This week, Australia learned that old geopolitical relationships and so-called ‘free trade’ treaties mean little when it comes to US policy. The obsequious way our political class fawns after the US has been a constant sickening element of our national identity for as long as I can recall. When I was a child, we were told by our Prime Minister that Australia was “all the way with LBJ”, a foreign policy that took out nation, against all reason, into the Vietnam War. Now, the US President is demonstrating why a reliance on the US as a ‘good citizen’ of the world is a poor strategy for an advanced nation to adopt. The other interesting aspect of what is going on is that the world is once again entering an experiment that will provide knowledge about the impacts of ripping up free trade agreements and increasing barriers to entry. Theorising is one thing but now we have a practical experiment underway. This is Part 1 of a series on the current debate about tariffs.
I considered the argument about free trade from a Modern Monetary Theory (MMT) perspective in this three part series:
1. The case against free trade – Part 1 (October 27, 2016)
2. The case against free trade – Part 2 (November 8, 2016)
3. The case against free trade – Part 3 (November 22, 2016).
I also considered Donald Trump’s industry policy in this blog post – Donald Trump’s tariff hikes are not good policy (March 20, 2018) – during his first term of office.
Here are some considerations that guide my thinking on this issue.
1. Early theoretical attempts (for example, Heckscher-Ohlin theorem) to justify so-called free trade (absence of protection) were shown to be flawed.
2. More recent developments in trade theory – the so-called ‘New Trade Theory’ in the 1980s – meant that economists could no longer argue that the results of the free-trade models held.
3. This shift in economic theory away from a blind acceptance of a proposition that free trade was always good, is quite apart from other considerations, which we might categorise under ‘fair trade’ issues.
4. When ‘free traders’ talk about the ‘free market’ and appeal to the narratives that appear in undergraduate economics textbooks they are being deceptive.
No corporate leader aims to achieve that state.
At a minimum, they aim to manipulate the ‘market’ they trade into to influence prices they can get and have to pay for inputs and end up with as big a margin on total costs as they can achieve.
They aim to create a unique product and drive competitors out of business as quickly as they can.
If they can take over a competitor and increase their market share they will.
They seek to manipulate consumers into believing their product is best through advertising, which uses psychological tools that go well beyond the textbook idea that such interaction with the ‘market’ is just to provide ‘information’.
5. The 2007 book by Ha-Joon Chang – Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism – documents extensively how nations used trade protection strategies in order to reach advanced status and demonstrates that the normal model of economic development, which has enriched the advanced nations such as Britain and the US, was not built on a ‘free trade’ platform.
Rather, they developed into rich nations through the use of industrial protection and government controls and supports.
None of the advanced nations would have achieved that status if they followed the IMF/World Bank approach.
6. The ‘infant industry’ justification for protection which has been used for centuries is logical but the problem is that the tariff wall provides a perfect environment for rent-seeking – so that the recipients of the protection have little incentive to innovate and become more competitive without the support.
The case of the Australia motor car industry is a classic example. The foreign-owned corporations profited from the tariffs and to avoid industrial unrest ‘shared’ some of the tariff benefits with the unions in the form of higher wages.
But by the 1970s despite effective protection rising, total employment was falling such was the competitive gains being made by Asian car manufacturers (Japanese initially) as the local industry failed to innovate.
In other words, the ‘baby never grew up’.
Too many companies set up to exploit the tariff and too many models were produced for a market that could barely support one manufacturer producing at lowest-cost scale.
The level of protection was so high that it was estimated in 1985 that it would have been cheaper for the government to give all the workers in the Australia car building industry $A1 million each and close the industry (Source).
7. Rich nations such as the US and the European Union still maintain a complex array of tariffs on goods attempting to enter its borders. Japan, for example, maintains a highly protectionist stance with respect to its primary products (particularly against rice imports).
These cases are generalised across most nations.
So when you read commentators, particularly Europeans railing against Donald Trump’s new tariffs on steel and aluminium and other goods, you have to realise that the protection levels in the EU are, on average, higher than they are in the US and many other advanced nations.
The issue of tariffs in Australia has been contested since the beginning of our nation.
In Colonial Australia, the now states were separate colonies and they used tariffs (tobacco, etc) to create barriers to trade at their borders and to raise revenue for the respective colonial governments, which used the British pound as the currency.
Tariffs were primarily a way for the colonial governments to get hold of the foreign currency they used.
However, part of the motivation was to generate local employment.
The – Victorian gold rush – in the 1850s, not only promoted rapid population growth (1851: 77,345; 1861: 538,628) but left the colonial government with a headache in the 1860s once the gold discoveries dried up.
They introduced tariffs on many manufacturd goods to promote growth in the burgeoning manufacturing sector as a strategy to absorb the surplus miners after the boom.
Australia became a nation in 1901 and that led to a major revision of the colonial tariff system and ended the cross-internal border tariffs.
The new federal government assumed responsibility for tariff policy upon federation.
It is clear that the pre-federation industrial structure changed once the state tariffs were made uniform and goods and services were free to move between states without imposts.
For example, manufacturing in Queensland collapsed as the protection was reduced and cheaper goods flowed into that state from Victoria and NSW.
The major political parties at the federal level, were committed to a protectionist strategy for the nation as a whole vis-a-vis the rest of the world.
For some imported goods, the tariff wall was higher than 40 per cent.
The major justification used was the so-called – Infant industry argument – where new industries that had not yet reached economic scale (lowest unit costs) could be protected in order that they grow and mature into a competitive entity.
It was clear that this strategy would increase the price of goods sold in the domestic market but the claim was that eventually as the firms in the industry innovated and developed best-practice technologies and operational capacities, the longer-run benefits would be realised – internationally competitive industries selling quality products at the lowest possible price to consumers.
The ‘infant industry’ justification goes back in time to the Tudor kings and queens in Britain who “used protectionism, subsidies, distribution of monopoly rights, government-sponsored industrial espionage and other means of government intervention to develop England’s woollen manufacturing industry—Europe’s high-tech industry at the time.”
That quote is from Ha-Joon Chang’s epic analysis of ‘How did the rich countries become rich?”, which is presented as Chapter 2 of his 2007 book by Ha-Joon Chang – Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism – documents extensively how nations used trade protection strategies in order to reach advanced status.
So there was nothing new about the idea of protecting new industries when the first secretary of the US Treasury, Alexander Hamilton in his – Report on the Subject of Manufactures – (published on December 5, 1791) articulated a systematic program to develop US manufacturing.
His inquiry was motivated by the desire to “render the United States, independent on foreign nations, for military and other essential supplies.”
The arguments that are presented in the public debate today have not really developed on those presented by Alexander Hamilton.
Hamilton first presented the view that was avowedly against state protection on industry – “To leave industry to itself, therefore, is, in almost every case, the soundest as well as the simplest policy”.
Thus in relation to protecting manufacturing that:
It is far preferable, that those persons should be engaged in the cultivation of the earth, and that we should procure, in exchange for its productions, the commodities, with which foreigners are able to supply us in greater perfection, and upon better terms.
His Report then turned to why the US should give “special and positive encouragement” for manufacturing enterprises and it was here that he developed the ‘infant industry’ argument.
He argued that local manufacturing firms would only reach an efficient scale (low unit costs) if the government provided them protection from external competition by introducing tariffs on imported goods, which were directly competing with US production.
He wrote: “The superiority antecedently enjoyed by nations, who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle …” for the development of US manufacturing.
He also wanted the government to abandon levies on raw materials that were used by these new manufacturing firms.
This was almost ‘treason’ given the growing dominance of Adam Smith’s view at the time among the mainstream.
Hamilton told the US government that the trading terrain was hardly ‘free’ and that:
… the greatest obstacle of all to the successful prosecution of a new branch of industry in a country, in which it was before unknown, consists, as far as the instances apply, in the bounties premiums and other aids which are granted, in a variety of cases, by the nations, in which the establishments to be imitated are previously introduced …
Thus “interference and aid of their own government are indispensible.”
The ‘infant industry’ argument became dominant across the world and while Hamilton was ignored at the time (because as Ha-Joon Chang notes “US politics at the time were dominated by Southern plantation owners with no interest in developing American manufacturing industries”) later, into the C20th, US policy makers used tariff protection extensively to protect its manufacturing sector as part of building a dominant economy.
Ha-Joon Chang said that the US became “the most protectionist country in the world throughout the 19th century and right up to the 1920s” and “the US was also the fastest growing economy.”
Was the fast growing economy achieved “despite protectionism” or because of it?
The modern free traders claim the former yet cannot explain why many other countries that didn’t have natural advantages (market size, natural resources, etc) of the US also “grew rapidly behind protective barriers”.
In relation to the free trade arguments, Ha-Joon Chang uses an example in Chapter 3 of why it is absurd to advocate abandoning all the parental care for his 6-year old son and force him out into the labour market (“He is over-protected and needs to be exposed to competition, so that he can become a more productive person. p.49”).
He writes (p.50):
Yet this absurd line of argument is in essence how free-trade economists justify rapid, large-scale trade liberalization in developing countries. They claim that developing country producers need to be exposed to as much competition as possible right now, so that they have the incentive to raise their productivity in order to survive. Protection, by contrast, only creates complacency and sloth. The earlier the exposure, the argument goes, the better it is for economic development.
The point that Ha-Joon Chang makes is that “the protection I provide to Jin-Gyu (as the infant industry argument itself says) should not be used to shelter him from competition forever.”
Eventually, the ‘infant’ has to grow up – more about which later.
The other point in relation to today’s debates in the US about tariffs is that in the immediate Post WW2 period and for the next four decades, the “US federal government funding accounted for 50–70% of the country’s total R&D funding”.
Ha-Joon Chang concludes that without that state funding “the US would not have been able to maintain its technological lead over the rest of the world in key industries like computers, semiconductors, life sciences, the internet and aerospace.”
This has implications for the Trump cuts to the bureaucracy and federal spending.
Tariffs helped the US grow but so did large state involvement in education, training, innovation and R&D.
Alexander Hamilton’s Report also considered tariffs to be only one measure a nation could take to protect its new infant industries.
He noted 11 protective measures are available to government, each with advantages and disadvantages:
1. ” Protecting duties—or duties on those foreign articles which are the rivals of the domestic ones, intended to be encouraged” – that is, tariffs, which “enable the National Manufacturers to undersell all their foreign Competitors.”
2. “Prohibitions of rival articles or duties equivalent to prohibitions”.
3. “Prohibitions of the exportation of the materials of manufactures”.
4. “Pecuniary bounties … avoids the inconvenience of a temporary augmentation of price, which is incident to some other modes, or it produces it to a less degree; either by making no addition to the charges on the rival foreign article, as in the Case of protecting duties, or by making a smaller addition.
5. “Premiums” which, unlike bounties are “rewards to some particular excellence”.
6. “The Exemption of the Materials of manufactures from duty” – no duties (tariffs) on raw materials.
7. “Drawbacks of the duties which are imposed on the Materials of Manufactures” – selective tariffs to allow essential goods for input or consumption.
8. “The encouragement of new inventions and discoveries, at home, and of the introduction into the United States of such as may have been made in other countries; particularly those, which relate to machinery” – R&D etc
9. “Judicious regulations for the inspection of manufactured commodities” – discourage fraud and poor quality.
10. “The facilitating of pecuniary remittances from place to place is a point of considerable moment to trade in general, and to manufactures in particular; by rendering more easy the purchase of raw materials and provisions and the payment for manufactured supplies.”
11. “The facilitating of the transportation of commodities” – state spending on roads, canals, ports etc. That is, public infrastructure to allow private enterprises to leverage their operations.
The point is that the state has an array of policies available to it in order to promote economic development each with different consequences.
The single reliance on tariffs may not be the best way to revitalise industry.
Conclusion
I will use this historical discussion to deal with a range of issues in Part 2:
1. Price impacts.
2. Possibility of import competing dominance.
3. The ‘revenue’ arguments used by Trump “it will make us rich”.
4. The logic of tariffs on Australian steel when the US steel industry has lower unit costs than the Australian sector.
5. The concept of state support for industry as a justification for tariffs.
6. Rent seeking and the infant industry argument – one cannot consider the tariff question without introducing the class context.
7. Deindustrialisation.
That is enough for today!
(c) Copyright 2025 William Mitchell. All Rights Reserved.
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