TCS Daily

Trade Grade

By Donald Boudreaux - October 10, 2003 12:00 AM

One of the most persistent arguments for raising tariffs, such as those currently imposed on foreign steel, is that imports are often subsidized by foreign governments. How can American producers compete fairly without protection against foreign competitors whose costs are lowered artificially by their governments?


Those who make this argument haven't thought it through to its logical conclusion. For every American industry that suffers a competitive disadvantage in foreign trade as a result of subsidies, there are other American industries that gain even greater competitive advantages from such subsidies. If fairness were the concern, we should do more to encourage imports from countries that subsidize their industries, rather than restrict them.


The claim that government subsidies increase the competitiveness of their nations' exports is an article of faith among many commentators. For example, The Washington Times, normally no friend of government regulation, endorses the current steel tariffs because of the alleged unfairness created by foreign-government subsidization of their steel producers.


Economics reveals at least three problems with such claims. First, protecting firms against competition, which is what subsidies do, reduces firms' incentives to operate efficiently. Much of the subsidy is squandered on management perks, cozy relations with labor-union leaders, cave-ins to numerous self-proclaimed "stakeholders," and the costly lobbying needed to secure and keep the subsidy.


Second, shielding firms from competition -- that is, "protecting" them from consumer choices -- reduces their ability to operate efficiently. When competitive pressure is reduced, so is the market feedback that informs firms about how their costs and the quality of their products compare to what is possible in competitive markets. There is simply no substitute for the information conveyed by market-driven changes in profits and in market share. Subsidizing firms increases their quality-adjusted costs, making their exports less competitive on world markets and, hence, increasingly dependent upon subsidization.


Third, no government can subsidize some firms without taxing others, either directly or indirectly. So while a government might be able to make some exporters artificially more competitive, by doing so it will necessarily make other firms less competitive through higher taxes, as well as greater inflation, more regulation, and general economic distortions and inefficiencies. As economists have known for a long time, these burdens on the domestic economy are always larger than whatever tax revenues are raised. (That's why economists call them "excess burdens.") Any competitive advantages realized by a few politically influential firms from government subsidies are more than offset by the competitive disadvantages those subsidies inflict on other firms.


True, some imports are subsidized by foreign governments. But if Uncle Sam points to such subsidies as justification for hiking tariffs on those imports, then consistency requires cutting tariffs on all imports whose costs are increased to pay for those subsidies.


The implausibility of such a finely calibrated tariff policy suggests the most important reason for dismissing the foreign-subsidy argument for raising tariffs. To apply this argument properly requires a level of information and commitment to consistent policy that no government ever has or ever will achieve. It is impossible to know how much the prices of some imports are artificially lowered, and how much the prices of others are artificially raised, by government subsidies. Neither is it possible to know how the myriad of government subsidies scattered throughout the American economy reduce the prices of some of our exports and increase the prices of others. And even if government policy makers were ingenious enough to gather and digest this information, they nevertheless would be swamped by political considerations having nothing to do with consistent or fair tariff policy.


The best policy for America, regardless of the policies of other countries, is free trade -- the complete elimination of all import restrictions. In those rare cases of foreign subsidization creating a genuine threat to efficient American firms, private capital markets are much more reliable than politicians at identifying such instances and mobilizing the private capital necessary to respond to such threats most appropriately. Subsidies, far from making foreign firms fiercer competitors, make them so bloated and sluggish that action by Uncle Sam will rarely be necessary to protect efficient U.S. firms from them.


We hope that the Bush administration keeps these truths in mind as it decides whether or not to maintain the steel tariffs.


Donald J. Boudreaux is Chairman, Department of Economics, George Mason University. Dwight R. Lee is Ramsey Professor of Economics, Terry College of Business, University of Georgia.

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