May 2000 Fraser Forum: Trade and Tariff Tall Tales
Early American industry thrived during a period of high tariff rates. Economic nationalists and so-called Third World advocates have used this fact to promote one of their favourite myths - that tariffs and other protectionist measures are good for the economy. These folks argue that tariffs were an important factor in the development of the early American economy in general, and more particularly in infant industries, such as tinplate production. They also give tariffs credit for increasing capital formation by increasing returns to investment. They cite the superior performance during this time of the "protected" United States to that of the less protected United Kingdom as proof positive of tariffs' beneficial effects. Finally, they claim that tariffs shifted the focus of the economy from agriculture to manufacturing, which resulted in faster productivity growth. Thus, they argue that tariffs were important to the development of the economy.
Pat Buchanan, a prominent US nationalist, has claimed that "behind a tariff wall... the United States had gone from an agrarian coastal republic to the greatest industrial power the world has ever seen - in a single century. Such was the success of the policy called protectionism that is so disparaged today" (quoted in Irwin 2000b: 3).
On its face, early American industrial history does seem to suggest that high tariff rates were beneficial to the development of the American economy. However, in three separate papers, Dartmouth College economist Douglas Irwin outlines a persuasive argument against this simplistic view of tariffs, growth, and economic well-being.
First, Irwin looks at two specific industries to see whether they - and society as a whole - benefited from tariff protection. He focuses on the pig iron and tinplate production1 industries and examines whether reducing tariffs on these industries would have affected production. He concludes that removing tariffs would not have had a substantial impact on domestic production in either industry. In the case of pig iron production, geographic constraints and other differences between foreign and domestic supplies meant tariff elimination would have reduced domestic production by only 15 percent, which was not nearly enough to destroy the industry. In the case of tinplate production, Irwin concludes that because of tariffs on imported tinplate, the domestic industry started production sooner than it might have otherwise. However, he argues that the industry would have eventually started regardless of these tariffs, and that the late start in the absence of tinplate tariffs can be attributed to higher costs of raw materials, due to other tariffs!
If these tariffs were indeed beneficial to society, one would expect that the additional costs they generated, including higher prices for domestic consumers, would have been offset by even greater gains. This was not the case. Irwin's calculations of the cost and benefits of these policies finds that the losses to society far outweighed the relatively minuscule gains that were channelled to a concentrated group of special interests within these industries.
In another paper, Irwin assesses the general argument that tariffs enhanced overall economic growth from 1870 to 1912. He acknowledges that during this time, the "protectionist" United States grew nearly 4 percent per year while the relatively "free trade" United Kingdom grew only around 2 percent per year. Even after accounting for population growth, American performance is still superior at 1.8 percent annually compared to 1.0 percent in the UK. However, once greater capital accumulation2 in the US is accounted for, the growth rate of productivity is similar between these two nations.3 Thus, the claim of superior economic performance is overstated.
"Aha," critics might exclaim, "greater US capital accumulation means that protectionist policies were important in channelling capital into important industries."
But Irwin notes that the biggest increases in capital accumulation occurred in non-traded sectors. In other words, those areas of the economy not affected by tariffs accumulated new investment more quickly than those that were.
Additionally, tariffs increased the costs of both domestic and foreign capital. Imported capital goods were slapped with tariffs, while domestic capital goods were made more expensive by tariffs on the materials that went into their production. This combination of higher prices may have suppressed additional investment. This, in Irwin's words, "could have proven very harmful to… economic growth"4 (Irwin 2000b: 13).
Finally, Irwin refutes the often-cited misperception that protectionist policies significantly increased productivity by shifting resources into industries with faster productivity growth. He notes that even a plausible movement of investment from agriculture into manufacturing would have had only a minor impact on productivity. However, as manufacturing became more profitable due to these policies, investment would have also moved from industries such as the trans- portation and communications sectors. These industries had, in fact, greater productivity growth than manufact- uring, and the movement of resources from these sectors could have resulted in lower overall productivity growth.
Irwin's articles debunk several often-cited arguments for protectionism. Other research by James Gwartney, Robert Lawson, and Charles Skipton supports the idea that the most open economies have the highest growth rates. Research by economists Dan Ben-David and Ayal Kimhi shows that liberalized trade between nations allows the poorer countries to "catch up" to the richer ones at faster rates. Overall, this suggests that the case for protectionism is tenuous at best.
In sum, there is no indication that high tariff walls were important in the development of the early American economy. The American experience provides no evidence that high tariffs would benefit any country, even developing ones. In fact, they would likely only benefit concentrated special interests, while lowering both overall economic performance and the rate at which poor nations catch up with the rich - outcomes most advocates of protectionism would find unfortunate.
Notes
1An examination of tinplate production is especially pertinent as it is often cited as an example of a successful "infant industry."
2Economic growth can occur either by increasing the inputs (labour or capital) used in production or by increasing the productivity with which those inputs are used. Thus, in order to examine productivity growth it is necessary to eliminate the roles of increased labour and capital from the analysis.
3Irwin also indicates that in a more laissez faire period in American history (1950 onwards), growth was faster than in the earlier protectionist period, and that a key factor in this better performance was increases in economic efficiency.
4The massive increase in savings seems to be due to an increased supply of savings rather than demand from businesses for investment capital.
Bibliography
Ben-David, Dan and Ayal Kimhi (2000). Trade and the Rate of Income Convergence. NBER Working Paper 7642. NBER: Cambridge, MA.
Gwartney, James, Robert Lawson and Charles Skipton (2000). Trade Openness and Growth. Working Paper. (Available from the authors.)
Irwin, Douglas (1998). Did Late Nineteenth Century U.S. Tariffs Promote Infant Industries? Evidence from the Tinplate Industry NBER Working Paper 6835. NBER: Cambridge, MA.
Irwin, Douglas (2000). Could the U.S. Iron Industry Have Survived Free Trade After the Civil War? NBER Working Paper 7640. NBER: Cambridge, MA.
Irwin, Douglas (2000b). Tariffs and Growth in Late Nineteenth Century America. NBER Working Paper 7639. NBER: Cambridge, MA.
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