Monday, May 18, 2015

Why low tariffs and free trade are good for economies

Some of my friends are upset with Bill Clinton for signing a bill creating free trade between the United States, Canada and Mexico. They say that all this does is benefit foreign economies at the expense of our own.

In 1888 Benjamin Harrison made tariffs one of the key issues in the election against incumbant president Grover Cleveland. Harison was a pro-business republican who believed it was necessary to keep tariffs high in order to allow local businesses to compete.

Cleveland contested that tariffs were already too high, as evidenced by a surplus of money in the treasury. Yet Harrison won the election, and republicans gained a majority in Congress. Future president William McKinley drafted what would become the McKinley Tariff Act of 1890, raising tariffs by as much as 50 percent.

Initially there was an economic boom, although it was short lived. (This is the same as what happens when taxes are raised).  By the time Cleveland was back in office in 1893 the country was embittered in a major depression, and high tariff was blamed.

A tariff is a tax on imported goods. While the purpose of a tariff is to benefit a local business, the overall effect is that it hurts the whole community.

So what is a tariff? It is a tax on imported goods. The purpose of it is to raise taxes on the imported goods so that local merchants can compete. Henry Hazlitt, in his book "Economics in One Lesson," explains it this way:

"An American manufacturer of woolen sweaters goes to Congress or to the State Department and tells the committee or officials concerned that it would be a national disaster for them to remove or reduce the tariff on British sweaters. he now sells his sweaters for $30 each, but English manufacturers could sell their sweaters for $25. A duty of $5, therefore, is needed to keep him in business. he is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whome their spending in turn gives employment."

So in this way, a high tariff sounds good. Throw these people out of work and you create more unemployment, and the economy takes a turn for the worse. So, in this way, republicans were right that tariffs are good. Of course that is what is seen. The problem here is the unseen.

Say the tariff of $5 is removed, which is what Bill Clinton accomplished with NAFTA. Certain American merchants will go out of business, because people will be more likely to buy the higher quality British sweaters at a better price. Sweater consumers now have a high quality sweater and they have an extra $5 to spend on other products. In this way, the value of the dollar increases. Instead of spending $30 on one sweater, he spends $25 on a sweater and $5 at McDonalds.

Now, on the surface this looks bad to the American merchants, and all the people who lost their jobs. But on the plus side, since America no longer needs to produce cheap sweaters and sell them at a high price, the merchant can focus on manufacturing another product that is necessary. For instance, the merchant will make washing machines or aircraftss instead. These industries then absorbs those who were previously unemployed.

Since American washing machines and aircrafts are of higher quality and less expensive than those made in Britain, British washing machine and aircraft manufacturers will be forced to close their doors. Those who lose their jobs will be absorved by industries that otherwise would not have been created if the tariff had been high.

Another advantage of lower tariffs is that the British are encouraged to sell their sweaters in the U.S., and, since American money is only good in America, they will have to spend it on American goods. So this in and of itself boosts the American economy.

"So," Hazlitt explains, "as a result of letting in more British goods, we must export more American goods. And though fewer peple are now employed in the American sweater industry, more people are employed -- in, say, the American washing machine or aircraft building business. American employment on net balance has not gone down, but American and British production on net balance has gone up. Labor in each country is more fully employed in doing just those things that it does best, instead of being forced to do things that it does inefficiently or badly. Consumers in both countries are better off. They are able to buy what they want where they can get it cheapest. American consumers are better provided with sweaters, adn British consumers are better provided with washing machines and aircraft."

So, in the end, lower tariffs are good, and so are free trade agreements between nations. The challenge is to look beyond what is right before your eyes. In order to see the big picture you almost need to use your imagination.