Peter Schiff—well-known libertarian financial author and podcaster—recently faced off against pro-tariff author Spencer Morrison in a debate about Trump’s tariffs on zerohedge.com. Schiff argued that tariffs harm American consumers and that—contrary to the usual protectionist narrative that trade deficits harm American workers and export industries—Americans, in fact, have been exploiting foreigners. Schiff correctly noted that America lives way beyond its means in part because of its unique ability to export dollar-denominated Treasury debts (the world’s principal reserve asset ever since President Nixon cut the ties between the US dollar and gold in 1971) to foreigners in exchange for valuable goods and services, and because these debts constantly lose their value in real terms due to continual fiat dollar creation.
Schiff also emphasized that capital flows are precisely the reverse of the protectionist canard (repeated by Morrison over the course of the debate) that Wall Street has been off-shoring savings from America to build up foreign industries at the expense of American workers. On the contrary, the very existence of a trade deficit logically implies that more foreign savings are flowing into America. By definition, a trade deficit means that the surplus earnings of foreigners are being invested in America or gifted to Americans, not spent on American exports of goods and services. The US’s negative and rapidly-plunging net international investment position quantifies just how extensive this recycling of foreign dollar earnings into America has been.
More could have been said about tariffs with respect to these capital inflows. In a previous article explaining why tariffs won’t reindustrialize America, I observed that America has been deindustrializing in spite of such inflows because domestic net savings have practically vanished since the mid-1960s. Interventions aiming to eliminate trade deficits without fixing the dearth of domestic savings means eliminating most of what little remains of America’s feeble ability to grow its production capacity.
In another article I noted that tariffs won’t save the US dollar either, as BRICS states have already built their own institutions for payment settlements and are working on creating a new reserve asset featuring partial gold backing as an alternative to dodgy US Treasury securities. BRICS is poised to break away from the US dollar and form a rival currency bloc of its own—a kind of radical fracturing of global trade and investment which the world hasn’t witnessed since the early 1930s. While economists can’t quantify just how damaging any particular tariff policy will be, the historical precedent of just how bad things can get with a breakup of the international division of labor points to a serious risk of a very dark future for the entire world.
While Schiff and Morrison didn’t delve into these deeper issues, Morrison did try to defend Trump’s tariffs by citing a theory originated by British economist Robert Torrens in the early 19th century, later popularized by John Stuart Mill, and further elaborated upon by several 20th-century economists. This “optimal tariff theory” claims that the burdens that tariffs impose on domestic consumers and the economic inefficiencies they impose on domestic production (the loss of comparative advantage arising from international trade) can, under certain special conditions, be more than offset by the revenues diverted from foreign manufacturers.
The basic idea is that if the slope of the domestic demand curve is shallow enough and the slope of the global supply curve steep enough, the rise in domestic price and fall in domestic demand caused by a tariff would be relatively modest, while the difference between the tariffed price paid by domestic consumers and and non-tariffed global price received by the foreigners would be relatively large. A steep supply curve means that the terms of trade could improve for the importing country by causing the global price to fall significantly upon imposition of the tariff. If the difference between domestic and global prices is large enough and the quantity imported is not diminished too much, revenue from a tariff could more than compensate for the additional expense borne by domestic consumers. It could also compensate for the domestic loss of productivity as labor and resources are withdrawn from more efficient export industries to focus on production for domestic markets. Torrens’s theory seems to provide a rationale for using tariffs to benefit one’s nation at the expense of other nations. So what is wrong with that?
Schiff didn’t answer this argument in detail; nevertheless, it is rife with errors. Unfortunately, Morrison didn’t spell out the specific assumptions underlying the theory. Instead, he attacked the additional assumptions made by a contemporary of Torrens and the free trade advocate who is more famously credited with the comparative advantage principle—David Ricardo. A brief consideration of the foundations for Torrens’s treatment of supply-and-demand analysis can bring its problems to light.
Like the theories of other classical British economists—including those of Ricardo and his famous though frequently-overrated forebear, Adam Smith—Torrens’s theory suffers from an excessive focus on the aggregate wealth of nations (and at times on particular classes within nations). This is at the expense of a focus on subjective individual utilities, as in the later Austrian School treatment of market phenomena. These shortcomings lead to four major flaws in employing Torrens’s theory in defense of Trump’s tariffs.
First, subjectivity of valuation means that each economic agent is only fully aware of one’s own personal contribution to the supply and demand curve for a given good or service. Trump and his team can’t possibly know the shapes of all the constantly-changing curves affecting thousands upon thousands of different kinds of imports; they can only observe one particular point on each curve before a change in the data occurs, namely, the market-clearing prices and quantities revealed by actual trades.
Rothbard pointed out that it is only a concrete action of an individual (in this case, participation in a voluntary market exchange) that discloses a demonstrated preference. The fact that such preferences are always changing over time means that all the other points on supply and demand curves at any given time aren’t revealed to economists via observable market data. Not knowing the relevant supply and demand curves, how is a tariff-setter supposed to optimize the rate?
Second, a separate Torrrens calculation is required for each kind of import and, at best, is only valid only so long as the relevant supply and demand data don’t change. But these data do change over time. Even worse, each production plan typically begins with an entrepreneurial decision to produce goods over a long span of time, simultaneously affecting many successive future supply curves of the good. Even if known to the tariff-setter, static supply and demand curve data alone are useless for rate optimization in a dynamic world and useless for enabling entrepreneurs and rate-setters to anticipate each other’s future actions.
Third, a Torrens calculation is indifferent to the country of origin as well as temporary and goods-specific. In contrast to this, Trump’s policies of uniform tariff rates on different kinds of goods, of different rates on identical goods produced in different countries, and of country-specific and/or sector-specific rates derived from mere political whims or negotiations all contradict Torrens’s conditions. The minimum 10 percent baseline rate on all imports (absurdly imposed even on non-existent imports from the Territory of Heard Island and the McDonald Islands, which only sports a few useless moss-and-lichen covered patches of open ground amongst its ice fields and some shoreline homes for its marine wildlife; the local penguins and seals not being known for engaging in any purposeful action) plainly violates Torrens optimality. This is because at least some goods won’t have the correctly-shaped supply and demand curves. Likewise, a virtual cessation of imports of many goods from China can’t be justified as Torrens-optimal. Whatever Trump and his team are doing, they aren’t using Torrens’s playbook.
Fourth, Torrens optimization illegitimately conflates taxpayer interests with the interests of tax-eaters due to its national-level aggregation. The state is never constrained to fully compensate any particular taxpayer out of the revenues it extorts from that taxpayer. The terms-of-trade shifting of fiscal burdens to foreigners may, in some cases, mitigate—but can never completely eliminate—the increased monetary expenses and utility losses tariffs inflict on Americans. Moreover, such shifting of burdens doesn’t do anything to curb the power of America’s overbearing government over the American people.
If we really want to optimize tariff rates in the interest of productive Americans, “optimal tariff theory” is no help at all. Instead, we must turn to Mises’s reformulation of the comparative advantage principle as a much broader and more general law of association. Mises fully accounted for labor and capital mobility and clarified with his individual-level analysis that only a privileged few—the state, domestic cartels, etc.—can ever gain from a tariff. For Americans earning an honest living, the correct conclusion is that tariffs can only be optimized at a zero rate.
