
Every once in a while, one will hear an argument for protectionism that protectionist tariffs will ultimately lead to lower prices. The argument they make is an adjusted form of the infant industry argument: domestic firms do not expand because of the presence of foreign competition. Tariffs will force foreign competition out of the market. Prices will rise, causing new domestic firms to form. These new firms enter the market and push prices down to the pre-tariff level (or even below the pre-tariff level). In short, tariffs allow firms to expand their scale and push down prices.
Like the infant industry argument, one can make an internally coherent prediction for tariffs along these lines. But, like the infant industry argument, it suffers from the same fatal flaw: tariffs are not needed to accomplish these goals. If it was profitable for firms to operate at such a scale as to match or beat the free-trade price, they would already be doing so. The presence of capital markets ensures the profit opportunities of those firms can be realized. Given all the political issues with tariffs, it’s quite improbable that the political marketplace would be better suited to realize those profit opportunities than the firms themselves and investors; I just have a hard time believing these people who are profit-seekers would leave billions of dollars in profit on the table. In short, if firms could match the free-trade price, they already would.
Financial markets allocate resources through time. By borrowing, firms and individuals can sacrifice some consumption in the future for consumption now. Firms in particular borrow to expand, fund new technology, fund new projects, etc., that could take years to payoff. These sorts of transactions occur all the time, to the tune of trillions of dollars per day. How could politicians properly identify profit opportunities those in the know do not know?
Relatedly, imposing tariffs is a long, public process. There are debates, votes, public hearings, etc. If, by some miracle, the political process was able to identify profit opportunities better than the market participants, once the tariff is announced, it would become public knowledge. Investors of all stripes would rush to the affected markets, eager to seize the profit opportunities. The tariffs would be rendered moot.
In short, while it is possible for tariffs to lower prices, it’s quite unlikely. Best case scenario, the tariffs simply recreate the status quo, but with more steps. Since tariffs are not costless (there are administrative costs such as collection and enforcement), this suggests that using tariffs to lower prices would still be a worse outcome than the free-market outcome.
READER COMMENTS
Knut P. Heen
Feb 5 2025 at 8:08am
Tariffs also reduce exports, the price of the exported goods will drop in the domestic market. Mature export industries will therefore scale back. Basically you are exchanging a mature export industry for a domestic infant industry.
It works exactly like the income tax. You cut back on your professional working hours to do amateur carpentry on your own house. Not very productive if you ask me.
Thomas L Hutcheson
Feb 5 2025 at 8:36am
Of course it’s true for anything that Country A has monopsony power in.
The problem with the infant industry issue is that tariffs are not the right way to care for the infant, subsidies are.
Jon Murphy
Feb 6 2025 at 8:40am
Yes, you’re absolutely right. If a country has monopsony power, then tariffs can lower prices.
However, I’d argue that the monopsony model only applies to a handful of edge cases, and even then tariffs probably do not help. Once we remember that trade is between individuals and not countries, the monopsony argument for tariffs weakens considerably.
Knut P. Heen
Feb 7 2025 at 9:48am
The purpose of financial markets is to inject cash when the corporation’s free cash flow is negative and to distribute cash when the corporation’s free cash flow is positive. Given efficient financial markets (the most tested hypothesis in all of science), other means like protection, subsidies, etc. are not necessary at all.
Free cash flow is defined as cash flow beyond what is necessary for taking on all positive NPV projects. FCFs will typically be negative for growth firms and positive for mature firms. The financial markets use the pay-outs from the mature firms to finance the growth firms.
The problem for some firms are that their prospects are so bad that they never get funded. Those are the firms that ask for protection and subsidies (usually based on a dubious positive externality argument).
Jon Murphy
Feb 7 2025 at 4:24pm
Your point is correct, but Thomas’s point is not about protection. In fact, in the scenerio he points out, tariffs would actually lead to more imports.
Matthias
Feb 7 2025 at 11:35pm
Financial markets can also take money from individual investors who have eg labour income to invest. Not just from other companies.
Similarly for giving money back to individuals, when they ask for it.
Billy Kaubashine
Feb 5 2025 at 12:32pm
Seems to me that the argument ignores the removal of comparative advantage when tariffs remove foreign competition.