A Theory of Tariffs as a Method of Promoting Long-Run Free Trade

Tariffs have been in the news lately. As is typically the case, economists have come to the rescue on social media and op-ed pages to defend the idea of free trade and to discuss the dubious claims that politicians make about protectionist policies. I have no quarrels with these ardent defenses of free trade (although I would note that claims about the supposed importance of New Trade Theory and New New Trade Theory and claims about the global optimality of free trade are potentially contradictory; perhaps economists don’t like NTT or NNTT as much as they claim, but I digress). Despite my general support of free trade, I also think we should take a step back and try to understand the motivations of politicians who embark on protectionist policies. In addition, I think that we should start with the basic premise that politicians are rational (in the sense that they have some objective they want to pursue and their actions are consistent with such a pursuit) and potentially strategic actors. In doing so, we might obtain a better understanding of why politicians behave the way that they do. Once upon a time, this type of analysis was referred to as public choice economics. What follows is a short attempt to do so.

Let’s start with the following basic assumptions:

1. We will refer to the country of analysis as the Home country and a trading partner as Country X.
2. Country X has imposed trade barriers on the Home country that are costly to a particular sector in the Home country.
3. Free trade is unequivocally good and is the long-run goal of all of the politicians in the Home country (I make no assumptions about the goals of Country X).

With these assumptions in mind, I would like to make the following claim:

Given that Country X is imposing a costly trade restriction on an industry in the Home country, the politicians in the Home country would like to reduce this trade restriction. They could try to negotiate the trade restriction away. However, if the Home country does not have trade restrictions of their own that they can reduce, they do not have much to offer Country X. As a result, the Home country might impose trade restrictions on Country X. By doing so, the Home country might be able to induce Country X to reduce their trade restrictions in exchange for the Home country getting rid of its new restriction.

So what is the basis of this claim? And why would politicians do this given the assumption that I made that free trade is unequivocally good and therefore all trade restrictions are bad?

Here is my answer. Without having trade restrictions on Country X, the Home country does not have anything to bring to the bargaining table to induce Country X to reduce trade restrictions (setting aside other geopolitical bargaining). So the Home country needs to create a bargaining chip, but the bargaining chip needs to be credible. For example, one way to create a bargaining chip would be to impose trade restrictions on Country X. However, for this to be a credible threat, these restrictions have to be sufficiently costly for the Home country. In other words, politicians in the Home country have to be willing to demonstrate that the trade restrictions imposed by Country X are so costly to the Home country that the politicians are willing to punish Country X even if their own constituents are harmed in the process. By demonstrating such a commitment, they now have a bargaining chip that they can use to negotiate away trade restrictions and end up with free(r) trade in the long run. At the same time, politicians in the Home country cannot broadcast their strategy to the world because this would undermine their objective. So the politicians will likely adopt typical protectionist rhetoric to justify their position.

The problem, of course, is that this is not a foolproof plan. Once the Home country imposes trade restrictions on Country X, this could turn into a war of attrition. If the Home country is not willing to commit to these trade restrictions indefinitely, then they might eventually unilaterally remove these restrictions without any benefit. Not only that, but by doing so, Country X might now see this as evidence that they can impose additional trade restrictions on the Home country without subsequent retaliation. So make no mistake. This sort of policy can be a gamble because it requires winning a war of attrition. However, some politicians might be willing to make that gamble in order to achieve the long run benefits.

One response to “A Theory of Tariffs as a Method of Promoting Long-Run Free Trade

  1. Pingback: Links for 03-26-18 – Courtier en Bourse

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