that even the manufacturer will be hurt to some degree by the tariff he lobbied so hard for.

First, he's still being out-competed by the Chinese manufacturer who still has lower operating costs - the American has, at best, merely erected an impediment to the outside world which won't help him sell outside America.  Like the moats and castles of old, the high, stone walls of his tariff will eventually become his (and our) prison - serving to isolate American markets while the unfettered world outside goes right along.

Also, the American manufacturer hurts himself in other more immediate ways. Consumers of his overpriced TVs now cannot afford to purchase other products that he may be making - say, DVD players or DVRs - because they've had to pay that money to the government so that they might be allowed to purchase a TV.  The tariff has also hurt the manufacturer's retailer partners, because they too will not be able to sell further products to consumers who have spent their money to the government to pay the manufacturer's tariff.

Finally, on top of all this, the TV manufacturer has ignored the fact that he himself is a consumer of all products he does not manufacture in the marketplace.  If the government "protects" all industries for which there is foreign competition (i.e., virtually every industry that exists), each producer will be hurt (in his role as consumer) by the artificially increased cost of others' products.

For example, in a tariff society, the wine maker must pay more for his presses, because the American machine-tool manufacturer has caused the government to artificially raise the cost of cheaper Mexican wine presses at the market. Meanwhile, the grocer must pay more for his wines, because the wine-maker has transferred his increased manufacturing costs to the grocer, his customer.  In turn, the machine-tool manufacturer has to pay more when he buys a bottle of wine for his supper at the market, because the grocer will transfer his costs to his shoppers.

In the end, everybody is poorer proportionate to the tariff - and no one is, therefore, ever really helped. When the government raises the price of even one good in the market artificially, it can't help but systemically affect the entire market for the worse.