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Fellows with Friedman

Free Trade and Dropping Tariffs

John Cochrane

Tariffs are bad for the economy. Tariffs on raw materials, produced by machine-intensive dirty declining industries are worse. Trade is good.

Trade is good. Why? Follow the money. If China sells us, say, a solar panel, what does it do with the dollars? There is only one thing to do with dollars—buy American goods, invest in America, or buy our government debt. Oh, and we also get a nice cheap solar panel.

China might use the dollars to buy, say, wheat from Australia, so it looks like China sells us more than we sell them. But then Australia must use the dollars here in America. Dollars always come home to roost. So how much more one country sells us than we sell them— the “bilateral trade deficit”—really is pretty meaningless.

The rest of the world sells us more than we sell them. But the rest of the world uses every cent of the extra dollars it gets from that trade to invest in the U.S. and to buy our government bonds. If we sell the whole world exactly as much as they sell us every year—in other words, if there were no overall U.S. trade deficit—we’re the ones who would have to start saving huge much larger amounts of our incomes in order to invest in U.S. companies, give mortgages to people to buy houses, and to fund the governments’ $1 trillion deficits.

Think of it this way: You run a huge “trade deficit” with the grocery store. Why not grow your own food? Well, you’re not very good at growing food. And if you do, the grocer will not have money to buy what you make, or to give to the bank to fund your mortgage.

So, trade is good. And tariffs? Tariffs are not good. Tariffs on steel hurt businesses that use steel, especially those that compete with imported products made of steel. Tariffs hurt consumers, who pay more for steel-using products. But perhaps the greatest damage is to the steel industry itself. Tariffs, like all protection, shield the industry from competition. And industries shielded from competition do not innovate, do not cut costs, do not make better products. Only when the Big Three faced import competition did they start to make better cars and cut costs.

To learn more, read “On tariffs” by John Cochrane, available here.

Edward Lazear

When I served in the George W. Bush administration, a group of Harley-Davidson-riding cabinet members and White House principals led the 2008 Memorial Day Rolling Thunder motorcycle parade. I own a 100th Anniversary Year Road King Classic. I am disappointed to see President Trump singling out the iconic American motorcycle company for harassment—a precedent that could inflict long-run damage on the U.S. economy.

In response to the Trump tariffs on steel and aluminum, the EU imposed a 25% tariff on American-made motorcycles. To avoid this levy, Harley-Davidson announced a shift of some of its production to overseas plants. Mr. Trump responded with a tweet promoting a boycott of the company.

The problem is the tariffs, not Harley-Davidson’s response. The company has a fiduciary responsibility to its shareholders to maximize their return—not to engage in what the president believes is patriotic behavior. The alternatives to shifting production abroad are to absorb the tariffs and accept lower profit, or else to raise prices and lose sales. Both imply harm to Harley’s stock price, which its board has a duty to protect. If it ignored shareholder interests to please the president, Harley’s management would be reneging on one of its core obligations.

To learn more, read “Keep Your Tariffs off My Harley” by Edward Lazear, available here.

Richard Epstein

Free trade offers an uncompromising indictment of, and a powerful corrective for, America’s unsound economic policies. Private investors have been voting with their feet in response to such policies. Simply put, the reason that local businesses outsource from the United States is the same reason why foreign businesses are reluctant to expand operations here. Our regulatory and labor environment is hostile to economic growth and there are no signs of that abating anytime soon. The United States has slipped to eleventh place on the Heritage Organization’s 2016 Index of Economic Freedom. And it is not just because other nations have moved up. It is also because the steady decline in freedom and productivity inside the United States has continued apace. Ironically, the strong likelihood that the next American president will expand protectionist practices will only make matters worse: firms, both foreign and domestic, are more reluctant to invest in the United States, and the risk of a trade war by other countries such as Mexico is a live possibility, especially if Trump imposes high tariffs on automobiles made there for the American market.

The great advantage of a free trade policy is that it both reduces these political risks and makes it impossible to conceal these glaring structural defects from the world. And once they are recognized at home, free trade gives the federal government and the individual states strong incentives to clean up their act so that they can once again be attractive to foreign investment. There is, moreover, only one way for that cleanup to proceed. The United States must reduce the drag that its regulations impose on all businesses that operate within its borders, which means rooting out the various forms of monopoly power, like unions, that can only survive if protected by state law.

To learn more, read “The Rise of American Protectionism” by Richard Epstein, available here.