Adam Smith would have approved of Trump’s trade tariffs

29 September 2018

9:00 AM

29 September 2018

9:00 AM

‘What the hell is going on?’ That anxious wail of economic incomprehension has been heard ever since President Trump decided last January to impose tens of billions of dollars of tariffs on China and other countries, including Canada, Mexico and the member states of the EU.

The wail went up another octave last week as the White House announced a further $200 billion in tariffs. Among the politicians and think tanks of Washington DC, where I have spent the past few days, there is talk of little else; talk rendered more feverish by the prospect of midterm elections in November.

A hundred billion here, a hundred billion there — pretty soon we could be talking real money. Include retaliations from the other side, fold in a goodly measure of escalation, and the world’s first trillion-dollar trade war is not an impossibility. That’s quite a thought.

So then: what is actually going on here? Having learned to take the President seriously, orthodox academic and policy opinion is now learning to take him literally, in his stated desire not merely to address what he sees as unfair trade practices, but to bring back supply chains and reindustrialise America. That’s a long-term agenda, and if Mr Trump believes tariffs and a new mercantilism are the way to achieve it, they could be around for some time.

It is this possibility that enrages the economists. Trade is not a zero-sum game in which each nation can gain only by beggaring its neighbour, they wearily point out. As David Ricardo showed, free trade frees up resources for both sides to focus on products where they have most comparative advantage. Result: win-win.

Indeed, didn’t the sainted Adam Smith himself, the father of economics, specifically argue for the benefits of free trade? Was it not Smith who said ‘Nothing… can be more absurd than this whole doctrine of the balance of trade’? After all, there can never be a trading system of any kind in which every country runs a positive balance of trade, let alone with every other country.

The idea that the White House is on a collision course with the great 18th-century political economist is one that Adam Smith himself would have enjoyed, for he did not shrink from the battle of ideas. Indeed, he once described his masterpiece The Wealth of Nations as a ‘very violent attack… upon the whole commercial system of Great Britain’, and so it was.

But Smith was not naive about trade, or politics, and it is far from clear that he would automatically have opposed what Trump has done. Contrary to the conventional wisdom, he was not a laissez-faire economist, and The Wealth of Nations offers support for a wide range of state interventions, ranging from a land value tax to regulation of the banks and currency and even the Navigation Acts, which protected British shipping — by some margin the most significant trade intervention of the 18th century.

What matters for Smith is less the rhetoric of ‘free markets’ than the reality of effective competition. It is competition that creates value and keeps markets honest. Yet he thought competition was constantly at risk from cabal and cartel: in his words, ‘-people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices’.

In Smith’s view, government interventions can undermine effective competition — even facilitate cartels — but they can also enhance it. Government can create red tape, but it can also tackle monopolies, remove subsidies and level out playing fields. Unfortunately, people today tend to hear only the first half of this message.

Moreover, though Smith argued vigorously for the long-term benefits of free trade, he was also a realist about power. He did not hold that the benefits of trade always created international harmony but believed that states would naturally seek to dominate each other, and he argued for the importance of international law to maintain a stable trading order.

As Smith anticipated, the US has never fully embraced free trade. Rather, policy has been continuously shaped to fit political ends. In the words of the doyen of American business historians Alfred Chandler, the century after the end of the Civil War in 1865 consisted of ‘ten years of competition and 90 years of oligopoly’.

Nor was the USA a free-trade country before that time. In his Report on Manufactures of 1791, Alexander Hamilton, then the US Treasury Secretary, had argued that tariffs were necessary to support American manufacturing until it could be strong enough to withstand the full blast of foreign competition.

This theme was taken up by the leading Whig politician Henry Clay after the war of 1812, and later by his great admirer Abraham Lincoln at the time of the birth of the Republican party; and the tariff lobby remained in the ascendant until it fell into disrepute during the Depression, after passage of the notorious Smoot-Hawley Tariff Act of 1930.

Even today, the idea that the US is a bastion of the free market is distinctly quaint, as anyone will know who has dealt with its labour laws, immigration rules, agriculture, and laws on foreign investment and ownership. But tariffs have fallen fast since the second world war, so a sustained trade war would represent an epoch-defining reversal of American policy.

Again, Adam Smith understood the point well. The prolonged use of tariffs would, he thought, have the negative effects of raising domestic prices, reducing competition and increasing crony capitalism and the demands of business for favours from the state.

But sometimes tariffs and other temporary retaliations might be called for nevertheless. This is, ultimately, a political choice. As Smith memorably put it, such decisions fall to ‘that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs’.

In politics, as in chess, the threat is stronger than its execution. To be effective, the threat of a trade war must, paradoxically, be credible yet never fully enacted. By imposing tariffs, President Trump has in one political stroke seized the limelight, reinforced his anti-establishment credentials and vigorously signalled his solidarity with working men and women. But there’s another possibility: the President sometimes insists that he is using tariffs not to protect American industry but to promote a radical free-trade agenda. Who knows? It may work.

Got something to add? Join the discussion and comment below.

You might disagree with half of it, but you’ll enjoy reading all of it. Try your first 10 weeks for just $10

Show comments