Some simple economics of mercantilism and import taxation

by on December 15, 2016 at 9:29 am in Current Affairs, Economics, Uncategorized | Permalink

If you tax imports and subsidize exports, the nominal exchange rate adjusts so that those policies don’t end up improving the real exchange rate at all, and thus the trade balance will not improve.  In other words, you get a stronger dollar and indeed we already see that.

This can be shown with offer curves (think of international trade as a kind of barter, and think of imposing two offsetting taxes on that barter; does anyone know of an on-line demonstration of this?).  Do note there are possible ambiguities due to the complexity of actual, real world forms of taxation, and furthermore real world exchange rate determination is not well understood, neither are changes in exchange rates.  That said, those ambiguities could just as easily work against the mercantilist proposal as for it.

Since many of Trump’s proposals, such as import-taxing tax reform, seem to involve versions of this idea, those proposals probably will not work.

1 Daniel in VA December 15, 2016 at 9:37 am

Really? If you imposed a tariff of 100 times the value of the good, the trade deficit would remain the same? I find that hard to believe.

2 Adrian Ratnapala December 15, 2016 at 9:58 am

You are assuming there is only one good in all the world.

3 Steve J December 15, 2016 at 10:57 am

And only 1 country. What is Daniel going to do with all the yuan he is accumulating? Apparently he is not going to buy Chinese goods (at least not efficiently).

4 Daniel in VA December 15, 2016 at 12:05 pm

I made no such assumption. Nor country. I was referring to a uniform tariff. And why would I or the US government end up accumulating yuan? If the trade deficit remained the same in such a scenario, the US government would be collecting 600% of US GDP in US dollars, wouldn’t it? I think that the people who think it’s hunky dory for the US to run the longest and deepest trade deficit ever, to have to then have a higher federal deficit to compensate people who lost their jobs, to “export” things like office buildings on the capital account so that ever more rents have to be paid out of the country are nuts. I have no interest in seeing the US default on those payments and defrauding those running trade surpluses. I think that manufacturing plays a valuable role in human progress, even if very few people are employed in it. I would point out that even if it generates no jobs having the manufacturing activity in the US generates tax revenue that would help the federal government deal with unemployment without taking deficits. And I wonder if there is a risk that the US dollar and US assets are themselves a bubble, and if exporting countries get tired of exporting to the US, we would not be able to replace the industries we’ve lost, nor afford imports, and end up completely impoverished.

5 Economics is Totally Science December 15, 2016 at 10:39 am

Oh of course it would. Didn’t you read Tyler, he referred to some curves. Very scientific.

6 JW December 15, 2016 at 10:51 am

*cringe*

7 Veobaum December 15, 2016 at 11:04 am

It is actually a trivial result with all three ingredients: tariffs, subsidies and flexible exchange rates. There is an open question of, “how quickly do you get to the new equilibrium?”. But there is no doubt about where that equilibrium will end up.

Also, what Adrian said below.

8 Daniel in VA December 15, 2016 at 12:12 pm

Shouldn’t just running a trade deficit cause the importing countries’ currency to decrease? Clearly that hasn’t happened enough to correct the trade deficit. Maybe the US could apply the income tax to foreign holders of US debt, including central banks, as well as taxing foreign holders of US shares and real estate. In any case, I am not convinced that there’s an iron law that the US must import 6% of GDP, and export precious rent-generating assets no matter what.

9 derek December 15, 2016 at 9:37 am

Is that evident in the mercantilist asian economies?

10 anon December 15, 2016 at 9:57 am

This is not industrial policy, this is jobs punishment, something I don’t think has been tried.

Are we mad at Carrier but not Samsung?

11 anon December 15, 2016 at 8:13 pm

To answer my own question, I think Trump has the simple view that Samsung is Korea’s problem, and Carrier is supposed to compete with them using American workers. If Carrier won’t do that, punish Carrier.

Overseas companies are fine, just not American companies overseas.

He complains about Ford, not BMW, for the same reason.

Not too sophisticated, IMO.

12 Rafael R December 16, 2016 at 12:18 am

Indeed. It’s quite a simple way of destroying US companies and allowing foreign companies to posses a massive advantage: in equilibrium you will expect foreign companies to take over the factors of production previously ran by US companies that are now punished for operating outside the US. Considering his nationalistic ideology he shooting himself in the foot by giving non-US based companies a massive advantage.

13 prior_test2 December 15, 2016 at 10:53 am

Thanks – I was just going to use Japan, but why not include them all.

14 Rafael R December 16, 2016 at 12:21 am

Average tariff rate in Japan: 1.2%

Average tariff rate in US: 1.5%

Average tariff rate in Brazil: 7.8%

Mimicking Japan means decreasing import tariffs not increasing them dummy. Japan’s econ policy is mercantilism? Please.

15 Floccina December 15, 2016 at 9:41 am

Would my buying foreign stocks tend to reduce the trade deficit?

16 c.9 December 15, 2016 at 10:33 am

No. And the “Trade Deficit” is a useless, imaginary construct.

If you buy foreign stocks with US Dollars– what do you think ultimately happens to those Dollars? Do the stock issuers paper their walls with them or stuff them in their mattress?

Mercantilism works just fine for a narrow class of ‘merchants’ and their corrupt politician-cronies in government, at the expense of everyone else. Trump is totally wrong on this, but perfectly in sync with standard Federal government policy over past century+.

17 prior_test2 December 15, 2016 at 10:57 am

‘And the “Trade Deficit” is a useless, imaginary construct.’

But that part where the U.S. imports over around 5 million barrels of oil a day? That is not imaginary – ‘In 2015, the United States imported approximately 9.4 million barrels per day (MMb/d) of petroleum from about 88 countries. Petroleum includes crude oil, natural gas plant liquids, liquefied refinery gases, refined petroleum products such as gasoline and diesel fuel, and biofuels including ethanol and biodiesel. About 78% of gross petroleum imports were crude oil.

In 2015, the United States exported about 4.7 MMb/d of petroleum to 147 countries. Most of the exports were petroleum products. The resulting net imports (imports minus exports) of petroleum were about 4.7 MMb/d.’ http://www.eia.gov/tools/faqs/faq.cfm?id=727&t=6

18 spencer December 15, 2016 at 11:06 am

No, it would not reduce the trade deficit, but it would reduce the capital account surplus. Since the current account deficit has to equal the capital account surplus it would cause rate spreads and/or the dollar to change to bring this accounting identity into balance.

19 Floccina December 15, 2016 at 2:53 pm

it would cause rate spreads and/or the dollar to change to bring this accounting identity into balance.

Would that tend to push down the trade deficit?

20 c.9 December 15, 2016 at 4:12 pm

The state of the trade account (Trade Deficit/Surplus) has NOTHING to do with currency exchange rates.

The fundamental determinant of a currency exchange rate is the relative purchasing power of those currencies.

21 Floccina December 15, 2016 at 9:45 am

Isn’t this a case where the deltas matter? If you impose tariffs and increase them at an accelerating rate could you stay ahead of the exchange rate for a little while?

22 anon December 15, 2016 at 9:54 am

I find it impossible to comment on the linked “35% import tax” because I cannot grasp a way for it to be implemented. If we are mad at China, or jobs moved offshore, are we also mad at new ventures to finish goods in Canada (or Russia, har) using Chinese parts?

As with many Trump plans it is dangerous though, as an idea that could become both real and stupid.

23 rayward December 15, 2016 at 9:57 am

Speaking of tax reform and imports and exports, how about economist Alan Auerbach’s proposed destination-based corporate tax reform (corporate profits are taxed where the goods end up not where they are produced, thereby not inducing companies to shift production to low cost countries for export back to the country where the goods had been produced) that has the support of the chair of the Ways and Means Committee. http://www.nytimes.com/2016/12/12/business/economy/new-approach-to-corporate-tax-reform.html

24 anon December 15, 2016 at 10:07 am

Sounds fine. In fact it sounds like economic rationale for my old preference: a low and uniform tariff on all imports, from oil to iPhones.

25 Sam The Sham December 15, 2016 at 10:33 am

Is that possible to do in practice? With permeable borders, how do you know the Widgets I’m buying from Nebraska (or Germany), while living in California, I’m not then retailing to clients in New York and/or Sicily? It gets hard to track where Stuff ends up, but it’s easy to say where it’s from.

26 c.9 December 15, 2016 at 10:47 am

“It gets hard to track…”

Nope — that’s a big reason behind the current, massive US surveillance state.
When the Feds get rid of cash — there will be no escape from Big Brother tracking.

27 Sam The Sham December 15, 2016 at 10:52 am

Ugh. You’re right and I hate it. Between India and Venezuela, banning cash is becoming acceptable.

I’ve taken to using cash again as an FU to banks and credit cards and the surveillance state. Don’t know how long my rebellion will last.

28 anon December 15, 2016 at 10:59 am

The Customs authority does everything required, and interprets a much more convoluted tariff system now.

29 Sam The Sham December 15, 2016 at 11:18 am

Not even close. I have 100 widgets in my warehouse, or 100 heads of lettuce in my store, I have no idea where they’re headed when I buy them. This would need a significant expansion in powers and budget of customs to enforce, if I’m understanding correctly… and I’m not seeing any advantage over tariffs.

30 anon December 15, 2016 at 11:25 am

As I understand Auerbach, “destination” is import. No internal tracking required.

31 anon December 15, 2016 at 11:38 am

OK, I misunderstood Auerbach’s border adjustment. It is done at corporate tax time, when you need two numbers, your domestic purchases/sales and your international ones.

You don’t need to worry if anyone else exports your widget, your tax is based on your domestic sale.

32 Sam The Sham December 15, 2016 at 11:41 am

Ok, thanks, that makes more sense.

33 JC December 15, 2016 at 10:25 am

Some of Trump proposals on trade (and Hillary’s btw) expose his need for some hours of Econ 101…

34 GA December 15, 2016 at 10:27 am

What does it say about the future of central bank independence?

35 Jim December 15, 2016 at 11:14 am

Well if Trump was really serious about this he could attempt to change the objective of the Fed to manage the exchange rate. There is at least some theoretical basis that trade barriers would be effective at closing the trade deficit in that case.

36 wiki December 15, 2016 at 10:50 am

Interesting how Trump’s trade interfering moves are scrutinized because they’re called tariffs but Obama’s regulations, especially environmental ones, were not. Certainly this blog seems to be devoting more attention to trade destroying moves from Trump than the many regulatory moves — often hidden from sight — that characterized regulatory and environmental overreach. And while Tyler is a big fan of dealing with climate change, his skepticism about the actual effects (vs. claims of externality improvements without hard evidence) of our real regulations were not so visible over the last eight years.

37 wiki December 15, 2016 at 10:51 am

And I’m not just talking about domestic effects here, I’m talking about how the promotion of a vast array of ostensibly environmental regulations has affected trade internationally.

38 Alain December 15, 2016 at 11:33 am

To be fair to MR, it has been louder than most when talking about opposing regulation.

However, that isn’t saying much as the media, in general, is so terribly left leaning that they must, due to team allegiance, support any and all regulation.

39 Troll me December 15, 2016 at 6:00 pm

For example, regulations which lead to police officers dragging people out of lines for the bathrooms because their boobs aren’t big enough to be visible and they don’t have ID on their person to prove gender before entering a bathroom?

What about regulations which result in people getting thrown in prison for putting fairly innocuous substances into their body?

There’s a big difference between regulations which make it more difficult for people to infringe on MY freedom and regulations which infringe DIRECTLY on my freedom.

40 mulp December 15, 2016 at 12:31 pm

Regulations create jobs and/or increase wages. If they didn’t increase labor costs, they would not be costly.

Tariffs profits of existing industry. A $50 a barrel tariff on imported oil would raise profits on much of US oil production, and reduce losses on other production. The prospect of $10 profit would get fools rushing back in to drill baby frack on private land, ramping jobs back up to 2014 in six months. Drilling on private land is something small startups can do which they can’t do on Federal leases.

$4 gasoline did not harm the economy, and falling to $2 a gallon did not spur job creation anywhere.

41 Bill December 15, 2016 at 11:21 am

Wiki,

When you use the word “regulations” please be specific. Regulation as a word means nothing. You need to refer to a specific regulation, and, when you do, please also specify what the regulation was meant to prevent (including direct and indirect costs of regulating and not regulating) or create.

Otherwise, you are just repeating meaningless slogans. (The cost/benefit analysis of this comment exceeded the cost of electrons if just one person thinks for a moment.)

42 c.9 December 15, 2016 at 4:39 pm

Government “Regulations” are forcible interventions into peoples’ lives, businesses, and markets. They are commands from politicians and bureaucrats to do or not do something, backed by a huge standing-army of police, prosecutors, inspectors, lawyers and bureaucrats.
There are now over 400,000 formal regulations on almost every subject imaginable.

Americans well understand what “regulations” means.

43 albatross December 16, 2016 at 9:18 am

Most people do not think they’re discussing drug laws or laws against murder when they speak of decreasing regulations–generally, they’re thinking of regulations applied to businesses that often don’t make much sense and drive up costs. There is no good purpose served by confusion about what we’re talking about.

44 Scott Sumner December 15, 2016 at 10:56 am

You are correct that this “will not work”, which is why Trump should be strongly encouraged to push ahead with the idea. It will divert him from doing some thing on trade that “will work”. Most European countries do the same thing.

Another way of explaining this plan is that it’s like adding a 10 cent per gallon subsidy to gasoline sellers and a 10 cent per gallon tax on gas purchasers. One lowers the price by exactly the same amount as the other raises the price.

45 Mike W December 15, 2016 at 11:59 am

But a 10 cent subsidy to gas purchasers and a 10 cent tax on gas sellers would get a politician re-elected.

46 rayward December 15, 2016 at 12:51 pm

Sumner has a great sense of humor. I encourage MR readers to visit Sumner’s blog. http://www.themoneyillusion.com/

47 prior_test2 December 15, 2016 at 1:05 pm

You are aware that Scott Sumner is the Ralph G. Hawtrey Chair of Monetary Policy at the Mercatus Center, and that reading his web site is not exactly going to be all that dissimilar from reading this one.

48 rayward December 15, 2016 at 1:24 pm

But it is very different. Sumner’s posts on Trump are over the top – and accurate. Cowen often speaks in (Straussian) code, but not Sumner. You say you want the truth. Sumner offers the truth (about Trump anyway). As for my earlier comment about destination-based corporate tax reform, read the NYT article I linked in my comment and then consider why the proposal hasn’t seen the light of day here.

49 Bill December 15, 2016 at 11:15 am

Import tariffs disproportionately tax lower income persons

Which is why

The rich get richer and the poor get poorer.

1890’s Great Again.

50 mulp December 15, 2016 at 12:37 pm

Why would low wage workers buy imports? Why would they start making them and sell them to earn more money.

I bet you argue low wage workers need to be paid less so the stuff they produce is cheaper so they can afford to buy what they produce.

51 Bill December 15, 2016 at 11:17 am

One man’s Mercantilism is

Another man’s

Industrial Policy.

52 Corplawyer December 15, 2016 at 11:21 am

Well it’s settled that it won’t work in theory. Surely reality will abide.

53 Mike W December 15, 2016 at 11:55 am

“Do note there are possible ambiguities due to the complexity of actual, real world forms of taxation, and furthermore real world exchange rate determination is not well understood, neither are changes in exchange rates.”

But assume a can opener anyway.

54 GoneWithTheWind December 15, 2016 at 12:24 pm

Free trade does not exist. Every country “protects” or limits or taxes trade to serve their purpose. To the extent a country does not do this they are taken advantage of by countries who do. To not control/protect/tax trade is to give away your country.

As the worlds greatest market the U.S. is prime for being scammed by those who have no allegiance to the U.S. This may be “fair” or legal or consistent with the intent of a moneymaking corporation but it isn’t “equal”. It is grossly one-sided. One side takes and takes and the other can only give. Laws should level the playing field. If any country wants to trade with us then they must buy as much from us as we buy from them. If any company wants to seek out the low tax low regulation low wage country to make their products rather then make them here then they must pay the costs of that choice by paying tariffs to sell their cheap goods into the worlds biggest market. Move your factory to China or Mexico and sell your junk into the U.S. market but pay 25% of the retial value of any goods and services to compensate for the externalities of your decision.

55 mulp December 15, 2016 at 12:40 pm

IE, the VAT.

56 Troll me December 15, 2016 at 6:06 pm

Because trade agreements are supposed to involve reciprocity, often it’s more about getting access to foreign markets in product areas where you have a competitive advantage. Unless referring to strategic (including infant industries) or culturally important sectors, generally speaking, those which cannot grow under free trade should not be of too much concern because those are not the areas where that country/economy can provide the most value and therefore earn the most money and create the most jobs of high quality, especially in the long run.

There are a number of counterarguments and things which make the situation more complex in reality, but to argue that no country benefits from reducing barriers to trade is a direct contravention of econ 101 theory which is basically just wrong, except perhaps in some very rare and strange circumstances.

57 GoneWithTheWind December 15, 2016 at 10:02 pm

” to argue that no country benefits from reducing barriers to trade is a direct contravention of econ 101 theory which is basically just wrong” Someone always benefits! Probably not the country but very likely someone who bought a lot of the country’s politicians. Someone ALWAYS loses. Not the politicians. Not the rich traders who bought the politicians. Usually the middle class (the Kulaks of the Democrats tax and spend America).

58 B.B. December 15, 2016 at 12:41 pm

Just an observation that Alan Auerbach has just written a short paper on the economics of border adjustments.

https://www.americanactionforum.org/wp-content/uploads/2016/11/The-Role-of-Border-Adjustments-in-International-Taxation.pdf

The House Republican plan is to try to turn the corporate income tax into the equivalent of a VAT.

As long as exchange rates adjust fully, the trade deficit shouldn’t change.

But that analysis assumes that exchange rate adjustment is easy (what about Hong Kong and China?) and are harmless (what will happen to the value of dollar liabilities of foreign banks?)

And if this tax reform gets Trump to stop his protectionist talk, it is worthwhile.

59 Harun December 15, 2016 at 2:08 pm

This also makes us taxes more territorial too rather than global do it’s good for that as well.

60 Dan in Philly December 15, 2016 at 1:47 pm

My dad used to say technology tells you what might possibly happen. Economics tells you what probably should happen. Politics tells you what will happen.

Economist must be a frustrating profession.

61 Harun December 15, 2016 at 2:07 pm

What happens when you force conversion of all export revenue to local currency then the central bank buys foreign bonds to sterilize the deficit?

62 Adam December 15, 2016 at 3:20 pm

“If you tax imports and subsidize exports, the nominal exchange rate adjusts so that those policies don’t end up improving the real exchange rate at all, and thus the trade balance will not improve. In other words, you get a stronger dollar and indeed we already see that.”

How sure is this? I imagine it’s somewhere between “demand, supply, and price are intimately correlated” and “aliens control the stock market”, but where on that spectrum does it fall?

63 HI December 15, 2016 at 7:05 pm

Haha. And that’s why most people have tuned out economists, and experts in general. Tyler is a smart guy and I enjoy his podcasts, but whenever an economist says stuff like this I cringe.

64 cjared December 15, 2016 at 7:07 pm

If you tax imports from countries that are mercantilist, and you do not tax imports from countries that are not, import sources will shift to those countries that purchase our goods and services. And it does not matter if they do not directly purchase from us, if they are not mercantilist, but purchase from Europe, who then purchase from us, our exports will still go up. No?

65 DJK December 16, 2016 at 9:19 am

Clearly the flaw here is the a priori assumption that an equilibrium is reached and that nothing thereafter changes. But it doesn’t take much critical observation to see that markets rarely reach an equilibrium position and in fact many markets are inherently unstable. Ergo, the conclusion that Trump’s mercantilist policies will not work is worthless.

66 Anonymous coward December 21, 2016 at 8:40 am

Another flaw is the assumption that all goods imported and exported are essentially the same, that is that there is no essential difference in production processes or spillovers from same. E.g. if I’m importing wheat and exporting rice, this logic might work. (Compare Sumner’s idiotic 10-cent gas taxubsidy example.) Suppose I’m importing wheat and exporting space sprockets, and that I tax the former and subsidize the latter. Yes, exchange rates might eventually equilibrate and trade might balance, but so what? I’m keeping more desirable industries, employment and R&D opportunities in exchange for a slight lowering of living standards via more expensive food. As long as my job offers stay competitive on the labor market, it’s a sensible trade.

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