For over two centuries, economists have understood the benefits of international trade. In 1817, David Ricardo explained the law of comparative advantage: if country A is more efficient than country B at producing both coats and shoes, but is relatively more efficient at producing coats, both economies are better off if country A specialises in coats, country B in shoes, and they trade.
While an understanding of this principle has helped build a more prosperous world through international trade, every so often the pendulum shifts back to protectionism. Some countries impose tariffs and attempt to “go it alone” by making more of their goods and services at home.
The 1930s Great Depression, which saw massive unemployment and unnecessary human misery, began with the financial collapse in 1929. In 1930, in reaction, the United States imposed tariffs of about 20 per cent on imports, and most European economies responded. This tit-for-tat aggravated the Depression in the US and across Europe. We also had our own “economic war” with the UK, involving exceptional tariffs.
After the second World War, the US and Europe espoused free trade to promote economic recovery. Six countries established the European Economic Community (EEC) in 1957, now the 27-member European Union, as a common market free of tariff barriers. However, throughout the 1950s Ireland ignored how free trade promoted growth elsewhere, persisting with high tariff walls. The outcome was low growth and massive emigration.
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With imports very expensive in Ireland due to these tariffs, the focus was on manufacturing whatever we needed – brooms and brushes, clothing and cars. Cars built in Britain were taken to pieces to be imported “completely knocked down”, and then reassembled here. Madness!
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Given the success of the EEC, it was essential that Ireland, along with the UK, joined in 1973. In preparation for membership, over the 1960s Ireland had undertaken a gradual reduction in tariffs. However, undoing tariffs also came with significant short-term costs. The workers who reassembled cars lost their jobs over the 1970s, as did many others in previously protected industries.
Looking back, we incurred the costs of transitioning to free trade before the undoubted major long-term major benefits were realised. If such transitions are not managed well, it results in damaged communities, and major opposition to freeing trade, even though all economies benefit from open markets in the long term.
While Trump has moved rapidly on his domestic agenda and on geopolitical issues, his threatened tariffs are only just beginning, starting with China and neighbours Mexico and Canada. Maybe some billionaire friends will warn him of the damage to their businesses from tariffs, possibly modifying his thinking
Ireland has been a prime example – we have developed an exceptionally successful economy, based on producing for export the goods and services where we have a comparative advantage.
Brexit led to the UK imposing significant barriers to trade with the EU, the large market on its doorstep. Unsurprisingly, a consequence has been the subsequent poor performance of the UK economy.
Slapping tariffs all round will make the US a poorer country. It will substitute more expensive US-made goods for cheaper imports, putting up prices for consumers and making them worse-off. It will disrupt integrated cross-border production, where components are made where they are relatively cheaper, adding to the cost of final products. There will also be job losses in export businesses – facing retaliatory tariffs – and in businesses that rely on importing components.
In the long run, these losses will be partly offset by new jobs producing goods previously manufactured abroad. However, the US will be less competitive, with higher prices and lower income as a result of this change.
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US tariffs will also damage the rest of the world. However, the rest of the world constitutes a much bigger economy than the US. Providing the unilateral US action does not set off a general trade war, the rest of the world economy will motor on.
The EU’s response to Trump tariffs remains to be determined, but a targeted response is likely. The best antidote to US economic isolationism is to double down on free trade with the rest of the world. The EU needs to build on the trade agreement with Canada and the South American Mercosur deal. While there are some strategic concerns about aspects of Chinese trade, it remains in the interests of the EU and China to continue largely barrier-free trade.
While Trump has moved rapidly on his domestic agenda and on geopolitical issues, his threatened tariffs are only just beginning, starting with China and neighbours Mexico and Canada. Maybe some billionaire friends will warn him of the damage to their businesses from tariffs, possibly modifying his thinking.
When the EU negotiates with the US on trade, cool heads and firm resolve will be needed.
