There’s a frustrating pattern among both defenders and detractors of capitalism. Instead of focusing on the outcomes of their systems, they debate whether the rich and the poor really deserve their fate. Take, for example, one exchange between Patrick Bet-David and a participant, Luc, on Jubilee:

Bet-David: Do you think it's easy or do you think it's hard?

Luc: To create jobs is probably hard.

Bet-David: Yeah, it's okay. So, the people that create jobs, you think they should have a little bit of incentive for having risked their life savings, spend time away [from] their families to create jobs so somebody like you can work for that company.

Luc: Sure. But that but that is the incentive and and bravo for them. But that does not give them the right to pay themselves $2 million bonuses while other workers are scraping by [on] $10 an hour.

Bet-David: You don't get to choose how much money I choose to make. That's not your business. That's my business.

Two other participants also lamented that single mothers often work harder than billionaires, and yet are scarcely rewarded. Another, Grace, would protest:

Grace: A millionaire is critiquing the people in poverty. You should work harder. You should you should work. You know, you can be me. We can't all be.

Bet-David: My hope is that you believe you can change and improve. That you believe you can upgrade yourself. That's my hope.

Grace: That's very, you know what? That's what rich people like you want to keep telling us. “You can be just like me. Do you want to be like me? If you work hard enough, you can be like me.”

Bet-David: It's actually you wouldn't be able to be like me because you wouldn't work that hard. Would you work that hard?

Grace: You don't I'm not going to tell I don't have to answer that. I don't have to measure my work ethic to be worthy…

Frustrated with PBD’s performance, I took the opportunity to follow up with Grace and several other anti-capitalists in the Jubilee video. I discussed several things with all of them, but the question of how capitalism compensates workers was a common theme.

One need not be committed to the supposed right of business owners to pay themselves what they want, or the moral worthiness of CEO pay, to defend a market system that determines how workers are compensated. In fact, as a determinist,1 I don’t believe anyone truly deserves their outcome in life. But if you don’t believe the rich and the poor really deserve their fate, the question that still must be answered is how we improve everyone’s lives. That requires economics, not value judgments.

Consider a white male genetically predisposed to being intelligent, born to rich parents2 who send him to high-quality private schools. He goes to business school on his parents’ dime and gets seed capital for his startup from them. His business is eventually wildly successful, and he becomes a billionaire. Does he deserve his wealth?

Probably not, but this is the wrong question to ask! The relevant question should be how valuable his business is to the world and how decisions to start businesses are influenced by policies meant to address this unfairness. Another inspiration for this article was John Cochrane’s similar point when discussing a wealth tax in France:

The wealthy may not "deserve" their comfort, but strangely confiscating the rewards to private success seems always to produce misery for the rest. The French tax system can surely be designed to produce its prodigious revenue with less economic distortion. Shouldn't that be the quest? Does France really need poorer people and much poorer rich people?

One can dispute whether a wealth tax would actually lead to “poorer people and much poorer rich people”. And this is precisely the debate we should be having!

If wealth taxes or socialism make us overall poorer, then even the best moral case for redistribution can’t avoid the fact that the poor will be worse off in the long run. Conversely, if redistribution boosts growth or well-being, defenders of billionaires must admit the property rights of the wealthy are worth the social cost of a worse society.

Focusing on efficiency also leads to the right questions being asked about the poor and poverty. Imagine a lazy Zoomer who slacks off in school to focus on his failing professional Fortnite career. He drops out of high school and can never hold down a job for long because he always stays up too late playing Fortnite to get to work on time. Does he deserve to be in poverty?

Again, this is the wrong question to ask! The life he lives is clearly pretty bad, and we should want to increase his quality of life. The relevant question is how poor decisions are influenced by policies meant to increase the standard of living for the poor.

Just like with taxes, the debate should be about how much we should redistribute and what the most efficient way to do it is. Models and studies done by economists will be the most useful tools in debating these issues!

Of course, moral claims can influence what trade-offs we are willing to make. If you think equality is intrinsically morally important, you may weigh the benefits of a more equal world against the decreased total utility. Once again, the work of economists will be the best tool to examine the costs and benefits here.

The reason I’m a capitalist is that I believe that markets typically lead to an efficient allocation of labor and capital, which central planning would struggle to recreate. It was never about a strict meritocracy or the deservedness of wealth. I defend this idea more in-depth in my debates with Jubilee participants. I think the one with Hunter was the best!

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Recently Trump’s been complaining about Jimmy Carter handing over the Panama Canal to Panama, allowing them to increase the passage fee. However, he’s also complained that we’re “subsidizing” Mexico and Canada because we have a trade deficit with them.

Well, Trump should be pleased to hear that the Panama Canal earns roughly $5 billion in revenue a year, whilst Panama “subsidizes” the US about $7-$10 billion a year!

Each fiscal year the Panama Canal releases a report detailing several figures, including its revenue. This year it reported a total revenue of 4.99 billion PAB, which is slightly over 5 billion USD. Now not all of this cost comes from ships heading to or from the US, or ships owned by the US. I don’t even think that data is available, so let’s just be extra generous and assume all of it is paid by the US.

The Panama Canal’s fiscal year 2024 runs from October 1, 2023, to September 30, 2024. Using data from the Census Bureau, we can calculate that the US ran a roughly $10.5 billion trade surplus with Panama in that period. Our trade surplus is Panama’s trade deficit, so with Trump’s logic they are subsidizing us about $10.5 billion a year and we pay Panama at most $5 billion a year. These numbers have been roughly the same for a few years with 2020 being a slight outlier. With Trump’s logic, we are clearly the winners from trade with Panama.

Of course, I’ve explained Trump’s logic as absurd in previous posts. But if you still adhere to it then maybe you think we could expand our gain by once again controlling the Panama Canal. Maybe that would benefit the US in the short term, but overall, I still think it would be a bad move. The US is by no means perfect but I think we’re generally a force for good in the world—at least relative to Russia, China, and Iran. I don’t much like Trump is threatening Panama for purely economic gain, at least Russia provides a pretext of “denazification” when invading Ukraine. The US needs allies to challenge China and tariffing or threatening allies is not a good way to reduce dependence on China.

Since his first meeting with Trudeau in December, Trump has repeatedly joked about Canada becoming a state. In his recent NBC interview, he complained that we are “subsidizing Canada to the tune of over $100 billion a year,” continuing, “If we’re going to subsidize them, let them become a state.”1 Trump has used this rhetoric that the US is losing in trade and the trade deficit (which is what he means by subsidizing) shows that for a while.

Maybe Trump’s just playing to his base, or perhaps he has a fundamental misunderstanding of trade. Trade between countries can be mutually beneficial even if there are some “losers.” Trade deficits aren’t necessarily bad and certainly aren’t evidence we’re losing at trade or “subsidizing” another nation. Lastly, there’s not a huge difference between trading in different US states and trading in different countries. If you think trade deficits are bad, then you should be equally concerned for the individual states that currently have trade deficits with Canada and continue to do so even if Canada was declared the 51st state.

Trade isn’t zero-sum

As I write this, I’m sipping my V8 energy drink. I chose to buy it because I preferred to fuel my caffeine addiction over the dollars I had, and V8 decided to sell it because they valued the dollars more than the drink they produced. So we exchanged, and both of us are better off overall. That doesn’t mean there was no cost; I lost my dollars, and V8 lost their drink, but in voluntary exchanges, both parties expect to benefit; otherwise, one party would have declined.

So, transactions between individuals don’t necessarily have to be zero-sum. All a free trade policy does is allow individuals to participate in these voluntary exchanges across political borders. The fact that an exchange happens to take place between a national and a foreigner makes it no less mutually beneficial. There’s good reason to believe free trade is not mutually beneficial if the voluntary exchanges that comprise it are mutually beneficial.

A basic model of comparative advantage can also show how trade makes us all better off. Countries have a limited number of resources that can be used to create different combinations of goods and services. Depending on a country’s geography, labor force, capital markets, and even things like regulations, countries can be better or worse at producing certain things. Even if a country is better at making everything than another country, countries can be comparatively better at producing certain goods because of opportunity cost.

Just take the US and Vietnam. In an absolute sense, the US is more efficient at producing shoes than Vietnam. But for the US to produce shoes, it has to give up a given amount of, say, aircraft production. Vietnam also has to sacrifice some amount of aircraft production to produce shoes. But if Vietnam has a comparative advantage in producing shoes, it can produce more shoes than the US can by sacrificing the same amount of aircraft production.

Conversely, the US can produce more aircraft than Vietnam by sacrificing the same amount of shoe production. The implication is if a country specializes in what they have a comparative advantage in each country can obtain a greater quantity of at least one good than if it had produced both goods for itself. I didn’t go into much detail, but if you want more, you can read a little from an introductory textbook or watch a YouTube video.

We can show the effects of this in a graph. First, we plot all the possible combinations of what either country can produce. Every point on the diagonal line represents an efficient use of their resources, whilst a point on the outside of the line represents a level of production that’s impossible for them to achieve. With trade, however, both countries can consume an amount of goods outside the line, which would be impossible for either to produce on their own.

I think there’s some confusion here because economists like to state that there are “winners and losers” in trade. Take a tweet that made the round on econ Twitter recently:

I hope I’ve illustrated why trade and exchange don’t have to be zero-sum, and someone tried to use similar logic in response to him:

Here, he resorts to pointing out there were indeed “losers” in the US when we began trading with China, primarily those whose manufacturing jobs were offshored. But the economist phrase “winners and losers from trade” doesn’t mean that a country lost overall while another country won overall. Instead, it means that within a country that is better off overall, there were some people made worse off whose loss was offset by the gain everyone else experienced. Just because there is a cost to something doesn’t mean you are worse off overall. You recognize this with every exchange you participate in, where you pay a cost (say dollars) for something you value more (say V8 energy).

It’s also worth noting the cost of manufacturing because of trade is often overstated, as it is here. Around 5.8 million manufacturing jobs were indeed lost in the so-called “China shock” period between 1999 and 2011. Some of those jobs were lost because we began trading more with China, and they have a comparative advantage in a lot of labor-intensive industries. Still, a lot of those jobs were also due to advancements in technology and automation. You can see manufacturing output grew over this entire period before stagnating after the Great Recession despite the decline in manufacturing employment.

Estimates of how much of the job loss was due to trade vs technology vary, but the highest I’ve seen is Autor, Dorn, and Hanson 2016 who estimate at most 2.4 million jobs were to trade. I list some other estimates in this tweet.

Manufacturing’s share of employment has been on a steady decline in America for decades with no visible shifts that would indicate the China shock was responsible. Although, the absolute number of manufacturing jobs did decrease during the China shock.

Eventually, I’ll write a full blog post dedicated to why trade isn’t responsible for the loss of manufacturing. For now, Martin Wolf summarizes why this is the case in his article based on a model provided in the book Behind the Curve — Can Manufacturing Still Provide Inclusive Growth?. Scott Sumner also has a short blog post about this.

The last thing I’ll note is we still see declines in manufacturing employment in countries with trade surpluses, so it looks like tariffs can’t save us here.

Trade deficits aren’t really bad

The trade deficit shows the difference between the amount of goods and services we sell to other countries (our exports) and the amount of goods and services we buy from other countries (our imports). Trump’s logic is fundamentally mercantilist, he presents the trade deficit as evidence we are “losing” at trade because we import more than we export. I don’t exactly what he means by subsidy, but if he believes every country should export more than it imports then we are in effect helping many other countries by buying their exports. Trump and the mercantilists fail to consider that a country isn’t wealthy because it hoards gold bars, but rather when it maximizes consumption possibilities. Secondly, the trade deficit largely reflects America’s favorability from foreign investors.

When you go to work, you produce things for other people, which is a cost to you. You’re compensated for that loss with an income, which, in turn, lets you consume what others produce. Similarly, exports are costly because we use our resources to produce for other countries. We are compensated for this loss with foreign currency with which we can purchase goods produced with other countries’ resources, to satisfy our consumer preferences. Trading with other countries increases the amount of goods and services consumers can actually utilize. This is what real wealth is.

Remember however that trade is not zero-sum, so even countries that run trade surpluses can benefit. That’s because when a country runs a trade surplus it is left with a surplus of foreign dollars that it invests abroad. That investment is also mutually beneficial, it grants someone the opportunity to start or expand their business and the investor a future return (at least if all goes well). Conversely, if a country is running a trade deficit it doesn’t receive enough foreign currency from exports to buy all of its imports. So it must receive foreign currency from investment in domestic industry.

The amount of investment and lending flowing in and out of a country is referred to as the financial account (or capital account). Importantly the capital account and trade balance must exactly cancel out. So if a country has a $50 billion trade deficit, it must have a $50 billion capital account surplus.

Part of the reason the US runs a trade deficit is because we’re such a good place to invest in. If Europe invests a lot of its currency in America, that increases demand for American dollars and increases the supply of Euros, both of which make the US dollar more expensive relative to the Euro. When the US dollar becomes more expensive or “stronger”, we can buy more foreign currency allowing us to import for cheaper. The capital account surplus also means investment opportunities in America are so large that Americans alone can’t finance them. Instead of forgoing these investments, foreign capital is brought in.

New Ideas from Dead Economists showcases Republicans haven’t made any progress on this issue since Lincoln:

Abraham Lincoln put one protectionist argument pithily: “I don’t know much about the tariff, but I do know if I buy a coat in America, I have a coat and America has the money—if I buy a coat in England, I have the coat and England has the money.” He was right—he did not know much about the tariff… If Lincoln buys the London coat he prefers, he cashes in some dollars for British pounds. So someone in London now has dollars. Londoners do not give up pounds just to wallpaper their flats with greenbacks. The Londoner will either (1) buy an American product or (2) trade in the dollars for pounds. If she buys an American product, Lincoln is happy because he preferred the London coat, and the Londoner is happy because she liked the American good. If she dumps her dollars, she will dump them on someone else who wants to buy American goods.

Furthermore, the US is the world reserve currency. That means US dollars are almost always in high demand, which keeps our dollar expensive. An expensive dollar keeps imports cheap for us but makes our exports more expensive for other countries to buy. So it looks like Mr. Trump’s 5th core promise to “STOP OUTSOURCING, AND TURN THE UNITED STATES INTO A MANUFACTURING SUPERPOWER” isn’t happening without breaking his 13th core promise to “KEEP THE U.S. DOLLAR AS THE WORLD'S RESERVE CURRENCY”.

So trade deficits don’t show if anyone is winning or losing at trade, and both can be beneficial to a country and those who it is trading with. Right now you have a trade deficit with your grocery store but that doesn’t make the relationship any less mutually beneficial.

There's not a fundamental difference between states tariffing each other and countries tariffing each other

I’ve used trade between individuals as an analogy to trade between countries. Really, they aren’t all that different. The same fundamental principles of voluntary exchange and comparative advantage apply equally. So, here comes the hard question for protectionists like Mr. Trump: If it’s bad that the US has a trade deficit with Canada, how will the problem get any better if Canada becomes a state? Wouldn’t Canada still have a trade deficit with the other 50 states? Why is it not equally as bad if California has a trade deficit with North Carolina?

Sometimes trade between countries can be complicated by differences in domestic regulation. I’ll make a full post about this one day but the differences in regulation don’t make it any less of a net benefit to trade. The line between an “artificial” comparative advantage due to regulation and a “natural” one isn’t partially clear or relevant. Really the case for free trade is unilateral and it’s almost always in a country’s best interest to engage in free trade regardless of another country’s regulations or trade policies.2

But regulations also differ between US states, should California tariff North Carolina because the minimum wage is $16.50 an hour in California but only $7.25 in North Carolina? Furthermore, Canada is a developed country with similar regulations, and the two indexes I found both show it has higher labor standards than the US.

If you think trade is zero-sum and/or trade deficits are bad then you should support states tariffing each other as much as countries tariffing each other. Consider tariffing your grocery store too. If Canada were to become a state trade would only increase. You could measure Governor Trudeau’s trade deficit with the rest of the 50 states in the US, and it would be about the same as it is today and equally irrelevant. Maybe it would change a little, but only because states can’t legally tariff each other. So if Canada's statehood avoids 25% tariffs on Canadian oil to the Midwest then count me in.

Tariffs are taxes on imported goods, paid by the US. By now, I think most people understand this. Unfortunately, many people learned this too late with searches for “Trump tariffs” peaking well after the election, but it’s still a good start! Understanding that tariffs are taxes is the first step, understanding what exactly they tax is arguably even more important. While on paper tariffs are just a tax on goods imports, this post explains what tariffs tax indirectly, and who pays the indirect price.

Tariffs are taxes on exports

Tariffs are used to reduce how much of a certain good is imported by incentivizing domestic investment. Why does that investment take place? Well, the tariff is used the raise the price of foreign products equal to domestic products. This means domestic producers can now receive a higher price because of the lack of foreign competition, increasing their profitability relative to other sectors, which draws investment away from other sectors and towards domestic production of the protected good.

So tariffs work by making it relatively more profitable to invest in domestic production of a certain good than to invest in other things. Now consider what would happen if we placed a tax on exporting goods. Exporters would decrease the amount they can export and receive lower profits. This reduces their profitability relative to other sectors, drawing investment away from exporters and towards domestic production.

A simple model from Doug Irwin can be used to illustrate this. Start with a country that imports clothes and exports aircraft. Placing a tariff on clothes would increase the price domestic producers could receive, incentivizing domestic investment. Domestic investment would flow toward the clothing sector and away from the aircraft manufacturing sector. Now what would placing a tax on exporting aircraft do? Well, aircraft manufacturing would now be relatively less profitable than the clothing sector. So domestic investment would flow toward the clothing sector and away from the aircraft manufacturing sector. So taxing imports also taxes exports.

But why do import taxes harm exports specifically? The answer has to do with foreign exchange rates. For someone to buy a good from another country they need that country’s currency. The amount of currency it takes for one currency to buy another is the foreign exchange rate. Generally, the standard rules of supply and demand apply to exchange rates. So for example, if the US dollar is in high demand the US dollar “appreciates” in value, or becomes “stronger”. What this really means is the US dollar is more expensive for other currencies to buy which hurts our ability to export.

So what does a tariff do to exchange rates? Ideally, a tariff reduces the amount of the tariffed goods we import, which reduces our demand for the foreign currency used to buy that import. When demand for foreign currency goes down, its price relative to the dollar goes down. Conversely, that means the price of the US dollar relative to foreign currencies goes up. The amount of appreciation depends on how much of a country’s goods you tariff which Noahpinion does a good job explaining in his article about targeted tariffs vs broad tariffs. The important thing to understand is that tariffs typically appreciate exchange rates, which makes it more expensive for other countries to buy our exports.

This is partly why tariffs struggle to reduce trade deficits. An IMF study of 151 countries from 1963-2014 found:

that tariff increases lead, in the medium term, to economically and statistically significant declines in domestic output and productivity. Tariff increases also result in more unemployment, higher inequality, and real exchange rate appreciation, but only small effects on the trade balance.

Another way to view this is to understand that trade is just a way to indirectly produce the things we import by first producing things to export and then exchanging them. So tariffs must hurt the people producing the exports that were previously exchanged for imports now produced domestically. David Friedman explained this with his Iowa Car Crop model:

There are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. Everybody knows about the first technology; let me tell you about the second. First you plant seeds, which are the raw material from which automobiles are constructed. You wait a few months until wheat appears. Then you harvest the wheat, load it onto ships, and sail the ships eastward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them.

International trade is nothing but a form of technology. The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans’ well-being. To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert wheat into cars. Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa. A tax or a ban on “imported” automobiles is a tax or a ban on Iowa-grown automobiles. If you protect Detroit carmakers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition.

Those are both things tariffs essentially always affect, however, there are two more potential reasons tariffs can harm exports. First is the potential to tariff intermediate goods and second is the potential for other countries to place tariffs on the US in retaliation.

Intermediate goods are goods companies use as components to produce other goods. Tariffing intermediate goods hurts domestic industry more than helps by increasing the cost of production for companies that use intermediate goods as input (Brian Albrecht goes into more detail). Tariffing steel, for example, may protect steel producers but harms firms that consume steel. In the US, steel‐consuming jobs outnumber steel‐producing jobs 80 to 1.

Tariffing intermediate goods also places US producers at a disadvantage to foreign producers, since only the US producers pay the increased production cost. Tariffing steel for example would make nail production in the US more expensive, but nail production in Canada would stay the same price. So US consumers would import more nails from Canada and other nations would as well.

Many other countries also choose to retaliate to the tariffs placed on them. So if the US places tariffs on Chinese steel, China will place tariffs on US soybeans. Although the cost of a tariff is primarily on the country implementing it, retaliatory tariffs still hurt US exporters by making it harder for them to sell in foreign markets. Exporters have to lower their prices to remain competitive against domestic producers in the tariff-imposing country, as well as exporters from other countries not subject to the tariffs.

Understanding that will make it obvious why Trump’s 2018-2019 steel and aluminum tariffs failed to help American manufacturing. As Federal Reserve economists Aaron Flaaen and Justin Pierce found in December 2019:

We find that U.S. manufacturing industries more exposed to tariff increases experience relative reductions in employment as a positive effect from import protection is offset by larger negative effects from rising input costs and retaliatory tariffs. Higher tariffs are also associated with relative increases in producer prices via rising input costs.

A February 2020 paper even estimates the equivalent export tax

Firms that eventually faced tariff increases on their imports accounted for 84% of all exports and they represent 65% of manufacturing employment. For all affected firms, the implied cost is $900 per worker in new duties. To estimate the effect on U.S. export growth, we construct product-level measures of import tariff exposure of U.S. exports from the underlying firm micro data. More exposed products experienced 2 percentage point lower growth relative to products with no exposure. The decline in exports is equivalent to an ad valorem tariff on U.S. exports of almost 2% for the typical product and almost 4% for products with higher than average exposure.

A report from the United States International Trade Commission estimated that whilst there was $2.8 billion worth of production increases in industries protected by the tariffs, was met by a $3.4 billion production decrease in downstream industries affected by higher input prices.

A 2024 study by David Autor et al. found:

Import tariffs on foreign goods neither raised nor lowered US employment in newly-protected sectors; retaliatory tariffs had clear negative employment impacts, primarily in agriculture

As mentioned agriculture was especially harmed by retaliatory tariffs (and exchange rate appreciation), and Trump had to use 92% of the revenue raised from his tariffs to bail them out.

The effect isn’t always temporary either. Even after a retaliatory tariff is removed, producers and consumers may remain uncertain of the possibility of another trade war and choose to buy from a friendlier nation instead. More importantly, when U.S. producers face disadvantages, other nations can use that time to establish and grow their own industries. Once those industries are built, the costs and efforts involved in starting them make it easier for these nations to maintain their presence in the market, even after the original trade disruptions are resolved. This was observed in a 2022 study focusing on Bush’s 2002 steel tariffs:

The tariffs did not boost local steel employment but substantially depressed local employment in steel-consuming industries for many years after Bush removed the tariffs. The tariffs also led to a persistent exit of steel-intensive manufacturing establishments, suggesting a role for plant-level fixed entry costs in translating the temporary shock into persistent outcomes

OK, that was a lot, but the main point of this post was to explain that tariffs also harm exports, since that’s what I think is most important to know. It’s also important to know that to understand some of the next points.

Tariffs are taxes on being poor

Tariffs tax poor people more than rich people. In other words, tariffs are a “regressive” tax as opposed to a progressive tax. Not all regressive taxes are necessarily bad, but progressivity is generally preferable.

Tariffs are regressive for a few reasons. Firstly, tariffs tax imports at a flat rate. So a 10% on a $10 banana tariff will increase the price by $1 for everyone. That may seem fair, but $1 is a higher percentage of a poor person’s income than a rich person’s income.

Secondly, poor people spend a higher percentage of their income on imported goods. A 2016 paper estimates the American consumer at the 10th percentile in the revenue distribution owes 69 percent of his or her purchasing power to international trade, the median consumer (at the 50th percentile) 37 percent, and the consumer at the 90th percentile only 4 percent. The 2016 US US International Trade Commission likewise found in its 2016 review:

U.S. consumers who are either middle income (income between $40,000 and $69,000) or lower income (income less than $40,000) benefit disproportionately from the savings associated with the tariff reductions

Tariffs also only tax goods, and poor people tend to spend a higher percentage of their income on goods over services.

Tariffs are taxes on goods relative to services

This is a novel argument I’ve only heard from Scott Sumner, so I want to make sure he gets the credit for pointing this out.

Remember all that time I spent trying to show that tariffs harm exports too? Well hopefully now we can move on to assuming the primary effect of a tariff is to reduce both imports and exports by about the same amount. Next, again consider that tariffs only tax goods and not services. This would mean a high tariff policy would tax the goods sector of the economy more than the service sector. The higher price of goods would also shift consumption away from goods and towards services. That would reduce goods as a share of GDP, and therefore increase the rate at which the service sector is overtaking the manufacturing sector.

I haven’t seen any empirical research on this or any other economist write about this, but it’s an interesting argument drawn from reasonable and empirically tested assumptions.

Tariffs are taxes on productivity

I’m not going to walk through the entire comparative advantage model (there are YouTube Videos and textbooks for that), but suffice it to say that if workers are employed in the areas a country has a comparative advantage in then their productivity will increase. The empirical evidence also backs this up, such as the same IMF study cited earlier:

tariff increases lead, in the medium term, to economically and statistically significant declines in domestic output and productivity.

Exposing domestic firms to international competition also makes markets more competitive, and economies of scale from international specialization also lead to efficiency gains.

But the simplest explanation is that importing goods doesn't just prevent domestic production, but rather prevents the production of more costly domestic substitutes. After a tariff is imposed domestic resources previously used (and still could be used) to produce other goods are reallocated to produce domestically an additional quantity of the protected good. This represents a loss because the goods in question could be imported at a better price, while domestic producers were able to produce something else instead.