@ pam
2025-02-05 06:05:33
During tough economic times, governments have to decide if they should open markets to global trade or protect local businesses with tariffs. The United States has swung between these two strategies, and history shows that the results are never straightforward
Just days ago, President Donald Trump imposed tariffs on imports from Canada, Mexico, and China. He framed these tariffs (25% on most Canadian goods, 10% on Canadian energy, 25% on Mexican imports, and 10% on Chinese imports) as a way to protect American industries.
But will they actually help, or could they backfire?
### A History of U.S. Tariffs
Many have asked if countries will retaliate against the US. They can and they have. Once upon a time, 60 countries were so pissed off at the US, they retaliated at one go and crushed US dominance over trade.
This was during the Great Depression era in the 1930s when the government passed the Smoot-Hawley Tariff Act, placing high taxes on over 20,000 foreign goods. The goal was to protect American jobs, especially American farmers and manufacturers, but it backfired so badly.
Over 60 countries, including Canada, France, and Germany, retaliated by imposing their own tariffs. By 1933, US imports and exports both dropped significantly over 60%, and unemployment rose to 25%.
After President Franklin Roosevelt came to office, he implemented the Reciprocal Trade Agreements Act of 1934 to reverse these policies, calming the world down and reviving trade again.
### The economist history of protectionism
The idea of shielding local businesses with tariffs isn’t new or recent. It's been around for a few centuries. In the 16th to 18th centuries, mercantilism encouraged countries to limit imports and boost exports.
In the 18th century, Adam Smith, in The Wealth of Nations, argued that free trade allows nations to specialize in what they do best countering protectionism policies. Friedrich List later challenged Smith's view by stating that developing countries need some protection to grow their “infant” industries which is a belief that still influences many governments today.
But how often do governments truly support startups and new small businesses in ways that create real growth, rather than allowing funds to trickle down to large corporations instead?
In modern times, John Maynard Keynes supported government intervention during economic downturns, while Milton Friedman championed free trade and minimal state interference.
Paul Krugman argued that limited protectionism can help large industries by providing them unfair advantages to become global market leaders. I have deep reservations about Krugman’s take, particularly on its impact or lack thereof in globalizing small businesses.
The debate between free trade and protectionism has existed for centuries. What’s clear is that there is no one-size-fits-all model to this.
### The Political Debate
Both the left and right have used tariffs but for different reasons. The right supports tariffs to protect jobs and industries, while the left uses them to prevent multinational corporations from exploiting cheap labor abroad.
Neoliberal policies favor free trade, arguing that competition drives efficiency and growth. In the US this gets a little bit confusing as liberals are tied to the left, and free trade is tied to libertarianism which the rights align closely with, yet at present right wing politicians push for protectionism which crosses the boundaries of free-trade.
There are also institutions like the WTO and IMF who advocate for open markets, but their policies often reflect political alliances and preferential treatment - so it depends on what you define as true 'free trade’.
### Who Really Benefits from Tariffs?
Most often, tariffs help capital-intensive industries like pharmaceuticals, tech, and defense, while hurting labor-intensive sectors like manufacturing, agriculture, and construction.
This worsens inequality as big corporations will thrive, while small businesses and working-class people struggle with rising costs and fewer job opportunities.
I’ve been reading through international trade economics out of personal interest, I'll share some models below on why this is the case
#### 1. The Disruption of Natural Trade
Tariffs disrupt the natural flow of trade. The Heckscher-Ohlin model explains that countries export goods that match their resources like Canada’s natural resource energy or China’s labour intensive textile and electronics. When tariffs block this natural exchange, industries suffer.
A clear example was Europe’s energy crisis during the Russia-Ukraine war. By abruptly cutting themselves off from the supply of Russian energy, Europe scrambled to find alternative sources. In the end, it was the people who had to bear the brunt of skyrocketing prices of energy.
#### 2. Who wins and who loses?
The Stolper-Samuelson theorem helps us understand who benefits from tariffs and who loses. The idea behind it is that tariffs benefit capital-intensive industries, while labor-intensive sectors are hurt.
In the US, small manufacturing industries that rely on low-cost imports on intermediary parts from countries like China and Mexico will face rising costs, making their final goods too expensive and less competitive. This is similar to what happened to Argentina, where subsidies and devaluation of pesos contributed to cost-push inflation, making locally produced goods more expensive and less competitive globally.
This also reminded me of the decline of the US Rust Belt during the 1970s and 1980s, where the outsourcing of labour-intensive manufacturing jobs led to economic stagnation in many regions in the Midwest, while capital-intensive sectors flourished on the coasts. It resulted in significantly high income inequality that has not improved over the last 40 years.
Ultimately the cost of economic disruption is disproportionately borne by smaller businesses and low-skilled workers. At the end of the day, the rich get richer and the poor get poorer.
#### 3. Delays in Economic Growth
The Rybczynski theorem suggests that economic growth depends on how efficiently nations reallocate their resources toward capital- or labor-intensive industries. But tariffs can distort this transition and progress.
In the 70s and 80s, the US steel industry had competition from Japan and Germany who modernized their production methods, making their steel more efficient and cost-effective. Instead of prioritizing innovation, many U.S. steel producers relied on tariffs and protectionist measures to shield themselves from foreign competition. This helped for a bit but over time, American steelmakers lost global market share as foreign competitors continued to produce better, cheaper steel. Other factors, such as aging infrastructure, and economic shifts toward a service-based economy, further contributed to the industry's decline.
A similar struggle is seen today with China’s high-tech ambitions. Tariffs on Chinese electronics and technology products limit access to key inputs, such as semiconductors and advanced robotics. While China continues its push for automation and AI-driven manufacturing, these trade barriers increase costs and disrupt supply chains, forcing China to accelerate its decoupling from Western markets. This shift could further strengthen alliances within BRICS, as China seeks alternative trade partnerships to reduce reliance on U.S.-controlled financial and technological ecosystems.
Will the current Tariff imposition backfire and isolate the US like it did a hundred years ago or 50 years ago? Is US risking it's position as a trusted economic leader? Only time would tell
### The impact of tariff on innovation - or lack thereof
While the short-term impacts of tariffs often include higher consumer prices and job losses, the long-term effects can be even more damaging, as they discourage innovation by increasing costs and reducing competition.
Some historical examples globally :
* Nigeria: Blocking import of rice opened up black market out of desperation to survive.
* Brazil: Protectionist car policies led to expensive, outdated vehicles.
* Malaysia’s Proton: Sheltered by tariffs and cronyism and failed to compete globally.
* India (before 1991): Over-regulation limited the industries, until economic reforms allowed for growth.
* Soviet Union during Cold War : Substandard products and minimal innovation due to the absence of foreign alternatives, yielding to economic stagnation.
On the flip side, Vietnam has significantly reduced protectionism policies by actively pursuing free trade agreements. This enabled it to become a key manufacturing hub. But Vietnam is not stopping there as it is actively pushing forward its capital-intensive growth by funding entrepreneurs.
### The Future of U.S. Tariffs
History has shown that tariffs rarely deliver their intended benefits without unintended consequences. While they may provide temporary relief, they often raise prices, shrink job opportunities, and weaken industries in the long run.
Without a clear strategy for innovation and industrial modernization, the U.S. risks repeating past mistakes of isolating itself from global trade rather than strengthening its economy.
At this point, only time will tell whether these tariffs will truly help Americans or will they, once again, make the rich richer and the poor poorer.