Tariffs: Academic theory vs. reality and what the Academics, the media, and politicians leave out

Here is an adamsmith.org blog entry by Tim Worstall.  My comments are in italics following Worstall’s.

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Worstall

If other people make things cheaper for us then what is it we should do? The correct response being to then enjoy that greater wealth that those others have enabled us to have. It’s not actually necessary to write a note to Santa as well but perhaps politesse would indicate we should:

The Chinese telecoms company whose role in the construction of Britain’s 5G network has been questioned amid growing security fears has received as much as £57 billion of state aid from Beijing, helping it to expand and undercut its rivals, it is alleged.

A review by The Wall Street Journal of grants, credit facilities, tax breaks and other state assistance shows for the first time the extent to which Huawei has been helped — allegedly enabling it to offer generous financing terms and charge 30 per cent less for network equipment than competitors.

Assume that all of this is true and isn’t just competitors trying to justify their own higher prices - what should our reaction be?

Well, as a result of the Chinese taxpayer being rooked by the Chinese government’s pandering to special interests we can have a 5G telephone network cheaper. Or, presumably, for the same price as we would pay elsewhere we can have more 5G telephone network. Either way we are richer as a result of those taxes paid in China.

The correct response then, to this claim of subsidy of Huawei is to buy Huawei for we’re made richer by doing so. This is true of any such foreign subsidy to a producer as well. The appropriate reaction to such unfair competition is to say thank you, please may I have some more?

That is, foreign subsidy is the same as an advance in production technology, or our useful reaction to trade itself. If, for whatever reason, other people are making us richer then we should enjoy that greater wealth. After all, that is the very thing we’re trying to do, get richer.

Certainly, the Chinese taxpayer has reason to complain but why wouldn’t we appreciate network equipment that is 30% cheaper, wherever the £57 billion to produce it has come from?

Some will complain that this all makes China richer somehow but that can’t be true. It’s a straight transfer of £57 billion from them to us, from China’s state revenues - thus the Chinese populace - to us consumers. Our only difficulty here is to work out where to send that thank you letter. D’ye think they’d let us post it up on the Tiananmen Gate?

Me

Worstall’s argument is correct only in aggregate for the US and China, and only currently. For example:

• Not all US citizens are better off. Some US workers have lost good jobs and must take less attractive jobs. While it is theoretically possible to arrange for all US citizens to be better off if China subsidizes its exports, for example, through transfer payments, that does not happen in practice.

• If China enables Huawei to drive out its competition and then act as a monopolist, or close to one, then China wins and the US loses.

• According to Worstall and his ilk, the US should buy Chinese products whenever they are cheaper than others. So, China could subsidize critical products, e.g., required directly or indirectly for defense, drive out competition, and then be in a position to win a war – or at least to put the US at a bargaining disadvantage.

Worstall and his ilk push the advantages of free trade. They rightly point out that international competitive free markets maximize the potential wealth of all, because comparative advantage leads to worldwide efficient production (i.e., worldwide production is on the production possibility frontier (PPF). While this is correct, real markets mostly are not competitive – China’s subsidized exports being an example. Subsidies, such as China’s, can destroy the efficient production and pricing they so laud (i.e., worldwide production is interior to the PPF. To see this, suppose competitive free markets, hence maximally efficient production and pricing yielding the full benefit from comparative advantage. This world economy is on the PPF. Now add Chinese subsidies. Production of the subsidized products decline in other countries and increase in China. Efficient production and pricing suffer and the worldwide economy moves to the interior of the PPF.

It is clear that what you hear from many academics, politicians, and media talking heads is misleading.