Tariff policy: a sword with two edges

President Donald Trump has announced that he plans to use tariffs as a strategic weapon in defense of the United States’ national interest, but this is not the first time US tariffs have been so used.

From the administration of George Washington, when the political chess master was Alexander Hamilton, to the time of Abraham Lincoln, tariff policy, named by then Speaker of the House of Representatives Henry Clay “the American System,” was a key instrument by which US foreign and domestic growth, development and economic independence were promoted. In the current situation, the tariffs may improve US domestic conditions, or, contrary to President Trump’s expectations, help advance the rest of the world’s power and influence.

Historical tariff policy, in critical ways, did work. The tariff created a situation, during the “infancy” of the US economy, that brought about a transformation of the young nation. Within the span of a human lifetime, America went from being a colonial agrarian economy to become a leading international presence.

By the application of “The American System,” the Americans threw off their dependence upon international buyers for the goods produced by their limited ability to “draw water and hew wood.” The “system” made clever use of agrarian strength. From the time of its founding until (and beyond) the Civil War, the US was a world-class export supplier of cotton, sugar, tobacco, rice and indigo dye.

After first reviewing that history, we will show that, just as in the past, the management of tariff policy is a most delicate balancing act. Trump may get things “right” for the American Interest. But there is a good chance that the long-run consequence of his new tariff policy will be destabilizing. There is a possible line of subtle international reaction, not a simple trade war, that will mainly advance the interests of China, and marginally benefit Europe, Russia and especially the non-Japanese Orient, all at the expense of the US.

Let us now review US tariff history.

The “American System” saved the new nation from being re-absorbed by the old colonial “masters” in Europe, but it also nearly destroyed the wealth it created. Alexander Hamilton understood that winning the American Revolution against England could have been a Pyrrhic victory. America had merely sent the colonial bureaucrats, armies, investors and governing elites back home.

But if the 13 former colonies remained enmeshed as rather primitive suppliers of raw materials, dependent upon European expertise in banking, finance, manufacturing, invention and technical innovation, then the “New World” and its democratic experiment would quickly fall back under European domination, living out a permanent economic childhood, quite dependent upon political, economic and social “grown-ups” across the ocean.

And so Hamilton, and his imitators in the Whig Party, successfully advocated for “home-made” (and initially quite inefficient) banks, factories, cities, immigrant populations and national infrastructure.  The worm in the apple was the design of the tax system – the tariff – that paid for it all. The folks who paid the tax were not those who benefited from it.

The tariff taxed and burdened those exports produced in the US South. In other words, world-class efficient Southern agriculture, as practiced on pre-modern big plantations, with the help of slave labor, paid the price for the innovative modernization of the North

The tariff, “invented” as a tool for development and change, taxed and burdened those exports produced in the US South, producing revenue that the Federal Congressional Government, controlled at the time by the North, devoted to what we today call “infrastructure spending” – building, in the North, roads, canals, protected but inefficient factories/industries and eventually railroads.

In other words, world-class efficient Southern agriculture, as practiced on pre-modern big plantations, with the help of slave labor, paid the price for the innovative modernization of the North.

The “Tariff of Abominations” (1828), as it was called in the South, averaged almost 40% on imported goods. In other words, a Southern planter/exporter who sold his raw cotton to a British textile mill in exchange for 1,000 English pounds sterling, who then looked around in Britain for things to buy with his profits, would lose £400 of purchasing power when he brought home to South Carolina efficient European farm machinery that might replace expensive slave labor.

As well, the planter’s buying power in all foreign markets for domestic goods, from elegant furniture to finely bred horseflesh, was also cut to 60% of its tariff-free original value.

The result was that rich Southerners were strongly induced to buy farm machines, furniture and even their breeding stock from otherwise non-competitive, high-priced American producers and suppliers.

It is possible to believe that low-cost, efficient, internationally available (but unaffordable inside the US because of the 40% tax) would have “freed” the slaves, but at the cost of un-employing them. Replaced by machines, they would have been expelled from plantations, with few economic or social alternatives – provoking a need for “reconstruction” perhaps greater than the problems following the Civil War.

No wonder the American Civil War nearly started in 1828. South Carolina’s threat to secede from the Union at that time was delayed, to 1860. In that year, the seceding Southern Confederate States claimed as a reason for their departure the continued insistence by the North-controlled US Congress of a somewhat diminished, but still onerous, tariff tax.

History shows how strategic, nation-building tariff policy has a double-barreled effect, both positive and negative. But what about the China connection we promised? Here it is.

Mr Trump’s idea, which is almost certainly an initial negotiating opening move, will be followed up by a trading “game” where the US takes on its many trading partners, one on one, bilaterally, in settings where smaller players cannot band together and support one another so as to minimize the power of the world’s most important buyer and seller of traded goods.

The problem for the US, and the opportunity for China, is that the best non-American response in this ‘great game’ is to come back with a new form of multilateralism. The counter-move for the rest of the world is to group around an alternative ‘big guy’ – China

It is a strategic move that the Americans have not employed up to now, and Trump is correct in thinking that the old multilateral system favored the rest of the world. If the rest of the world does not behave with as much strategic cleverness as does Mr Trump, he will benefit.  The problem for the US, and the opportunity for China, is that the best non-American response in this “great game” is to come back with a new form of multilateralism. The counter-move for the rest of the world is to group around an alternative “big guy” – China.

Up to now, China has followed a classic, but somewhat expensive, plan for economic development. As with the Americans in the 19th century, over the most recent generation, China needed to create a modern economy in a setting where others nations were, for the time being, technically speaking, well ahead of it. So China built up, from a basic starting point, an industrial manufacturing base that was initially not efficient, but was able to sell its excess production (there is no adequate home market) into the very markets where there already existed highly advanced competitive firms.

China succeeded via aggressive price competition, soon followed by advancing technical competence. This policy was expensive: Consumers at home were left in distress and need. Consumers at home could only dream of the goods that were put together in China’s factories, but sent away, at bargain prices, to already rich foreign buyers.

But the eventual outcome was (and now is) a manufacturing base that can turn its energies to meet the needs of its Chinese worker/buyers.  There is great need, especially in the parts of China that, up to now, have been left behind. And thus, for China, today’s domestic strategic plan is to turn away from export sales toward a domestic plan of “lifting up and equalizing” the standard of life enjoyed by all, so as to avoid domestic unrest and resentment.

But what international game of strategy might China play in response to toughened US trade practices? China may do more of what it is already doing – investing abroad to draw into itself needed high-level inputs – not mere raw materials, but “virtual” products like banking, financial, insurance and even “rule of law” services produced abroad.

It might even continue, for a while at least, its past practice of providing its non-American trading partners with super-inexpensive but solid-quality export goods, from home appliances to raw steel. Such a policy would improve living standards because of low-cost consumer goods and bargain-priced manufacturing “raw materials” such as steel and rare-earth elements.

Such a plan would set up China as the trade leader, perhaps even as world-currency provider, to a host of increasingly dependent trade partners, ranging from upwardly mobile smaller-than-China Asian nations (think Cambodia or even Indonesia) to Western nations that cannot (or do not) themselves adequately serve their own industrial needs or consumer demands (think Russia, Greece or Italy).

Even relatively successful European nations like the UK may realize they could benefit, just as did the US, from China’s ability to advance UK consumer benefits, while reducing the cost of industrial inputs. It would be a new order of things.

That is, China may integrate itself into markets now dominated, or at least fixated, by their relationship with the US. China will not replace American “virtual” inputs, but form close associations that mix economic dependences among world players, while the Americans remove themselves – even to a limited degree – from the “game board” and thus give an opportunity to an imaginative, more outgoing China to advance its interests and agenda.

Trump is quite smart enough to see this entirely possible scenario. He correctly says that the United States would win any ordinary trade war, waged by unorganized smaller nations against the only superpower. He knows that if the US steps aside (temporarily and as part of a strategic plan) from its role as the world’s leading trader, only a nation as significant as China can fill the vacuum and organize a coherent opposition.

He is a gambler. He is betting that China does not have the ambition, or the desire, or the willingness to gamble against him. So he bets that an unorganized, unfocused rabble of smaller nations will be bent to his indomitable will, and so succumb to his new “America first” trade rules.

But China could surprise him. China knows how to “gamble” too. Our question is, will it?