What’s Wrong with Free Trade?

There are important reasons why trade deficits and domestic industry still matter

by Tom Sarrouf

As election season continues and both Joe Biden and Donald Trump seek to win voters, America’s tariff policy has been a major topic of conversation. President Biden recently called for tripling tariffs on Chinese steel and aluminum, and President Trump has promised to raise tariffs to 60% if elected to a second term. Indeed, both parties seem to be pushing full steam ahead on a more protectionist industrial policy. But is this a good idea?

Published in partnership with the Mercatus Center during the 2018 tariff battles in the Trump administration, Pierre Lemieux’s What’s Wrong with Protectionism?: Answering Common Objections to Free Trade responded to eight arguments supporting protectionism–specifically tariffs–and claimed to show why free trade is better. As a leading advocate for free trade, Lemeiux provided the best case for free trade and against protectionism one could expect to find. However, tariffs remain the best way to reindustrialize and restore prosperity.

Do Trade Deficits Matter?

In his book, Lemieux takes up the question of trade deficits. He argues that consumption is the goal of an economy, which is why GDP, though P stands for “product,” is a stand-in for how much a country consumes every year. The current accounts balance as of 2023 stood at a $773 billion dollar deficit. He then moves onto explaining the other side of this balance, the financial account balance, which describes the “flow of money and other financial instruments that corresponds to the flow of goods and services on the current account.” He emphasizes how the financial account balance must zero-out the current account deficit, which “as a matter of accounting” means that the $773 billion dollar deficit in America’s current account must be a $773 billion dollar financial account surplus since “debits equal credits.” What this means in practice is that foreign investment in the United States is strong.

Lemieux also emphasizes that these two measures, while a mathematical identity, are independent of one another. He claims that “it is at best misleading” to say that we fund our current-account deficit through foreign investment. But, how else would we fund it? Lemieux argues that we “export in order to import” (another way of saying that consumption is the goal of economic activity), and that the trade deficit really means that we are getting more imports for our exports. In this way of thinking, the difference between exports and imports means that we are “getting more for less.”

In reality, the difference between imports and exports is financed by either debt or selling assets. The net U.S. International Investment Position at the end of 2023 was -19.77 trillion dollars, meaning that foreigners owned 19 trillion dollars more of US assets than Americans owned abroad. This is equal to our cumulative trade debt. While Lemieux argues that this investment is a good thing that offers capital inflows into the United States to help finance business, it means that foreigners increasingly own American assets, and that this is how America is able to consume so much relative to what we produce. As David Goldman has pointed out, “Substituting cheap imports for domestic manufacturing may have been a policy error, but it was an affordable policy error because of America’s leadership in the digital age.” However, the continuation of this current model means that America would continue to import more, export less, and sell more assets to compensate; ultimately it means a future owned by foreigners. While Lemieux may not care because he only sees countries as “individuals and companies,” being beholden to potential rivals sounds like the makings of a hostage situation.

Lemieux seems to understand that this model is unsustainable. Even as he touts the benefits of a trade deficit, he adds a key assumption to his defense of “import[ing] as much as [a country] can and export as little as possible (assuming it were possible to maintain this regime for long).” [emphasis mine] This is an important—and wrong—assumption. Businesses that are consistently unprofitable are forced to close. Why is this any different with an economy writ large (especially if, as Lemieux insists, the economy is only the summation of all firms and households)?

How would tariffs help rectify these problems? As already mentioned, they would help preserve what we already have while also altering the incentives to make reshoring more attractive. They would also serve as a disincentive to consumption of foreign goods, driving down imports over time and fostering greater demand for domestic products, creating even more opportunity for companies to reshore and hire Americans.

Why is America Losing Its Factories?

There is no satisfactory  answer to the above question from Lemieux, but rather he responds to the objection that “The United States is Losing Its Factories.” He doesn’t dispute the claim so much as explain why it is not a problem. After reminding us that “American factories” mean factories owned by American corporations, not the government nor its employees (implying that they have the right to move wherever they want, consequences be damned for those “left behind”), he explains how manufacturing has changed. Manufacturing employment has decreased by seven million jobs since 1979, manufacturing share of GDP dropped from 25% to 12% from the 1940s to 2015, and the total percentage of manufacturing employment across the workforce has decreased from 26% in 1953 to 8% in 2016.

Despite this, Lemieux states that “real manufacturing production has increased by 180 percent from 1972 to 2007, and has nearly recovered the reduction suffered during the 2008-2009 recession.” Immediately following this point, he says “manufacturing output has not dropped like employment because labor productivity has increased as a result of a number of factors, including technological progress and long (often multicountry) supply chains.” However, much of that output growth is frontloaded in the timescale. As St. Louis Bank data shows, after making that “near recovery,” total manufacturing production flatlines, which makes sense given that manufacturing productivity (output per manhour) has declined each year for the last decade. Where trends go from here remains to be seen, but the story of continued efficiency in manufacturing has not panned out.

Lemieux finishes by dubbing the objection as “misleading,” but he does concede that “the old manufacturing jobs for low-skilled workers have disappeared and will not come back unless the world gets much poorer,” as American manufacturing has become more advanced as well as shifted to the aforementioned service economy. Efforts at protectionism are dubbed as “Luddite resistance” instead of “helping workers and communities adjust to inevitable change.”

But who is to say that the change is inevitable? The trends that we have seen thus far are a function of decisions about what counts and how to conduct business, like lowering tariff rates and opening American companies to increased competition from abroad, while allowing China’s entrance into the World Trade Organization and excusing their “dumping” and other policies such as capital allocation for new businesses and ventures using the state-owned China Investment Corporation. There was nothing inevitable about either of those decisions, or of funding decisions to fund student college tuition rather than trade schools. David Goldman lays out a list of what he describes as America’s “industrial policy,” and they were all choices, not “inevitable” forces.

Tariffs would help resolve some of these problems through a combination of preservation but also shifting incentives. Additionally,  tariff revenue collected by the government could be used towards other policies, be it capital allocation, investment in R&D as Goldman promotes as a way of innovating and increasing labor productivity and thus output, or simply towards creating a more balanced budget and putting a dent in the government deficits that Lemieux is concerned with.

Jobs, Wages, and Opportunity

Further on in his book, Lemieux addresses the objection that “trade destroys jobs” and “trade lowers wages,” respectively. His central argument on the jobs question is that net jobs are created by trade because economic efficiency and comparative advantage increases total employment and opportunity. While some jobs are destroyed in the short term, long-term job growth is the result of free trade. Moreover, the benefits to consumers from cheaper goods outweighs costs incurred to producers who lose out to changing economic conditions, and that’s what matters. On wages, he does not dispute that nominal wages have decreased, but rather argues that real wages (defined as what one can buy with wages) increase due to trade causing decreased prices for goods as well as boosting overall productivity, which is the main driver of wages.

But the key problem with Lemieux’s analysis on jobs is his eliding the negative side of the trade-offs. In part, it stems from viewing consumption rather than production as the driver of an economy as articulated above. Lemieux himself concedes throughout the book, some people do lose from trade. Using “net jobs created” hides specific clusters of lost jobs. When a factory closes down, that can devastate a community and leave a hole. For example, Charles Murray’s fictional Fishtown as described in Coming Apart paints this picture well. The decline in marriage, industriousness, honesty, and religion from 1960 to 2010 are all increasingly prevalent problems, and mutually reinforcing.

The “China shock” of mass importing goods from China at lower prices starting in the early 2000s was particularly harmful, as Lemieux notes, citing a study from Autor, Dorn, and Hanson, which states that “as many as 2.4 million jobs were lost in the whole economy. The researchers calculated that a large number of individuals who lost their manufacturing jobs to the China shock were not able to find new jobs or had to accept new ones with lower wages.” Those jobs sustain families, and are often concentrated in specific locations. Net jobs created also don’t tell us where those jobs are created. If factories shut down in Steubenville, OH or my hometown of Worcester, MA, are enough net jobs created in those communities, and do they pay well enough? Autor, Dorn, and Hanson seem to indicate that the benefits are to other parts and places in the economy.

Tariffs do have a particular benefit when it comes to jobs: they are both job preserving by protecting industries that are threatened by unfair trade practices or intense competitive pressures, as well as creating new jobs over time as reshoring takes place. Manufacturing jobs tend to pay well for people without post-secondary education, so taking the reshoring agenda for manufacturing seriously promises to help improve wages for people in those lower-income brackets, which is where economic thinking and development should be targeted.

The Real History of American Tariffs

Much of this discussion has been theoretical. However, it is worth looking briefly at America’s own history to rebut Lemieux’s general thesis. For most of American history, the United States had significant tariffs in place. Historically, it was the main source of government revenue prior to the income tax in the Progressive Era. It protected infant industries as part of the “American System,” as explained by Alexander Hamilton in the Report on Manufactures, and later championed by Henry Clay. From 1820 to 1950, the tariff rates ranged from a low of 14% in 1950 to as high as 50% in 1875 following the Civil War. As Troy Senik describes in his recent biography of Grover Cleveland, debates over tariffs were not over whether there would be tariffs, but how high. It was common sense that countries would pursue an industrial policy to its own benefit. Even once the United States began to pursue more free trade policies, that did not stop Ronald Reagan from using tariffs and other policies to protect American industry from foreign competition by Japan.

How did these policies turn out? Rather than being an economic disaster or leading to authoritarianism, America became an industrial powerhouse, and was in fact the fastest growing economy in the 19th and into the early 20th century. If this does not prove that tariffs were the cause of this growth in prosperity and global economic prominence (indeed, American industrial policy during the 19th century was more aggressive than merely using tariffs), it certainly disproves Lemieux’s theories that tariffs were a hindrance to growth. Tariffs were widely and liberally applied, and things turned out great for America.

Lemieux closes his book with a focus on the politics of trade and the question of fairness, describing how cronyism is the underlying motivation of protectionism rather than fairness or sound economics. He also points to nationalism as a bogeyman in American politics as an impediment to free trade. On “nationalism,” Lemieux’s starting point that nations are not superorganisms predetermines his analysis against government involvement in its own interest. However, a nation does take account of its own good and sets policies and goals to achieve it.. On the point about “special interests” seeking corporate arbitrage and indefinite protection from the government, it is worth noting that at least in 2024, tariffs enjoy bipartisan support, and so reflect democratic choice. That does not make tariffs good policy by themselves, but as Lemieux has repeatedly affirmed the importance of individuals and their interests, perhaps a self-governing people ought to drive their own economies rather than be driven by “inevitable changes” that they do not like or support.

Tariffs are not a silver bullet—in politics, there are none. That said, our current trade deficit runs on an unsustainable business model rooted in a priority of consumption. Lemieux demands we make a choice between consumer sovereignty focused on consumption enabled by low prices from cheap foreign goods, and a “system where producers rule by vying for privileges from the state.” We have done the former since the late 1970s. It has given us a staggeringly large trade debt, declining output and productivity, increased income inequality and class stratification, and malaise for the bottom, which threatens the rest of the social order. While we must be careful to avoid corruption as much as possible and make sober-minded trade-offs, we should gladly accept producer sovereignty with all of the energy and dynamism that will entail. As such, tariffs should be utilized where they can protect our current capacity and move more companies onto American shores. Revenues should be spent in the most prudent way, either towards creating further industrial policy, or in fixing the mistakes of the past. More importantly than tariffs, however, is taking the blinders off by rejecting false assumptions about politics, economics, and the good life.

This article is part of the “American System series” edited by David A. Cowan and supported by the Common Good Economics Grant Program. The contents of this publication are solely the responsibility of the authors.

Tom Sarrouf is the Senior Academic Programs Manager at the Intercollegiate Studies Institute and co-hosts the podcast, "Conservative Conversations with ISI." He was a 2023 Publius Fellow with the Claremont Institute.