Free trade, tariffs or managed trade, three theories side by side

Three Republicans walk into a diner. The first orders the pie and says that tariffs are taxes on your own people and that the market should be left alone. The second says that a country that cannot make its own steel, ships and medicine is a country that has stopped being free, and that a tariff is the price of staying independent. The third says both of them are naive: trade is a negotiation, every other nation plays hardball, and the job of the American government is to make deals that are fair and enforced. All three call themselves conservatives. All three vote Republican. And they will argue until the pie is gone, each convinced that the other two have left the true faith.

I want to settle nothing today. I want to do something more useful: lay the three theories out side by side, in their strongest forms, so that you can see what each one actually claims, where each one is weak, and which one sounds like you. Because the fight inside our own coalition is real, and we cannot win the argument with the other side if we cannot describe the argument at our own table.

The table

Now let me take the three in turn, with the numbered argument and the strongest objection, the way a debate should be run.

Theory one: free trade, from Smith to Ricardo

Adam Smith made the opening case in 1776 in The Wealth of Nations. If a foreign country can supply a good cheaper than you can make it, he argued, it is better to buy it with something you make well than to produce it yourself. The household analogy is hard to beat: the tailor does not make his own shoes, and the shoemaker does not make his own clothes.

The cleverest step came from David Ricardo in 1817. Smith's logic works when each country is better at something. Ricardo asked what happens if one country is better at everything. His answer, called comparative advantage, is the most important idea in international economics, and it is worth working through with numbers.

Take the classic illustration, as it is usually presented. England needs 100 workers for a year to produce a given amount of cloth, and 120 to produce a given amount of wine. Portugal needs 90 for the cloth and 80 for the wine. Portugal is better at both. Yet look at the trade-offs. In England, one unit of cloth costs 100 divided by 120, or about 0.83 units of wine given up. In Portugal, one unit of cloth costs 90 divided by 80, or 1.125 units of wine given up. Cloth is cheaper, in terms of what you sacrifice, in England. Wine is cheaper in Portugal. If England specializes in cloth and Portugal in wine, and they trade, both end up with more of both than they would alone. A country does not need to be best at anything to gain. It needs only to be relatively better at something.

The strongest objection, from the other two camps, is that this is a model, and the real world has frictions. Ricardo's workers do not glide from one industry to another. They are people with mortgages in towns that depend on one plant. The economists Autor, Dorn and Hanson wrote a well-known paper in 2013 documenting how American local labor markets exposed to a surge in Chinese imports after China joined the World Trade Organization in 2001 suffered lasting job losses. It is a fair point and free traders should face it. The honest answer is that the gains from trade are real, and so are the losses, and the losses were allowed to land on specific people with little help. A free trader worth listening to supports a serious answer to that problem rather than a shrug. For the claim as seen from the consumer's side, read I, Pencil and the price system, how nobody plans your breakfast.

Theory two: Hamilton and the case for protection

In December 1791, Treasury Secretary Alexander Hamilton sent Congress his Report on Manufactures. His argument did not deny that cheap imports have value. It said that a young country will never develop industries if it must compete against established foreign producers from day one, so it should use protective duties and bounties until its industries stand on their own. This is the infant-industry argument, and it was the intellectual spine of American economic policy for much of the nineteenth century. Henry Clay called his version the American System.

There is a second, separate branch of the protectionist case that has nothing to do with infants: national security. A country that depends on a rival for its steel, its semiconductors or its medicines has handed that rival a weapon. This is why American law has long allowed tariffs on national-security grounds. Section 232 of the Trade Expansion Act of 1962 gives the President authority to adjust imports of goods found to threaten national security, after an investigation by the Commerce Department. Adam Smith himself, notably, accepted an exception for defence, saying that defence is of much more importance than opulence.

Here is the argument in numbered form.

1. Markets price what is cheap today, not what is vital in a crisis.
2. Some industries, such as steel, shipbuilding and certain high-tech components, are needed for defence and cannot be improvised on short notice.
3. A tariff, or equivalent protection, can keep a domestic capacity alive that the market would let die.
4. Therefore a nation may rationally pay a premium in prices to keep that capacity.

The strongest objection is that tariffs are paid by Americans. The importer pays the tax at the border, and the cost usually shows up in higher prices for buyers, a story told with the dollar-by-dollar detail in who really pays a tariff, following the dollar from dock to shelf. Protected firms also have a way of staying protected: once the shield is up, the owner lobbies to keep it, whether the infant ever grows up. Tariffs on inputs hurt the American producers who use them. And retaliation lands on exporters. The honest protectionist answers by narrowing the case: protect what is genuinely strategic, set a time limit, and count the cost.

Theory three: managed and reciprocal trade

The third camp starts from a different premise. Its members do not claim that markets are bad or that tariffs are good. They claim that the real world is not a classroom, and that other governments subsidize, restrict and manipulate. In that world, the American role is to bargain for terms that are matched and enforced, using the size of the American market as leverage.

The precedents are real. The Reciprocal Trade Agreements Act of 1934, sponsored by Secretary of State Cordell Hull, allowed the President to negotiate tariff reductions with other countries in exchange for matching concessions, a story told in Smoot-Hawley, 1930, what the tariff did and what it did not do. In 1981 Japan agreed to limit its automobile exports to the United States, under pressure from the Reagan administration, an arrangement known as a voluntary export restraint. In 1983 Reagan raised the tariff on large motorcycles, a measure that was meant to last five years and that Harley-Davidson later said it no longer needed. Later, the continental deals, covered in From the 1989 Canada deal to USMCA, a timeline of North American trade, tried to write common rules for North America.

The strongest objection is the one the free trader and the protectionist can both make: who does the managing? A government that sets terms and picks sectors needs officials who know more than the market, and history says they often do not. Studies of the 1981 auto restraints found they raised the price of cars for American buyers and handed Japanese producers a windfall. And deals, once made, can be changed with every election, which is hard on a business trying to plan a factory for twenty years. The honest manager answers that a negotiated outcome, with clear enforcement, is better than either unilateral surrender or unilateral tariffs.

One tariff, three verdicts

To see how the three camps actually disagree, run one hypothetical through all of them. Imagine an imported widget that lands at the dock for $40, and a 25 percent tariff on it. The tax is 25 percent of $40, which is $10. That lets a domestic maker charge up to nearly $50 without losing the sale to the import. Suppose a family buys three widgets a year. That is $30 a year more out of the household budget, and the domestic factory, selling 100,000 widgets at the higher price, collects an extra $1,000,000 in revenue.

The free trader looks at the $30 and the households behind it and says the family is paying for the factory's comfort. The Hamiltonian looks at the factory and asks whether this is a widget the country needs in a war or can only make if it keeps the plant open, and if the answer is yes, the $30 is cheap insurance. The manager asks why the foreign price is $40 in the first place: if their government is subsidizing the widget, the right move is to bargain the subsidy away rather than tax the family, and if it is not subsidizing it, then the tariff is just a bill. Same $10, three different questions. None of the three is stupid. Which question is the right one depends on the widget.

Where our own history sits

If you think the free-trade position is the only Republican tradition, you have been told a short story. The party was born protectionist, and the long arc of its trade politics is traced in Republicans were the tariff party first, from Lincoln to McKinley. If you think the tariff position is the only one, you will have to explain the many Republicans who backed the agreements of the late twentieth century. The truth is that all three strands are in the party's family tree, and each has been right at some times and wrong at others.

A five-question test to place yourself

Answer each with a, b or c.

1. A foreign firm can sell steel for less than any American mill. (a) Buy it, the savings go to every user of steel. (b) Tariff it, because steel is a defence industry. (c) Negotiate, with limits tied to what their government subsidizes.
2. A factory town loses its plant to imports. (a) Retrain and relocate, and keep the market open. (b) Protect what is left. (c) Press for better enforcement of trade rules and for help.
3. What is the right size of a tariff? (a) Zero. (b) High enough to keep strategic capacity alive. (c) As high as needed to bring the other side to terms, then lower.
4. A deal that trades one market for another is (a) fine if both consumers gain, (b) suspicious if it hollows out a vital industry, (c) the whole point.
5. When another country cheats, (a) you do not hurt yourself to punish them, (b) you shield your producers, (c) you retaliate in kind until they stop.

Mostly a: you are in the Smith and Ricardo tradition. Mostly b: you are in Hamilton's. Mostly c: you are a manager. If your answers are scattered, welcome to the Republican Party. Most people hold a blend: free trade as the default, protection for genuine national-security industries, and negotiation as the way to get from here to there. For a ground-level check on what both sides get wrong, read seven trade myths both parties repeat, tested against the record.

The bottom line

• There are three conservative trade philosophies, not one: free trade (Smith, Ricardo), protection for industry and security (Hamilton), and managed or reciprocal trade (Hull's 1934 act and its descendants).
• Each has a strongest argument and a real weak spot. If someone tells you their view has no costs, they are not describing a policy.
• Ask of any tariff: who pays, for how long, what vital capacity does it protect, and what is the exit?
• Do not let anyone tell you that the Republican tradition is only one of these three. It is all three, and the argument is the tradition.
• When you argue with a neighbour, first say which of the three you hold, and why. Half the shouting stops there.