On the Ineffectiveness of Counter-Tariffs

Viewpoint showing that counter-tariffs are generally harmful, and not very useful as a policy tool for influencing the trade policies of other nations

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This Viewpoint was prepared by Vincent Geloso, Senior Economist at the MEI, in collaboration with Renaud Brossard, Vice President, Communications at the MEI. The MEI’s Taxation Series aims to shine a light on the fiscal policies of governments and to study their effect on economic growth and the standard of living of citizens.

It is understandable that Canadians are irritated by the protectionist turn in the United States after enjoying a highly beneficial free trade agreement for decades.(1) As a consolation, it is heartening, at least, to realize that free trade rhetoric still has a sizable constituency in Canada. The issue at hand, though, is how best to deal with a protectionist administration in the United States. Whatever the course of action going forward (legal, political, or diplomatic), counter-tariffs are unlikely to achieve much, and will end up hurting Canadians.

Protectionism Guarantees Slow Growth

As economist Bryan Caplan points out, “just avoiding a short and clear list of awful economic policies […] is a sufficient condition for long-run economic growth.”(2) Protectionism is one of those awful policies. Others summarize this view by stating that “openness to trade is not a guarantee of economic growth, but no national economy has enjoyed long-run growth without being engaged in foreign trade and investment.”(3)

There are two reasons why this is so. The first is that raising the cost of imported inputs has a number of negative economic effects, including reducing export competitiveness. It also reduces competitive pressure on national firms, making collusion easier,(4) and reduces the gains from specialization and scale,(5) ultimately slowing down growth.(6) This first reason is familiar to most people.

The second reason, less well-known, is that protectionism incentivizes interest groups to spend resources to obtain those policies that benefit them specifically. In other words, they lobby for protection. Resources spent obtaining political protection are diverted from productivity-enhancing investments within firms. Over time, this can make protection self-reinforcing: the larger the “rents” (economic advantages) made available by trade barriers, the stronger the coalition with an interest in maintaining them. This so-called “rent-seeking” is a far larger drag on economic growth.

Counter-tariffs suffer from both of these drawbacks. First, they reduce the living standards of Canadians in the present. However, as businesses line up to ask for their own share of the spoils, the counter-tariffs get harder to repeal and may become a permanent drag on economic growth.(7)

Politically Ineffective

Not only are counter-tariffs generally harmful, with major downsides, but the supposed upsides as a policy tool for influencing the trade policies of other nations are tiny, if not nonexistent, for small economies like Canada’s.(8) Canada during the Great Depression provides a good illustration of this.

Following a major liberalization in 1913, the United States made a sharp turn toward protectionism in the 1920s.(9) This culminated in the introduction of the Smoot-Hawley tariff in 1929,(10) which President Herbert Hoover ultimately signed into law in June 1930. The Canadian government of Mackenzie King deployed important pressures to try to limit the odds of the tariff passing, frequently hinting that if it were adopted, Canada would engage in “probable retaliation.”(11) The official opposition Conservatives, led by Richard B. Bennett, were promising even steeper tariff increases in retaliation.(12)

When it was ultimately adopted in spite of Canadian warnings of retaliatory measures, economic historians noted that “the most important foreign tariff increases following Smoot-Hawley were those imposed by Canada.”(13) An initially small increase in May 1930 was introduced (partly offset by tariff reductions on non-American goods such as British Empire products). However, the far more pro-retaliation Conservatives won the July 1930 election and imposed substantial additional tariff increases in September on a wide range of goods, many of which were imported predominantly from the United States. The counter-tariffs imposed accounted for roughly 30% of U.S. exports to Canada.(14) From 1928 to 1933, average tariffs increased around 20%.(15)

Using the Historical Statistics of Canada to produce the usual historical measures of tariff stringency (customs duties collected over imports) and a similar measure for the United States, we see that Canada increased its tariffs in 1930 to respond to American trade policy. However, the counter-tariffs had no effects on American tariff levels (see Figure 1), and alternative measures confirm this.(16)

Bennett and the Conservatives realized the inefficacy of the tariff response, and its economic costs, and they reversed course.(17) They were fortunate enough that the Democrats—then more historically aligned with pro-free-trade positions—returned to power in 1932. The new president’s secretary of state, Cordell Hull, was a steadfast free trader.(18) In 1934, Congress passed the Reciprocal Trade Agreements Act (RTAA), which delegated to the president substantial authority to negotiate reciprocal tariff reductions with foreign countries without requiring Congress to vote on each individual agreement.(19) As a result, Bennett was able to negotiate a reciprocal trade agreement with the United States, although it was ultimately signed into law in 1935 by his successor.

Thus, at no point did the Canadian counter-tariffs have any discernible effect on American trade policy. The large shifts were the Democrats’ electoral victories of 1932 and the passage of the 1934 Reciprocal Trade Agreements Act, which fundamentally changed the institutional structure of American trade policy.

However, the counter-tariffs did harm the Canadian economy. Admittedly, it is difficult to disentangle the effects of tariffs and counter-tariffs from the broader collapse in international trade at the time. Pedro Amaral and James MacGee document that Canada’s trade share fell by roughly a third during the Depression and estimate that the collapse in traded-goods prices, interacting with domestic wage rigidities, can account for roughly half of Canada’s Great Depression contraction.(20) The counter-tariffs certainly contributed to some part of this, and made the Great Depression worse than it otherwise would have been.

Conclusion

Effective remedies to the return of protectionism in the United States are not easy to find, especially if the objective is to induce them to return to the negotiating table and reach a bilateral free trade agreement. A superior course of action would simply be to ignore American protectionism and pursue unilateral free trade.(21) Obviously, a renewed bilateral free trade agreement with our biggest trading partner by far would be desirable, but whether such an outcome is politically attainable remains to be seen. What is clear is that counter-tariffs are in no way an effective instrument. They impose additional costs at home without providing any reliable mechanism through which foreign governments can be compelled to liberalize.