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Why Tariffs and Quotas Don't Work

A tiny story that most newspapers would bury below the fold on B17 has an interesting, if uncomfortable message for trade protectionists. Chinese trade with Europe is about to be revolutionized by the rebirth of the old overland silk route - this time via rail.

An alliance of rail operators from the Pacific to the Baltic have just completed a trial run, moving cargo from China to the EU in just 15 days, under half the time it takes to ship containers. The message here is that increases in international trade do not depend solely on what governments do in trade agreements, in raising or lowering tariffs or quotas. Whether people buy goods from their neighbors, their fellow countrymen or from foreigners depends upon the total price differences of their doing so, not just the barriers placed in the way by their own governments. Further, if you look at the history of trade, it is changes in transport costs which have been vastly greater as a determinant of those total costs than anything that governments do. With one tragic exception, which we'll get to in a minute.

Essentially, we can see any large increase in trade historically as being caused by a reduction in the costs of transport. It might have been the Mongol Empire making that Silk Road safe to travel, it might have been the European invention of caravels to cross the oceans, it could be the railroads and steam ships of the 19th century or the container and vast ships of the late 20th and our own age-but each and every time there was a cheaper or faster way of transporting goods from one nation to another, there was an increase in such transport.

Further, associated with such an increase was an increase in wealth of all three parties involved: those doing the selling, those doing the buying and those doing the transporting.

We can make a rough guess of what the next couple of decades will bring us. Given that most of the economic activity in advanced economies is in services improvements in ships, canals and containers, that's not going to do much for us. But the Internet does allow the trading of services: it allows me to be in the south of Portugal as I type this for an American corporation. The huge increase in wealth that has come over the past few decades from the outsourcing of manufacturing is about to hit services to the benefit of us all.

However, above I mention the one tragic exception: that was the period from the late 1920s to WWII. There was no technological revolution in transport under way at that time. The basic mechanisms were in place by the 1890s and the huge expansion of shipping in WWI meant that very little that was new was built in subsequent decades with whatever marginal improvements there were. Changes in the cost of trade were therefore almost exclusively in the hands of governments and, sadly, they decided to raise them. Tariffs were raised right across the industrialized world, trade fell precipitously and, as you might have noticed, the 1930s were not a time of great economic growth. Certainly, such tariffs were not the only cause but they also certainly made a bad situation vastly worse.

This tragedy was driven by two things, both the result of economic illiteracy on the part of the political classes. The first was that people like Mssrs. Smoot and Hawley (who gave their names to the U.S. versions of such tariffs) were still in the grip of mercantilism. They thought that exports made a country richer and imports poorer. We've known that it is in fact the other way around, imports are what we desire, imports are what make us richer, since David Ricardo published his theory of comparative advantage in 1817.

The second is that they were rather fooled by evidence from the late 19th century itself. It's a commonplace of the debate over protectionism that many (if not all, with the exception of Britain) of the industrialized nations became both industrialized and wealthy while sitting behind protectionist barriers. Indeed, the huge growth of the late 19th century happened while tariffs were rising. This argument is still used: we got rich while raising tariffs, so we should raise tariffs and we'll get richer.

Unfortunately this ignores the point above: trade is driven by the total costs of it, not simply by tariffs. And there was a technological revolution going on in the 19th century. Here are Ronald Findlay and Kevin O'Rourke in their brilliant book, %%AMAZON=069111854X Power and Plenty: Trade, War, and the World Economy in the Second Millennium%%: "On balance, it appears that the new transport technologies were so cost-reducing that their effects swamped those of rising European and American protectionism."

Those who point to the rising of both wealth and tariffs of the 19th century are therefore being fooled by not looking at the effect upon the total costs of trade: those were falling which is why everyone was doing more of it and getting richer as a consequence. Something that those who wish to raise protective barriers now would be well advised to consider.

There's a shorter version of this argument available. The barriers to trade are both those imposed by government - tariffs, quotas and so on - and those imposed by the state of the technology at the time. We're currently being told that raising tariffs and imposing quotas is going to make us richer. No such luck.

Tim Worstall is an Englishman who has failed at many things. Odd bits and pieces of his writing have been known to turn up in The Times, the book pages of the Daily Telegraph and the Philadelphia Inquirer, he's been a long term contributor to TCS Daily and also blogs for The Business and the Adam Smith Institute.