Tariffs and Broken Windows

Matt Fagerstrom

Matt Fagerstrom

Matthew Fagerstrom is an economics and political science student at Villanova University. He is currently working alongside a professor on a study of wealth inequality. His favorite areas of economics are the minimum wage and monetary policy.
Matt Fagerstrom

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I had originally written this piece for my own blog, which has since been shuttered in the move to this new shiny blog. This is the first in a two part series on tariffs and subsidies, of which the second part never got written. It will be written soon.

I will begin with tariffs, which are the more readily denounced of the two, but there are figures out there, such as everyone’s favorite businessman and presidential candidate, Donald Trump, who call loudly and passionately for tariffs on foreign made goods, such as those made in China or Mexico. The arguments in favor of tariffs are often rather simplistic, hinging on the natural inclinations of citizens to support domestic goods, producers, and, most importantly, workers. The theory goes that tariffs need to be put in place to protect domestic industry from overly competitive foreign goods that would put American producers out of business, and so the tariffs put a tax on foreign goods so that domestic producers can compete. Well, this seems like a good idea on paper. Foreign goods now cost more than domestic goods and consumers will patronize those same domestic firms, employing Americans and keeping the economy strong by ensuring that American industry can compete.

What’s the problem here? The issue is that it ignores opportunity costs, or what the French economist Frederic Bastiat called the broken window fallacy, or that which is seen and that which is unseen. The broken window fallacy is described by Bastiat in a parable wherein there is a baker who has his window broken by vandals, and then must spend some amount, say $100, going to a glazier and having his window repaired. So, the townspeople, when they see this, remark to themselves that this breakage of the window has been good for the economy because it means that the baker had to spend $100 repairing his window, but that is only what they see. What they do not seen is that this $100 spent on the glazier could have been spent on any number of things, such as a new suit from the tailor, or a new pair of shoes from a cordwainer. Thus, instead of being able to get this new good, he must instead spend money on repairing a broken window, so the overall economy is worse off because money had to be spent on fixing economic damage rather than pursuing new production.

This is the same thing that happens with tariffs, since the money that went to paying the tax on the foreign good, or on paying the higher cost of the domestic good cannot be spent pursuing other economic ends, and so consumers are now worse off, and only the domestic workers in the industry effected by the tariff are better off, because their goods are now competitive. To illustrate, let us say that there is a tariff on computers. If, in a purely free market, domestic computers cost $500 and foreign computers cost $400, then consumers will buy the foreign computers at the cheaper cost and be able to use the extra $100 on whatever other goods they desire, and thus will be better off, since they have a computer and $100 worth of additional goods. Then, the computer industry comes along and demands a tariff, since they cannot compete with the foreign produces, so, the government levies a $100 tariff on foreign computers to bring the price of both up to $500, which means that domestic producers can compete. Consumers now must spend $500 on computers, leaving them with $100 fewer dollars to spend on other goods, so they are clearly worse off because of this tariff. Foreign producers are worse off, since they cannot sell their goods. Domestic and foreign producers in industries not impacted by the tariff are worse off as well because consumers now have less money to spend on those goods. The only people who are better off due to tariffs are the domestic producers in the industry effected by the tariff, since their goods are now competitive. So, in the process of levying a tariff to support American jobs, all Americans not employed in the tariff impacted industry are worse off, even though the whole purpose of the tariff was to benefit American jobs. Money that was being diverted to the industries benefitting from the tariff comes from the consumers, so those Americans now have less real income, and American producers in other industries will see their income diminished because consumers have less income to spend on their goods, so these businesses are now worse off as well because of the tariff. Tariffs in no way make the American economy stronger, and in fact can only harm it because it takes money from more efficient producers of goods and gives it to less efficient producers, make literally everyone worse off except for those lucky enough to be in the domestic industry impacted by the tariff. What we see from the tariff is that domestic producers in the industry effected by the tariff are now better off, but what is unseen is the diminished income of consumers and the lower incomes of all other businesses, foreign and domestic, but just because this impact is not readily seen, does not mean it is not there, for it most certainly is.

Another argument for tariffs is the infant industries arguments, which is, as the name implies, a line of thinking that states that new industries need to be supported by tariffs because they are too new to be able to effective compete against the already established foreign industries. The industry is given a tariff until they can get on their feet and then the tariff is supposed to be removed and competition can resume its natural course. Many people are sympathetic to this line of thinking because it is temporary, and because it is encouraging domestic production. On the surface, this seems much less objectionable, because it is not permanent and because it is not giving favors to well established businesses and industries.

However, the same argument applies here, and a new one comes up as well. Simply put, nascent industries do not have the political capital to be able to get tariffs, whereas more established firms do have the political capital to get tariffs, so they are more likely to get tariffs than industries that supposedly need it. This argument against infant industries is effective because it shows that these infant industries cannot actually lobby for tariffs, so any infant industries would be suspect. Moreover, as Ludwig von Mises noted, these tariffs are also harmful economically because resources are being funneled from where they would have otherwise gone without the tariff, that is, not into these infant industries and instead going to wherever the market would have allocated those resources, to these new industries, which is not the most efficient use for them, since the government had to step in and change prices through the use of tariffs to support the new industries. Economic welfare is being reduced because the labor, land, and capital that went to secure the creation of these infant industries, which are only profitable through the tariff, and was not used to satisfy the most urgent wants of the consumer. For these reasons, tariffs must be opposed at all time and wherever possible. They cannot increase economic welfare because they are diverting resources from where they would have gone in a free market, which is, at least ex ante, their most efficient use, and is instead being funneled into an industry that is not efficient or in high enough demand to warrant its creation.

  • Spencer

    I like comments.