Protectionism is not inflationary
By Scott Sumner
Protectionism is clearly a bad policy. But it’s not bad for the reasons that many people assume. If you put barriers on the import of a specific good, it tends to raise the relative price of that good. But an across the board import tax does not raise the overall cost of living. Recall that the Fed determines the rate of inflation, which is likely to be about 2% regardless of whether policy is protectionist or not.
Here is the Washington Post:
The GOP plan to reform corporate taxes — which the Trump administration last week claimed could make Mexico pay for President Trump’s border wall — would effectively charge companies 20 percent on their imports. To consumers, it would feel a lot like a hefty new sales tax on foreign-made products. And, like any sales tax, it would put the most strain on the poorest households.
That would be the case if the Fed allowed the tax to boost inflation. More likely, they Fed would push the dollar 25% higher to prevent an inflationary impact, and consumers would not see any increase in import prices. I can’t guarantee that would be the case, but it is what has occurred in other countries under similar circumstances.
I am particularly skeptical of this claim:
Research shows, furthermore, that when the prices of imports increase, the prices of domestic goods also increase because there is less competition. Russ’s estimates represent a range: On the low end, only imports become more expensive; on the high end, the price of domestic goods also increases, by 5 percent.
Let’s say the policy was not the tax/subsidy scheme proposed as part of corporate tax reform (which is not protectionist), but rather was simply a border tax—which actually would be a protectionist policy. What then?
In that case, there would still be no inflationary effect, as long as the Fed kept inflation close to 2%. But the relative price of imports would rise, and the relative price of domestically made goods would fall. Lower prices of domestic goods would lead to lower nominal (and real) incomes. Consumers would be worse off, but not because of higher prices. Instead, they would see smaller pay increases, and the same rate of inflation.
The following graph is also somewhat misleading:
The poor might be hurt more than the rich if they are more likely to buy imported goods. But they are not worse off by virtue of the fact that they consume a greater share of their income. Any policy that makes consumption 10% more expensive also makes everyone 10% worse off, because even wealthy people who are quite miserly see the purchasing power of their wealth decline by 10%.
Just to be clear, I do think it likely that the poor are more likely to buy imported goods. My only point is that this is the only reason why import tariffs are regressive. A VAT is not regressive if it applies to all goods, as all wealth eventually ends up in consumption.
HT: Tyler Cowen