How High a Fence? How Small a Yard?

Americans can choose less efficiency and slower innovation for more security and job protection, but they should understand the trade-off

Adam Jones from Kelowna, BC, Canada, CC BY-SA 2.0, via Wikimedia Commons

America's politicians agree on so little that you may not have noticed just how much they have aligned around an unspoken new course toward protectionism and industrial policy.  Beyond a few tactical choices, there is precious little debate around the next wave of tariffs, sanctions or export controls.  Each new measure finds justification in rising geopolitical tensions, dishonest trade practices or the need to dominate a strategic industry.  Sometimes it’s a mix of all three.

But every benefit comes with a cost and for all the consensus around erecting these barriers to trade and financial flows, not much is said about how much we stand ready to pay.  Does America really need to seize control of its own solar panel production and how much should that cost?  Will additional sanctions punish Russian firms or drive them into the arms of Chinese customers?  Can anyone explain the national security risks around a crucial Asian ally buying a troubled American steel company?

Decades of broad consensus around expanding U.S. access to foreign markets foundered with the election of Donald Trump in 2016.  Ultimately, the benefits of free trade were too slow to materialize and too difficult to measure, while the costs were quick and visible in lost jobs and empty factories.  Workers never got enough compensation or retraining to help cushion the transition.

America’s policy shift is an inevitable response to this pain, but it creates the opposite set of risks.  The benefits of greater protection are immediate as a response to cheap Chinese exports, a troubled U.S. steel industry or a menacing Russian military.  Over time, however, every barrier to the free flow of goods and money adds costs to consumers and slows the course of innovation.

Tariffs are ultimately passed along to households rather than Chinese competitors, which simply sell their goods elsewhere.  Embargoes on Russian energy imposed huge costs on European households.  Keeping the latest semiconductors from the People’s Liberation Army may make sense for now, but it likely redoubles China’s efforts to catch up. 

Of course, we have never lived in the textbook world of free commerce, peaceful democracy and herds of unicorns galloping across flowery fields.  The U.S. and its allies naturally need to protect security and defend against predatory trade practices.  Voters absolutely have a right to express their outrage at a trade agenda that left too many victims behind.

But policymakers should make explicit the costs from every barrier they erect, whether it’s tariffs that ultimately show up in store prices or sluggish innovation when government puts its thumb on the scale to benefit a favored industry.  Beyond making the case for each individual decision, it’s even more important for investors and businesses to know where they may expect barriers and where they should expect none at all.

Trump’s presidency delivered a blunderbuss of China tariffs that reduced household income by $1.4 billion every month, according to one study.  The measures helped deliver a thin trade agreement dubbed “Phase One,” before the pandemic disrupted further negotiations.  The steep tariffs he now promises (60% on China, 10% on everyone else) may ultimately be threats in pursuit of more deals, but the costs will likely prove much steeper.

The Biden Administration kept most of Trump’s China tariffs and added their own more targeted measures on a range of products from semiconductors and solar panels.  They have also layered on further restrictions on exports, investments and financial flows, arguing the need to build "high fence" around a "small yard."  

But the yard apparently encompasses medical equipment and port cranes, too.  And Chinese electric vehicles may be banned from U.S. markets in part because of the data they may collect on American drivers.  These all sound plausible, but hardly clarify the limits to likely future restrictions.  Chinese lawn furniture and toys are probably not a threat, but what about ball bearings or pharmaceuticals?

This is what makes reports that the president will block Nippon Steel’s purchase of troubled U.S. Steel so disturbing.  Everyone understands the political rationale of securing union backing in the throes of a tight election campaign.  But the president is badly stretching powers that were specifically designed to judge foreign investors on national security risks alone. 

The benefits of greater protection are immediate in response to cheap Chinese exports, a troubled U.S. steel industry or a menacing Russian military.  Over time, however, every barrier to the free flow of goods and money also adds costs to consumers and slows the course of innovation.

If even this minimal guideline disappears, investors are left to guess where new barriers might suddenly appear.  Even as U.S. Steel itself warns of large job losses without the sale to Japan, there is no assessment around the broader costs to a domestic steel industry that desperately needs modernization or damage to an economic relationship with a key ally. (It doesn’t make Biden’s decision any better knowing that Trump would do the same thing.)

Maybe it’s because assessing costs is so difficult that policymakers find it easier to impose them.  But one creative suggestion from Matthew Goodman of the Council of Foreign Relations is to categorize risks as red, yellow or green in an attempt to define which flows of goods and money must be restricted, which might be watched and managed and which should be left untouched.

It's hardly a perfect approach, but it may help clarify the debate around where fences should be built, how big yards may grow and how much -- in immediate costs, lost opportunities and long-term inefficiency -- we stand ready to pay.