A protectionist organization is trying to rewrite the laws of economics. The Coalition for a Prosperous America (CPA) suggests that a 10 percent tax on all imports would generate $728 billion in U.S. economic growth, $263 billion in federal revenues, and 2.8 million jobs. These results are based on a CPA-modified version of the widely used Global Trade Analysis Project (GTAP) multiregion, multisector, computable general equilibrium model.
CPA provides details on its modifications in a journal article which, ironically, must be purchased from abroad, including this key change: “. . . we introduce tariff productivity elasticities into the model, which allow domestic production to increase when tariffs are raised.”
In other words, the authors have manipulated the economic model so it assumes that domestic production increases when tariffs increase. They have changed the model so that it will confirm what they already believe to be true.
To justify this modification, CPA cites a Federal Reserve Bank of Minnesota report that questions the results generated by the standard GTAP model. Here’s an excerpt from that 2018 paper: “Preliminary work with modified AGE models provides predictions far closer to actual data and indicates that trade liberalization generates significantly greater welfare gains than those predicted by standard AGE models.” This suggests the direction CPA assigns to its tariff elasticity should be reversed.
CPA’s chief economist writes: “USITC (the U.S. International Trade Commission) studied tariffs in twelve U.S. industries and found that those tariffs led to statistically significant increases in domestic production in all those industries.”
Of course it did. When tariffs are applied to imports of particular products, domestic production of those goods tends to increase. For example, if the government imposes tariffs on fertilizer, it initially may stimulate more domestic production of fertilizer. But the tariffs also discourage production by raising costs for downstream farmers who use fertilizer as an input. What really matters is the impact on the overall economy, not the impact on domestic fertilizer manufacturers.
Here’s an example regarding the impact of steel and aluminum tariffs from the USITC study cited by CPA:
“The increases in production quantity in the steel and aluminum industries translated to an increase of about $2.25 billion in 2021 for these industries combined . . . In terms of the decline in the absolute dollar value of their downstream domestic production, the downstream industries experienced a decline of about $3.48 billion in 2021 because of the steel and aluminum tariffs.”
So the USITC study suggests that tariffs reduce net manufacturing output—that’s the exact opposite of the interpretation CPA relies on to justify its assertions.
It’s not just downstream industries that are affected by tariff hikes. Import barriers increase prices for the targeted goods, leaving Americans with fewer dollars to spend and invest elsewhere in the economy and thereby reducing output in other American industries.
Across-the-board tariffs would further weaken the economy by increasing the cost of capital goods and intermediate goods used by American producers. The USITC defines these goods as parts or components that are embedded in final goods and fixed inputs that assist in the production of other goods. They account for over half of U.S. imports.
CPA attempts to provide additional justification for its assumption by suggesting that high trade barriers generate “tariff-jumping” investment. This refers to the idea that tariffs incentivize foreign producers to invest in U.S. facilities to avoid paying tariffs. CPA cites research in the International Economics and Economic Policy journal to support this approach.
But that article concludes that broad-based tariff increases would not boost investment: “We find that the tariff jumping effect on FDI (foreign direct investment) is largely outweighed by a cost effect if the tariff is imposed on all imports.”
CPA seems to support high tariffs to encourage tariff jumping in theory, but, in practice, CPA has argued that the United States should not allow tariff jumping, at least when it comes to the steel industry. This appears to conflict with CPA’s argument that tariff jumping is a benefit of high trade barriers.
Example: Foreign Direct Investment in the Automobile Industry
It’s more probable that low tariffs, not high tariffs, would lead to an increase in investment. Consider motor vehicle manufacturing. According to former U.S. Trade Representative Robert Lighthizer, “The Reagan demand for car quotas (restricting imports) is one of the major reasons why the Japanese auto companies began to shift production to the United States.”
Lightizer is referring to President Ronald Reagan’s efforts to persuade Japan to voluntarily restrict automobile exports to the United States to head off even worse protectionist actions by Congress. Following the imposition of those limits, Japanese producers proceeded to expand car production in U.S. facilities.
However, the evidence that U.S. import barriers are required to stimulate such investment is weak at best. Japanese auto production in the United States surged under a quota-free, low-tariff environment from 1994 to 2019, just before the pandemic. During this time frame, the number of vehicles that Japanese-headquartered manufacturers produced in the United States increased by 78 percent.
Similarly, European-headquartered auto manufacturers who were never subject to U.S. quotas or high tariffs also expanded their manufacturing base in the United States. From 2000 to 2021, facing no U.S. import quotas and a 2.5 percent tariff, the combined value of foreign investment in U.S. production of motor vehicles, bodies and trailers, and parts increased by 142 percent. Foreign-based manufacturers now account for nearly half of U.S. light vehicle production.
This track record demonstrates that tariffs and quotas are not needed to attract foreign direct investment in the automobile industry.
The Congressional Budget Office provided a more likely result of tariff hikes on U.S. investment and output: “On balance, tariffs are projected to lower economic output, primarily by making consumer goods and investment goods (such as structures and equipment) more expensive. Uncertainty about future trade policies also reduces business investment.”
Whatever economic models might predict for the future, research on the impact of previously enacted tariffs in the Journal of Policy Modeling concluded: “Using an annual panel of macroeconomic data for 151 countries over 1963–2014, we find that tariff increases are associated with an economically and statistically sizeable and persistent decline in output growth.” More broadly, 95 percent of economists agree that tariffs and quotas usually reduce general economic welfare.
CPA’s introduction of its “tariffs increase domestic production” assumption into the GTAP trade model is unjustified and renders its results meaningless. Its efforts at economic revisionism should be rejected.