Bill Mitchell: Tariffs and more – Part 1
(https://billmitchell.org/blog/?p=62428)
March 13, 2025
This week, Australia learned that old geopolitical relationships and so-called ‘free trade’ treaties mean little when it comes to US policy. The obsequious way our political class fawns after the US has been a constant sickening element of our national identity for as long as I can recall. When I was a child, we were told by our Prime Minister that Australia was “all the way with LBJ”, a foreign policy that took out nation, against all reason, into the Vietnam War. Now, the US President is demonstrating why a reliance on the US as a ‘good citizen’ of the world is a poor strategy for an advanced nation to adopt. The other interesting aspect of what is going on is that the world is once again entering an experiment that will provide knowledge about the impacts of ripping up free trade agreements and increasing barriers to entry. Theorising is one thing but now we have a practical experiment underway. This is Part 1 of a series on the current debate about tariffs.
I considered the argument about free trade from a Modern Monetary Theory (MMT) perspective in this three part series:
1. The case against free trade – Part 1 (October 27, 2016)
2. The case against free trade – Part 2 (November 8, 2016)
3. The case against free trade – Part 3 (November 22, 2016).
I also considered Donald Trump’s industry policy in this blog post – Donald Trump’s tariff hikes are not good policy (March 20, 2018) – during his first term of office.
Here are some considerations that guide my thinking on this issue.
1. Early theoretical attempts (for example, Heckscher-Ohlin theorem) to justify so-called free trade (absence of protection) were shown to be flawed.
2. More recent developments in trade theory – the so-called ‘New Trade Theory’ in the 1980s – meant that economists could no longer argue that the results of the free-trade models held.
3. This shift in economic theory away from a blind acceptance of a proposition that free trade was always good, is quite apart from other considerations, which we might categorise under ‘fair trade’ issues.
4. When ‘free traders’ talk about the ‘free market’ and appeal to the narratives that appear in undergraduate economics textbooks they are being deceptive.
No corporate leader aims to achieve that state.
At a minimum, they aim to manipulate the ‘market’ they trade into to influence prices they can get and have to pay for inputs and end up with as big a margin on total costs as they can achieve.
They aim to create a unique product and drive competitors out of business as quickly as they can.
If they can take over a competitor and increase their market share they will.
They seek to manipulate consumers into believing their product is best through advertising, which uses psychological tools that go well beyond the textbook idea that such interaction with the ‘market’ is just to provide ‘information’.
5. The 2007 book by Ha-Joon Chang – Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism – documents extensively how nations used trade protection strategies in order to reach advanced status and demonstrates that the normal model of economic development, which has enriched the advanced nations such as Britain and the US, was not built on a ‘free trade’ platform.
Rather, they developed into rich nations through the use of industrial protection and government controls and supports.
None of the advanced nations would have achieved that status if they followed the IMF/World Bank approach.
6. The ‘infant industry’ justification for protection which has been used for centuries is logical but the problem is that the tariff wall provides a perfect environment for rent-seeking – so that the recipients of the protection have little incentive to innovate and become more competitive without the support.
The case of the Australia motor car industry is a classic example. The foreign-owned corporations profited from the tariffs and to avoid industrial unrest ‘shared’ some of the tariff benefits with the unions in the form of higher wages.
But by the 1970s despite effective protection rising, total employment was falling such was the competitive gains being made by Asian car manufacturers (Japanese initially) as the local industry failed to innovate.
In other words, the ‘baby never grew up’.
Too many companies set up to exploit the tariff and too many models were produced for a market that could barely support one manufacturer producing at lowest-cost scale.
The level of protection was so high that it was estimated in 1985 that it would have been cheaper for the government to give all the workers in the Australia car building industry $A1 million each and close the industry (Source).
7. Rich nations such as the US and the European Union still maintain a complex array of tariffs on goods attempting to enter its borders. Japan, for example, maintains a highly protectionist stance with respect to its primary products (particularly against rice imports).
These cases are generalised across most nations.
So when you read commentators, particularly Europeans railing against Donald Trump’s new tariffs on steel and aluminium and other goods, you have to realise that the protection levels in the EU are, on average, higher than they are in the US and many other advanced nations.
The issue of tariffs in Australia has been contested since the beginning of our nation.
In Colonial Australia, the now states were separate colonies and they used tariffs (tobacco, etc) to create barriers to trade at their borders and to raise revenue for the respective colonial governments, which used the British pound as the currency.
Tariffs were primarily a way for the colonial governments to get hold of the foreign currency they used.
However, part of the motivation was to generate local employment.
The – Victorian gold rush – in the 1850s, not only promoted rapid population growth (1851: 77,345; 1861: 538,628) but left the colonial government with a headache in the 1860s once the gold discoveries dried up.
They introduced tariffs on many manufacturd goods to promote growth in the burgeoning manufacturing sector as a strategy to absorb the surplus miners after the boom.
Australia became a nation in 1901 and that led to a major revision of the colonial tariff system and ended the cross-internal border tariffs.
The new federal government assumed responsibility for tariff policy upon federation.
It is clear that the pre-federation industrial structure changed once the state tariffs were made uniform and goods and services were free to move between states without imposts.
For example, manufacturing in Queensland collapsed as the protection was reduced and cheaper goods flowed into that state from Victoria and NSW.
The major political parties at the federal level, were committed to a protectionist strategy for the nation as a whole vis-a-vis the rest of the world.
For some imported goods, the tariff wall was higher than 40 per cent.
The major justification used was the so-called – Infant industry argument – where new industries that had not yet reached economic scale (lowest unit costs) could be protected in order that they grow and mature into a competitive entity.
It was clear that this strategy would increase the price of goods sold in the domestic market but the claim was that eventually as the firms in the industry innovated and developed best-practice technologies and operational capacities, the longer-run benefits would be realised – internationally competitive industries selling quality products at the lowest possible price to consumers.
The ‘infant industry’ justification goes back in time to the Tudor kings and queens in Britain who “used protectionism, subsidies, distribution of monopoly rights, government-sponsored industrial espionage and other means of government intervention to develop England’s woollen manufacturing industry—Europe’s high-tech industry at the time.”
That quote is from Ha-Joon Chang’s epic analysis of ‘How did the rich countries become rich?”, which is presented as Chapter 2 of his 2007 book by Ha-Joon Chang – Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism – documents extensively how nations used trade protection strategies in order to reach advanced status.
So there was nothing new about the idea of protecting new industries when the first secretary of the US Treasury, Alexander Hamilton in his – Report on the Subject of Manufactures – (published on December 5, 1791) articulated a systematic program to develop US manufacturing.
His inquiry was motivated by the desire to “render the United States, independent on foreign nations, for military and other essential supplies.”
The arguments that are presented in the public debate today have not really developed on those presented by Alexander Hamilton.
Hamilton first presented the view that was avowedly against state protection on industry – “To leave industry to itself, therefore, is, in almost every case, the soundest as well as the simplest policy”.
Thus in relation to protecting manufacturing that:
It is far preferable, that those persons should be engaged in the cultivation of the earth, and that we should procure, in exchange for its productions, the commodities, with which foreigners are able to supply us in greater perfection, and upon better terms.
His Report then turned to why the US should give “special and positive encouragement” for manufacturing enterprises and it was here that he developed the ‘infant industry’ argument.
He argued that local manufacturing firms would only reach an efficient scale (low unit costs) if the government provided them protection from external competition by introducing tariffs on imported goods, which were directly competing with US production.
He wrote: “The superiority antecedently enjoyed by nations, who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle …” for the development of US manufacturing.
He also wanted the government to abandon levies on raw materials that were used by these new manufacturing firms.
This was almost ‘treason’ given the growing dominance of Adam Smith’s view at the time among the mainstream.
Hamilton told the US government that the trading terrain was hardly ‘free’ and that:
… the greatest obstacle of all to the successful prosecution of a new branch of industry in a country, in which it was before unknown, consists, as far as the instances apply, in the bounties premiums and other aids which are granted, in a variety of cases, by the nations, in which the establishments to be imitated are previously introduced …
Thus “interference and aid of their own government are indispensible.”
The ‘infant industry’ argument became dominant across the world and while Hamilton was ignored at the time (because as Ha-Joon Chang notes “US politics at the time were dominated by Southern plantation owners with no interest in developing American manufacturing industries”) later, into the C20th, US policy makers used tariff protection extensively to protect its manufacturing sector as part of building a dominant economy.
Ha-Joon Chang said that the US became “the most protectionist country in the world throughout the 19th century and right up to the 1920s” and “the US was also the fastest growing economy.”
Was the fast growing economy achieved “despite protectionism” or because of it?
The modern free traders claim the former yet cannot explain why many other countries that didn’t have natural advantages (market size, natural resources, etc) of the US also “grew rapidly behind protective barriers”.
In relation to the free trade arguments, Ha-Joon Chang uses an example in Chapter 3 of why it is absurd to advocate abandoning all the parental care for his 6-year old son and force him out into the labour market (“He is over-protected and needs to be exposed to competition, so that he can become a more productive person. p.49”).
He writes (p.50):
Yet this absurd line of argument is in essence how free-trade economists justify rapid, large-scale trade liberalization in developing countries. They claim that developing country producers need to be exposed to as much competition as possible right now, so that they have the incentive to raise their productivity in order to survive. Protection, by contrast, only creates complacency and sloth. The earlier the exposure, the argument goes, the better it is for economic development.
The point that Ha-Joon Chang makes is that “the protection I provide to Jin-Gyu (as the infant industry argument itself says) should not be used to shelter him from competition forever.”
Eventually, the ‘infant’ has to grow up – more about which later.
The other point in relation to today’s debates in the US about tariffs is that in the immediate Post WW2 period and for the next four decades, the “US federal government funding accounted for 50–70% of the country’s total R&D funding”.
Ha-Joon Chang concludes that without that state funding “the US would not have been able to maintain its technological lead over the rest of the world in key industries like computers, semiconductors, life sciences, the internet and aerospace.”
This has implications for the Trump cuts to the bureaucracy and federal spending.
Tariffs helped the US grow but so did large state involvement in education, training, innovation and R&D.
Alexander Hamilton’s Report also considered tariffs to be only one measure a nation could take to protect its new infant industries.
He noted 11 protective measures are available to government, each with advantages and disadvantages:
1. ” Protecting duties—or duties on those foreign articles which are the rivals of the domestic ones, intended to be encouraged” – that is, tariffs, which “enable the National Manufacturers to undersell all their foreign Competitors.”
2. “Prohibitions of rival articles or duties equivalent to prohibitions”.
3. “Prohibitions of the exportation of the materials of manufactures”.
4. “Pecuniary bounties … avoids the inconvenience of a temporary augmentation of price, which is incident to some other modes, or it produces it to a less degree; either by making no addition to the charges on the rival foreign article, as in the Case of protecting duties, or by making a smaller addition.
5. “Premiums” which, unlike bounties are “rewards to some particular excellence”.
6. “The Exemption of the Materials of manufactures from duty” – no duties (tariffs) on raw materials.
7. “Drawbacks of the duties which are imposed on the Materials of Manufactures” – selective tariffs to allow essential goods for input or consumption.
8. “The encouragement of new inventions and discoveries, at home, and of the introduction into the United States of such as may have been made in other countries; particularly those, which relate to machinery” – R&D etc
9. “Judicious regulations for the inspection of manufactured commodities” – discourage fraud and poor quality.
10. “The facilitating of pecuniary remittances from place to place is a point of considerable moment to trade in general, and to manufactures in particular; by rendering more easy the purchase of raw materials and provisions and the payment for manufactured supplies.”
11. “The facilitating of the transportation of commodities” – state spending on roads, canals, ports etc. That is, public infrastructure to allow private enterprises to leverage their operations.
The point is that the state has an array of policies available to it in order to promote economic development each with different consequences.
The single reliance on tariffs may not be the best way to revitalise industry.
Conclusion
I will use this historical discussion to deal with a range of issues in Part 2:
1. Price impacts.
2. Possibility of import competing dominance.
3. The ‘revenue’ arguments used by Trump “it will make us rich”.
4. The logic of tariffs on Australian steel when the US steel industry has lower unit costs than the Australian sector.
5. The concept of state support for industry as a justification for tariffs.
6. Rent seeking and the infant industry argument – one cannot consider the tariff question without introducing the class context.
7. Deindustrialisation.
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Bill Mitchell: Tariffs and more – Part 2
(https://billmitchell.org/blog/?p=62434)
- March 17, 2025
This is the second part of the discussion on Tariffs that I started in – Tariffs and more – Part 1 (March 13, 2025). In the first part I considered some of the historical motivations including the infant industry argument. Today, I plan to expand on that discussion and add further considerations that might help us understand what is going on at the moment.
The Fortune article (March 16, 2025) – Trump claims tariffs will make the U.S. ‘rich again.’ But 5 undisputed facts about how they work throw cold water on that notion – listed the five principle objections that economists have against tariffs:
The most common argument is that they “are a tax that will be mainly, if not wholly borne by U.S. consumers”.
This is the most obvious objection – that it forces the domestic consumer (including users of imported raw materials) to pay more than they have to for the product or input.
The train of events is clear – the foreign company exports product A into the US and if subject to a tariff the payment will be made by the importer (usually incorporated in the local economy).
There are several possibilities then.
The exporting firm absorbs the tariff impost and passes the good onto the importing firm at a lower price.
Many economists think this is likely because the US market is so large that foreign firms can reduce per unit margins (absorb the tariff) while making it up on volume.
Under certain circumstances the local importer may absorb some or all of the tariff impost.
Alternatively, the local importer passes on the tariff charge to the final price of the good.
Which of those alternatives turns out to follow the tariff impost depends on the state of the global market, the state of the local market and more.
This 2020 study of Trump’s first term tariffs – Who’s Paying for the US Tariffs? A Longer-Term Perspective (published January 2020) – found that
… recent U.S tariffs have been passed on entirely to U.S. importers and consumers … We find heterogeneity in the responses of some sectors, such as steel, where tariffs have caused foreign exporters to drop their prices substantially, enabling them to export relatively more than in sectors where tariff passthrough was complete.
So it depends on the sector.
Trump’s justification is that the ‘tax’ imposes costs on the foreign entities, which is somewhat true if local consumers have locally-produced alternatives and substitute away from the imported good.
But the whole point of the tariff is to make any locally produced goods commercially viable (by being able to operate at higher unit costs behind the tariff wall, which effectively addresses the difference in unit costs between the local and foreign producers.
But if there is already a commercially-viable local product available, then there is no need for the tariff protection.
Such protection would just go to profits of the corporation.
Australia had a long history with tariff protection, as I explained in – Tariffs and more – Part 1 (March 13, 2025).
When the federal government first started widespread protection around 1917, the motivation was various but the overriding aim was to provide an incentive for “Australia’s existing horse-drawn carriage manufacturers (and their 7,000 or so employees) to make car bodies instead” (Source):
The next step to tariffs was designed as an ‘infant industry’ strategy but there were several problems with the strategy.
The Australian market was small relative to say the US market where several firms in the same sector could achieve economies of scale (lowest unit costs).
In Australia, the tariff walls meant that the infants never really matured.
They had no incentive to innovate much because their profits were protected and the government introduced few incentives or penalties to encourage rationalisation or innovation..
They could also avoid industrial action by unions by agreeing to share out the ‘rents’ (excess profits) that the tariff wall provided them.
So by the 1970s, import competition from Japan (particularly) in the motor car industry was such that the imported product was superior and was offered at a lower price to consumers despite the tariff wall.
At that point, one realises that the tariff strategy had largely failed in terms of its original mission.
The federal government began too late to require the protected industries to innovate and reduce their local costs in return for the protection.
But there are nuances to that as I explain below.
There was an interesting article on the Australian Broadcasting Commission page this morning – How Australia’s leather boot manufacturing industry has changed (March 17, 2025) – which documents the demise of a once robust leather products (boots and shoes in particular) industry in Australia.
There are now very few manufacturers in this trade left as the traditional firms shifted their operations to countries with cheaper labour and also cut the quality of the materials used.
The demise of many local firms in this part of the textiles sector in the 1980s onwards was not unique.
When the then Labor government cut tariffs on imports, which had protected the firms by allowing them to maintain higher price levels as they continued to agree to higher wages, the firms were no longer able to sustain profits.
There were two-sides to the situation:
1. The manufacturing jobs were well paid and secure (at the time) – so workers benefitted from growing real wages (generally in line with productivity improvements).
2. But as consumers the same workers and others paid higher prices for goods than they would have paid in other countries, given the disparity of cost structures.
The tariff wall was highly protective and it was not only higher prices that were the issue.
There was a joke around when I was a student that if you parked an Australian made car on the top of a crest, the front would sag down one side of the slope and the back the other, such was the quality of cars manufactured here.
It was not until the first wave of Japanese imports came and threatened to out price the Australian-made cars even with the high tariff walls that local car makers started to put in heaters and radios to their vehicles.
The tariff-protected Australian-made cars were from memory (I was young) pretty primitive.
And that was the problem – the infant never really grew up.
By the 1970s it was estimated that the government subsidies and other protections were so large that the government could have ‘saved spending’ by closing the industry down altogether, while continuing to pay the workers.
Such was the level of protection.
Even as the protection rose, employment levels fell in the face of the import competition.
However, to just blame the reduction in the tariff wall as the reason, for example, that the Australian car manufacturing industry has disappeared is only one part of the story.
The car industry in Australia also received large subsidies from the federal government.
They were also removed progressively as the obsession with fiscal surpluses grew from the late 1970s and Australia signed up to various ‘free trade’ agreements that prohibited state aid.
Another problem that is not often understood is that the local manufacturing plants were foreign-owned – GM, Ford, etc.
I was consulted some years ago by a group that wanted the federal government to nationalise one of the large plants after it decided to end subsidies and the foreign owner shut the local production down.
At the time, imported cars were quite cheap relative to the locally-produced vehicle.
This group explained to me that the local price included two cost elements: (a) franchising licence charges from the headquarters in the US on the local subsidiary; (b) costs relating to the design team that was located in Melbourne, Australia yet was the major industrial design capacity for the foreign-owned company’s operations abroad. Only a small component of those costs were actually allocated to the local product.
While I cannot recall the exact figures they were something (with a few thousand $A) like this.
The local family sedan sold in the Australian market for around $A49,000.
Net out the franchising costs and the overseas design costs and the same vehicle could be produced and taken to market for around $A15,000.
So the local products were massively subsiding the profits of the foreign-owned operations.
This sort of cost-shifting across corporate structures and national borders is clearly a common accounting trick.
The consortium that approached me wanted to make the case that if the federal government purchased the plant that was being scrapped and maintained the operations and the employment levels, it could still offer highly-paid, skilled jobs to local workers and more than compete on price with the imported competitors.
It was a compelling argument that the federal government rejected because they claimed it would ‘damage the budget’ – an argument so asinine that one could just laugh at their cant.
As a consequence, there are no motor cars manufactured in Australia.
And let’s not confuse the issues.
I wasn’t in favour of the massive handouts that the Australian government was giving to the foreign-owned manufacturing corporations producing here.
That was just an elaborate form of blackmail.
The corporations would threaten to shut down unless they received further bailouts.
Successive governments fearing the political backlash would cave in and up the subsidies.
And they just went to the profits of foreign shareholders.
But had the government agreed to the plan put by the consortium wanted to preserve local production and outlaid whatever was necessary to maintain the operations (without the franchise and design imposts) then that would have been very productive expenditure and, of course, the government could have easily achieved that mission had they not been infested with neoliberal thinking.
So there is more to the story than just the tariffs and that should be borne in mind.
This also related to Trump’s claim which he has rehearsed often that:
We’re going to raise hundreds of billions in tariffs; we’re going to become so rich we’re not going to know where to spend that money.
That quote was a throwaway line he gave the press on March 12, 2025.
In other words, he expects the US government will reap a lot of revenue by imposing import duties on goods and services that come into America.
But think about that for a moment.
The US government doesn’t need revenue in order to spend on goods and services.
If the government felt that there were advantages in promoting the ongoing existence of a sector – for example, the automotive sector – on employment grounds, say – then it could do that without tariffs.
If there was a genuine ‘cost’ disadvantage faced by a desirable local producer, then the government could simply offset that advantage and ensure the price remained at the lower imported good price, without tariffs.
That is, it could maintain integrity in the local industry while allowing low-cost imports in and leaving it up to the consumer to choose which they preferred.
I am not saying I support public subsidies for private profit seeking corporations, but an understanding of the currency capacity of the government certainly allows us to understand that there are alternative ways to assisting local corporations without invoking a so-called ‘trade war’.
There are also several reasons why protecting an industry is desirable.
Here are some.
First, there are so-called ‘spill-over benefits’.
These benefits relate to the advantages other sectors enjoy from the maintenance, say, of an automotive manufacturing sector.
They include skill development, which can permeate down through the supply chain.
Also, refining operational management techniques that reduce unit costs could assist other sectors.
And, importantly, R&D outlays by one manufacturing sector can benefit other sectors where similar technologies etc are used.
Research has shown that “the total benefits of R&D are twice as large as the private benefits from this investment, presenting a strong case for publicsupport for R&D activity” (Source):
Second, there are multipliers associated with specific government outlays that generate output and employment benefits well beyond the initial outlays.
Third, a strong local manufacturing sector is an ‘attractor’ for FDI, which may reduce unit costs.
Fourth, nations with a manufacturing sector are said to have strategic advantages in the case of geopolitical conflict.
This has been an oft-used argument.
That in the case of a war or threat of war manufacturing processes can be quickly retooled to produce weapons etc.
Fifth, to promote ‘fair trade’.
This argument recognises that the conditions of workers in some exporting nations are so appalling, which is the reason there might be a cost-disadvantage for the local firms against the imported products, that government policy should thwart the import of such goods.
However, tariffs are not the best way to achieve that sort of outcome.
It is far better to just prohibit the import of goods that can be identified with production processes that violate human rights.
The other issue is the role of class power and class struggle.
Why should we want our governments protecting corporations that underpay their workers or offer inferior working conditions?
While workers in the manufacturing sector were well paid as a result of the cosy ‘rent sharing’ of the protection provided by the federal government, there are clearly situations where private profit is ‘protected’ and workers are also not well rewarded.
There is never a justification for that sort of policy.
Finally, and relatedly, if the cost disadvantage is the result of the poor investment decisions taken by American industrialists, for example, then pushing the costs of those management failures onto the consumers does not appear to be sound policy.
Creating nationalised industries that provide unit cost benchmarks to ensure profit gouging firms fail is one alternative.
Conclusion
I will write more on this issue another day.
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