The Best Trade Policy Is to Ignore Other Governments’ Trade Policies

The Chinese are accused by many Americans – including Secretary of Commerce Wilbur Ross – of purposely creating “overcapacity” in the Chinese steel industry and, hence, in the global steel industry.

If such overcapacity is real, then by its very nature it is on the whole undesirable. According to protectionists, this overcapacity, while desirable for the Chinese, is undesirable for Americans.

The protectionist fear is this: unless the excess capacity of the Chinese steel industry is reduced, the artificially low steel prices that result from this excess capacity will cause steelmaking capacity in the United States to fall, leaving the Chinese with more than their fair share of global steelmaking capacity. Not only will there then be too-few jobs in steelmaking factories for American workers, U.S. national defense will be weakened.

Overcapacity is Not Relevant for National Defense

We can dispense with the national-defense concern quickly, for it’s not an economic rationale for protectionism. The premise of the national-defense concern is that the U.S. must maintain a high amount of steelmaking capacity if Uncle Sam’s military is to be adequately provisioned with weapons. It follows that the U.S. government should intervene to maintain this capacity regardless of whether or not China’s steelmaking capacity is excessive, and regardless of the reasons why China’s capacity is whatever it is.

That is, if we grant the truth of this premise, U.S. government intervention to protect U.S. steelmaking capacity is justified even if China’s capacity is universally agreed to be optimal. Whether or not China’s capacity is excessive is irrelevant to this national-security concern.

But concerns about national security are almost certainly an afterthought; they are raised only to better secure public support for steel tariffs. The real concerns are economic. So, are allegations of Chinese overcapacity an economically valid reason for U.S. tariffs on steel?

No.

Overcapacity in Chinese Steelmaking is a Cost to the Chinese

First, there’s no objectively discernible optimal level of steelmaking capacity, either for each country or for the globe. The actual amount of capacity depends upon countless factors, such as the size of the aluminum industry, the availability of iron ore and other steelmaking inputs, workers’ preferences, transportation costs, each government’s regulatory and tax policies, and consumer demand for products made with steel. Furthermore, because the many factors that affect steel production frequently change - for example, new deposits of iron ore are discovered - it is folly to suppose that government officials can look at the existing amount of capacity and discern that it is or isn’t “excessive.”

Nevertheless, there is an economically sensible meaning of “excess capacity.” Any portion of capacity is excessive if the cost of maintaining that portion exceeds the value of the outputs that it produces. One beauty of free markets is that, when capacity is excessive, the resulting losses suffered by firms with excess capacity prompt these firms to trim their capacity. In other words, the fall in prices caused by excess capacity is the market’s means of curing this economic illness. Absent government intervention, any genuine excess capacities that arise soon self-destruct.

Alas, government intervention is often not absent. And such intervention can indeed create and maintain industrial capacity that is legitimately described as “excessive.” If indeed Beijing subsidizes Chinese steel producers or erects import barriers on steel imported into China (or does both), China’s steelmaking capacity likely is larger than it would be otherwise.

I say “likely” because it’s possible that subsidies and tariffs make Chinese steel producers so complacent or lazy that the final result is less, not more, steelmaking capacity in China. But here I ignore this possibility in order to engage American protectionists who insist that China’s capacity is indeed excessive.

If China’s steelmaking capacity is excessive, it is excessive mainly from the perspective of the Chinese people. It is they who bear the bulk of the costs of this overcapacity, for it is they who pay the taxes used to subsidize China’s steelmakers. And it is the Chinese people who pay the artificially higher prices caused by Beijing’s tariffs on steel. In short, when Beijing transfers resources from non-steelmaking sectors in China to the steelmaking sector there, it causes the former to artificially shrink and the latter to artificially expand. And because this pattern of resource use is not the one that would arise in free markets, the end result is that the Chinese economy, on the whole, becomes less efficient and the Chinese people poorer.

American steel buyers, in contrast, are enriched by this Chinese policy. The artificially lower price that Americans pay for steel is a benefit to us, one paid for by the Chinese people.

Protectionists object. They insist that the resulting reduction in American steel production is a loss to Americans. But they are mistaken. This reduction in American steel production is, for us Americans, not a loss but a gain. Releasing resources from American steel mills enables us to produce goods and services that would otherwise be too costly to produce. An artificially increased supply of steel from China allows us Americans to enjoy even greater quantities of goods made with steel PLUS greater quantities of goods and services that we, absent Beijing’s policies, would be unable to afford.

Overcapacity in Steel Causes Under-capacity in Other Industries

The story, though, does not end here. Some Americans truly are harmed by Beijing’s creation of overcapacity in China’s steel industry. The reason is that, as a result of Beijing’s policy, Americans pay higher prices for some goods that aren’t made with steel.

By artificially transferring resources away from China’s non-steelmaking sectors to China’s steelmaking sector, Beijing creates under-capacity in some Chinese industries. This under-capacity means artificially reduced output from these industries and, thus, higher prices for these outputs. Consequently, any such outputs that are exported to the U.S. are exported here in quantities smaller than otherwise. The result is higher prices for these outputs in America and increased production by American firms that compete with these artificially hamstrung Chinese exporters.

Yet we never hear of the under-capacity that is necessarily a byproduct of overcapacity. We never hear of those American producers whose markets expand because of the alleged overcapacity of China’s steelmakers. All we hear is of a group of Americans - U.S. steel producers and workers - who are not among those whose losses are economically relevant.

Ignore Other Governments

Still, a question remains: even though U.S. steel producers don’t suffer economically relevant losses as a result of Beijing’s policies, should the U.S. government nevertheless heed these rent-seekers’ calls for tariffs given that such tariffs might inspire Beijing to stop artificially inflating the size of China’s steel industry?

No.

Governments should treat each others’ economic policies as given, if only because almost all government interventions artificially help some producers and hurt others. Because every government is forever grasping for excuses to protect politically powerful domestic producers from foreign competition, each government can find such excuses in even the most mundane actions of foreign governments.

A policy of taking other governments’ economic policies as given – that is, as supplying no excuse for “retaliatory” tariffs – would have at least two wholesome consequences. Such a policy would deter domestic producers from wasting resources on lobbying for special privileges, and, in addition, it would dramatically reduce the prospect of trade wars by denying to each government a convenient excuse to fire the first shot.

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Donald J. Boudreaux

Donald J. Boudreaux is a senior fellow with American Institute for Economic Research and with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University; a Mercatus Center Board Member; and a professor of economics and former economics-department chair at George Mason University. He is the author of the books The Essential Hayek, Globalization, Hypocrites and Half-Wits, and his articles appear in such publications as the Wall Street Journal, New York Times, US News & World Report as well as numerous scholarly journals. He writes a blog called Cafe Hayek and a regular column on economics for the Pittsburgh Tribune-Review. Boudreaux earned a PhD in economics from Auburn University and a law degree from the University of Virginia.