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Tariffs not Tax Breaks

Jan 30, 2012, Vol. 17, No. 19 • By IRWIN M. STELZER
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Right diagnosis. Wrong prescription. That’s the fairest way to describe Rick Santorum’s idea to provide tax breaks for “manufacturing.” Leave aside the definitional issues—some of us at The Weekly Standard who “manufacture” ideas might qualify for the benefit he intends for others. The solution to the problem of unemployed and anxious blue collar voters lies in trade rather than tax policy.

Photo of Rick Santorum

Everyone agrees on three things. 

n The tax code is impossibly convoluted, stuffed with special benefits, some for the worthy, many for those not so clearly worthy but well represented in the corridors of power in Washington.

n The impact of competition from China varies from industry to industry, and occupation to occupation. No one will fly to Beijing for a haircut because barbers there work for less than they do here, or ship their laundry to China because the Chinese laundries there are cheaper than the laundries here. In economists’ jargon, these are not tradable goods, subject to direct foreign competition. Nor is the “output” of local, state, and federal employees, whose unions know that all they need fear is riling American voters by overreaching; Chinese workers are not about to take their jobs, so not for them wage restraint of the sort private-sector workers are forced to endure.

n It is difficult for free-market conservatives to have a sensible discussion about trade policy, because the idea of free trade is one to which conservatives cling pretty absolutely, even though we have been mugged by reality. 

That reality is that China manipulates its currency to keep the renminbi sufficiently low to ensure that its goods are the lowest priced available in most markets. The regime aims to create enough jobs to avoid unrest that might threaten it. Yes, there are some areas in which China has a real competitive advantage. But there are others in which its artificially low currency combines with subsidies to tilt the playing field: No matter how efficient an American manufacturer might be, it loses and China wins.

Which is what troubles conservative candidates whose commendable support for free trade leaves them uncertain how to respond. But Santorum has reached for the wrong weapon with which to deal with the problem: the tax code. He and his rivals should consult their surely dog-eared copies of the Wealth of Nations, where Adam Smith does not counsel sitting idly by while his nation’s tradable goods industries are devastated by a predatory competitor.

In fact, the Great Scot concluded, “Revenge .  .  . naturally dictates retaliation .  .  . when some foreign nation restrains by high duties or prohibitions the importation of some of our manufactures into their country.” Such retaliation is especially indicated when it is likely to produce the repeal of the “prohibitions complained of.” The job of doing all of this requires “the skill of that insidious and crafty animal, vulgarly called a statesman or politician,” in ample supply here.

Smith also recognized that it “will be generally advantageous to lay some burden” upon imports “when some particular sort of industry is necessary for the defence of the country.” And it is acceptable to tax imports to offset any taxes imposed on domestic firms that exceed those imposed by foreigners on their companies: “When some tax is imposed at home upon the produce [of domestic industry] it seems reasonable that an equal tax should be imposed on the like produce” of foreign companies with which the hometown boy competes.

Finally, Smith pointed out that such restrictions as are imposed on trade should be removed only “gradually, and after a very long warning,” lest workers and capitalists “suffer very considerably.” 

There are, of course, also warnings about the negative effects of some of these measures, and these restrictions are exceptions to Smith’s general rule that free trade in most cases enriches the parties to it. But if currency manipulation doesn’t warrant retaliation, if theft of intellectual property is not a sufficient barrier to the free flow of capital to justify retaliation, if the variety of administrative restrictions on both imports and exports of items such as rare earth metals doesn’t warrant retaliation, if the persistent trade imbalances do not constitute a threat to “the defence” of the nation (all those IOUs in the hands of the Chinese regime surely affect our foreign policy), it is difficult to imagine what would. 

That is the case whoever ends up facing off against Obama can make. It’s trade policy, not the tax code, that can achieve the objective of providing American manufacturing a fair playing field. There are those who would accuse him of protectionism. He can respond by distinguishing his limited tariffs in a free trade regime from real protectionism. He can ask what his critics propose instead. And he can help move the debate among Republicans on economic policy in a more realistic direction.

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