U.S. Commerce Secretary Wilbur Ross told CNBC last week that President Trump’s tariffs wouldn’t hurt American consumers, noting that because the price increase would be “spread over thousands and thousands of products, nobody’s going to actually notice it at the end of the day.”
Needless to say, poor Ross was summarily tarred-and-feathered by “experts.” What doesn’t this kook understand? Tariffs are a tax, and taxes are always bad.
The logic seems straightforward enough: tariffs increase costs and these costs invariably get passed on to consumers. Thus, tariffs won’t punish China—they’ll punish American consumers. We will pay the price for Trump’s ignorant bravado.
But, as always, the “experts” are wrong. Tariffs will not hurt American consumers, they’ll actually make America richer in the long run.
The Brave Little Toaster
The main reason why so many Americans oppose tariffs is that they don’t understand them. They think tariffs are just another sales tax, and assume that imposing a 10 percent tariff on a product will increase that product’s price by 10 percent. That’s not how it works.
Unlike sales taxes, American tariffs are not applied to a product’s retail price, nor are they applied to the wholesale price. In fact, they’re often not even levied on the entire import price. Instead, tariffs are levied on the first sale price—the price paid to foreign vendors by American companies or their middlemen.
This method of calculation reduces the tax burden on American consumers, but preserves the tariff’s punitive effect on foreign producers.
For example, suppose President Trump were to impose a 10 percent tariff on all Chinese toasters.
Black & Decker makes toasters in China. These toasters sell for $60 in American stores. That’s the retail price. Are tariffs imposed on retail prices? No. This means that the price of toasters will not rise by 10 percent—$66 toasters are a media-concocted boogeyman.
So just how much would this hypothetical tariff increase the price of toasters?
American stores buy their toasters from Chinese manufacturers. But because of China’s (intentionally) convoluted regulatory framework, they often buy them via middlemen located in Hong Kong, Singapore, or Taiwan. These middlemen charge somewhere in the neighborhood of $14 per toaster.
And of course these middlemen don’t work for free: they buy the toasters directly from Chinese factories for $7 per toaster. This is the first sale price, and tariffs are calculated on this figure. Thus the tariff charged on a Black & Decker toaster that retails for $60 works out to just 70 cents.
American consumers don’t pay 10 percent more for toasters—they pay just 1.15 percent more. And that’s assuming Black & Decker doesn’t simply source its toasters from one of China’s competitors, in which case consumers may not see any prices increase whatsoever.
This same rule applies to component pieces, meaning that toasters assembled elsewhere using Chinese parts would only increase in price relative to their proportion of Chinese origin. For example, if a Taiwanese factory assembles $7 toasters using foreign parts, half of which are from China, then tariffs would apply only to half of the value. The final retail price of this hypothetical Taiwanese toaster would increase by just over one-half of 1 percent
Americans consumers may not notice the tariffs, but Chinese producers will. After all, the only reason Americans manufacture in China is because they’re cheap. If Trump’s tariffs change this fact then American companies will do business elsewhere—ideally in America. China is vulnerable and Trump knows it.
In this way tariffs give America leverage over China—leverage we can use to achieve important goals. For example, China steals up to $600 billion in American intellectual property every year. Tariffs could coerce the Chinese into enforcing American IP law (which they pledged to do when they joined the World Trade Organization), thereby generating astronomical amounts of cash and upholding the rule of law.
Innovation Expands Economies and Tariffs Push Innovation
Tariffs will also enrich America because they help expand the economy. Here’s how:
America’s economy grows when we make more or better stuff—more cars or more luxurious cars, more software or faster software.
Great minds from Plato to Adam Smith to Henry Ford recognized that one way to make more stuff is to divide our labor more efficiently. When people specialize in making only what they’re best at, and trade for what they’re not, they can make and consume more stuff overall. Henry Ford took this principle to its logical conclusion by perfecting the assembly line, and unlocked enormous prosperity as a result.
But there’s a problem: we can only divide labor so efficiently. Once we reach the limit, growth will stop.
Thankfully there is another way to make more stuff: increase productivity, make more stuff in the same amount of time. How? Invent and adopt better technology.
Technology is also the key to making better stuff—it’s why today’s iPhones are more powerful than computers that filled buildings in the 1970s. Or why a trip from London to New York takes six hours by airplane, as opposed to three-and-a-half days by steamer.
Technology makes us richer. Economic growth is a predicate of technological progress, it is a footnote to the story of mankind’s creativity.
Everyone I speak with understands this point intuitively. But let me flesh it out with an example.
There are two islands. One island is home to the Flintstone culture: a technologically primitive, yet industrious people. The Flintstones worship their deity, Adam Smith, by dividing their labor and trading as much as possible. In return, Adam Smith blesses them with prosperity. He is a generous god.
The second island is home to the Jetson culture. Unlike the Flintstones, their technology is highly sophisticated—far more advanced than our own. For example, their crops are drought, disease, and pest-resistant, highly nutritious, and whole fields can be harvested in an hour, by a single man riding a floating tractor.
Who’s richer? The Flintstones or the Jetsons?
Obviously the Jetsons. No matter how efficiently the Flintstones divide their labor, no matter how freely they trade, they will always produce less than the Jetsons. Stone tools cannot compete with hover-tractors (or the parochial diesel-powered ones Americans use).
America Must Retain Our Advanced Industries
If we want to grow the economy we need to improve our technology. How?
We cannot simply force people to invent “the next big thing” any more than we can force them to compose like Beethoven or perform like Daniel Day Lewis. Instead, we must create an economic climate that maximizes our exposure to technological discoveries. Doing this requires tariffs.
Most discoveries are generated by America’s technologically advanced industries—sophisticated manufacturers, information technologies, pharmaceuticals. The Brookings Institute focused on the economic impact of “advanced industries” in a recent report. The study found that although such industries employ just 9 percent of America’s workforce, they file 85 percent of all patents, provide 90 percent of private sector research funding, and employ 80 percent of America’s engineers.
Advanced industries are the engine of growth—and we’re losing them.
Not only is it cheaper to make bobble heads in China, it’s also cheaper to make automobile components, computer processors—everything. It’s also cheaper to perform basic research and product design abroad now that many developing countries are training large numbers of (relatively) competent engineers and scientists.
Without tariffs to equalize cost differences, America’s advanced industries will continue to leave, taking with them our jobs, our prosperity, and our economic future. President Trump’s tariffs on China are a good start, but they’re not enough.
The problem isn’t that our industries are leaving for China, it’s that they’re leaving to begin with. Where they end up isn’t all that important. For this reason President Trump should protect America’s industry from asymmetrical foreign competition wherever it lurks. And he needs to do it quickly, while there’s still something to protect.
Photo Credit: Mark Ralston/AFP/Getty Images