Tariffs Are a Losing Game for Everyone
Opinion piece by Sam Bonnett* featured exclusively on our website.
In the current trade war between Canada and the United States, a lot of the rhetoric coming from South of our border seems to be centred around the need to reduce the trade deficit. Indeed, Trump’s Council of Economic Advisors claimed tariffs “would be consistent with driving bilateral trade deficits to zero.”
Yet trade deficits are not intrinsically harmful. The fact is that tariffs and protectionist policy strangle the very economy and people they are supposed to protect, while free trade fosters efficiency through innovation and creates welfare gains for the working class and developing nations. Sound economics points to free, globalized trade as the optimal trade policy.
The word “deficit” has a negative connotation, and it is certainly true that governments’ budget deficits are often worrisome, particularly when they are large and recurring. Unlike budget deficits that are a profound risk to long-term fiscal stability, trade deficits are less concerning as they simply reflect a high import demand that can be responsibly financed through capital inflows. The financial inflows from trade deficits can finance productive investment.
Since a trade deficit reflects investment exceeding savings (net exports = savings – investment), the U.S. can fund innovative technologies that would otherwise be outside of its means. For example, from 1970-2018, the U.S. invested $11 trillion more than it saved. Eliminating the 2024 U.S.-to-Canada trade deficit alone would mean $63.3 billion less in capital inflows to the U.S.
The U.S. has been able to grow and maintain the world’s largest economy while sustaining a trade deficit for decades. So why have trade deficits recently become a point of contention in American politics? For one thing, President Trump claims that long-standing trade deficits have gutted U.S. manufacturing jobs.
But a 2018 Federal Reserve Bank of St. Louis report tells a different story, pointing to technology and productivity advancements as the real root cause of declining employment in the manufacturing sector. The paper points out that agriculture once required 80% of the labour force, but now uses under two per cent, even as demand grows.
Protectionist policies pose a threat to everyone’s welfare. Policymakers should reject tariffs and negotiate free trade deals that open domestic markets and give market access to emerging economies.
Similarly, United States manufacturing employment relative to overall employment has been declining steadily since the late 1940s—approximately 30 years before the U.S. trade deficit became prominent. Although admittedly disruptive for some workers at the time, it is beneficial if we can now produce as many or more goods with fewer hands, as it frees those workers up to do other things and further enrich society.
But it’s not just that tariffs attack a phantom problem; protectionist policy is also myopic resulting in transitory welfare gains for some, and costly losses in long-term welfare for most.
At an aggregate level, free trade results in a more productive and streamlined economy, which benefits all consumers. Because, in the world of free trade, less competitive firms are forced to either become efficient through innovation or exit the market. In fact, the poorest 10 per cent of people gain the most from trade, seeing their living standards improve by 63 per cent, according to a study published by the International Monetary Fund. This is because the poor typically spend a greater portion of their income on traded goods.
The dilution of global competition through protectionism ultimately suppresses innovation and productivity growth by reducing incentives. The National Bureau of Economic Research finds that protectionist policies such as tariffs slash incentives for so-called defensive research and development whereby firms innovate to stay competitive. Without foreign market pressures, industries will tend to stagnate, and consumers will end up paying more for less. Additionally, domestic industries will struggle to compete in foreign markets against firms that have engaged in more of this research and development.
Free trade is associated with increased income equality, greater job opportunities, reduced corruption, and higher real incomes for everyone, but especially for developing economies. A study from 2018 estimates that 3.3 million people could be lifted out of poverty in Nigeria if tariffs were reduced. Moreover, another study from 2015 finds that 40,000 families across Kenya could be brought out of poverty if protectionist trade barriers were removed, as reported by The International Monetary Fund paper on “Trade and Inclusive Growth.”
Protectionist policies pose a threat to everyone’s welfare. Without free-market forces incentivizing everyone to do a better job, ineffective firms go on being ineffective, plaguing the very economies that protectionism is meant to protect.
The takeaway is clear: Policymakers should reject tariffs and negotiate free trade deals that open domestic markets and give market access to emerging economies. Embracing liberalized trade in this way would lead to a more competitive, and a more cooperative, world, filled with opportunity.
Sam Bonnett is an intern at the MEI. The views reflected in this opinion piece are his own.