Don't Cry for Me, Argentinian Import Substitution

And more from this week...

Spend more than a few minutes debating trade policy and you will hear about the sad case of Argentina. Its attempt to promote industrialization through “import substitution,” protecting its domestic market with tariffs in hopes of nurturing home-grown producers of things otherwise bought abroad, is widely seen as a costly failure. Argentinian firms, which never had to compete in the global market, fell far behind global leaders. No one else wanted what these firms produced, so exports stalled. The nation ended up poorer, less competitive, and more reliant on imports.

The lesson, for many, is that tariffs are self-defeating. Any effort to reduce a trade deficit or strengthen domestic industry must be premised on improving the global competitiveness of exporters who can manufacture more efficiently than global peers. And if they can do that, they don’t need tariffs anyway. The right strategy is thus one of “export promotion” as pursued by the East Asian economies that developed rapidly in the second half of the 20th century.

In last week’s New York Times roundtable, Larry Summers and Jason Furman both made this point.

Furman:

This has been unleashed by a misunderstanding of basic economics, which starts with imports. They’re good, not bad. They’re good for consumers who buy products we barely produce, like bananas. They’re good for industries that rely on imported parts to make their products. Any attempt to curb imports also reduces exports. And exports are also good because they let Americans work in higher-paid, more productive jobs.

Summers:

It’s just wrong to think that trade barriers reduce trade deficits. Think of India before its recent reforms, or Argentina at many moments as examples of countries with high tariffs and, frequently, large trade deficits. Also, Oren and the president forget what Jason mentioned, that many imports contribute to our own exports, and so we hurt our competitiveness.

I think this makes a conceptual mistake, overlearning the Argentina lesson and drawing an analogy inapplicable to the American situation today. But to see why, it’s worth starting with a clear and compelling articulation of the exports-first argument. So your one thing to read this week is Sam Hammond’s essay in the New York Times, “What Would Be Much Better Than Tariffs? More Exports.”

In general, I’m a big fan of Hammond’s work—indeed, he is a member of American Compass’s Advisory Board on Industry. I agree wholeheartedly with his point that reindustrialization requires much more than just tariffs—that we also need robust financing mechanisms, subsidies in critical industries, more investment in research, and so on.

But the core of his argument is this:

Reindustrialization means more than protecting existing factories behind a tariff wall. It requires building new industries and pushing them to aggressively compete with rivals, scale up production and export their products. Countries don’t get rich by creating expensive substitutes to cheaper imports; they get rich by making things the world wants to buy.

If you were Argentina in the middle of the 20th century, this would surely be true. But the American situation today is different in several ways:

1. Our $1 trillion trade deficit presents an enormous opportunity. Most economic analysis of the American position in the global economy seems to assume that export markets represent the key opportunity for U.S. industry and thus success depends upon winning in those markets. From that perspective, for instance, tariffs on the intermediate goods that manufacturers might use in their own production is a disaster. How can a U.S. producer hope to compete with a German producer if the U.S. producer has to pay a tariff on components from China and the German producer does not?

This assumption makes good sense in the typical developing-country situation where the domestic market is small and trade imbalances are likely a minor factor. Bootstrapping the economy to higher output and faster growth requires finding another market in which to sell. When Taiwan decided to become a semiconductor hub, “we will meet Taiwan’s demand for advanced chips” would have been a nonsensical strategy. Taiwan did not have sufficient demand for chips to support a world-class semiconductor industry.

But the top priority and major opportunity for the United States is not higher exports, it is recovering the capacity to meet domestic demand with domestic supply. Thus, the goal in building a leading-edge TSMC plant in Arizona is not to produce chips for export, it is to meet the domestic demand currently filled by imports. Indeed, the U.S. will be building leading-edge semiconductor fabs to meet domestic demand for a long time before it needs to consider export markets at all.

To be clear, a reindustrialization focused first on serving domestic demand is not a recipe for isolation or autarky. Even if the United States closed its trade deficit solely through expanding production to meet domestic demand, annual exports and imports would each still exceed $3 trillion, with exports at double their 2000 level. Presumably, that pattern of trade hews more closely to the trajectory that the United States would have followed had it not foolishly tolerated rapid offshoring and gaping imbalances in the first place. We should not decry as unnatural or inefficient the sort of outcome that economists had promised would be the beneficial result of embracing globalization.

2. There is no global free market. The export-led strategy pursued by East Asia also took for granted that producers would be competing in a free market where the most efficient producer would win. And it took for granted that the global free market would be a large one. This worked especially well in the liberal world order of the late 20th century, in which the United States offered seemingly insatiable demand for whatever could be produced most efficiently somewhere else, and preserved open access and a level playing field for all competitors. The export-led countries took great advantage of this, indeed exploited it, tilting the playing field toward themselves with subsidies and other industrial policy.

This scenario is not open to the Untied States today. Global markets are dominated by producers from countries already pursuing export-led strategies; the U.S. market is the one into which they are selling! Export competitiveness has become something of a sham, dictated by efforts at market distortion and the scale built through prior efforts at market distortion. If the United States responds in kind, attempting to out-subsidy China in the global market, the result will be a glut of supply that wastes resources and leaves everyone poorer.

Note that, to a significant extent, the export-led strategy is no longer even open to newly developing countries. Whereas the East Asian countries got to compete against a United States that was happy to deindustrialize and allow its market to be used to build production capacity elsewhere, a new set of countries pursuing that strategy would have to compete against the national champions of that prior wave. There has been no next wave of export-led development following on the East Asian success.

3. Competition in the U.S. market is already robust, or can be. For a developing country, or even a small, rich country, tariff barriers run the risk of stifling competition. Without sufficient competition, market forces cannot impose discipline or promote efficiency and innovation. But the United States accounts for more than one-quarter of global GDP and is by far the world’s largest consumer market. In any industry, it can support multiple producers competing at scale to meet domestic demand. If U.S. regulators allow Boeing to become the only airplane maker and Intel the only chip maker, that’s obviously a problem. But the solution is to ensure there are multiple airplane makers competing domestically, not to tell the single American maker to go get disciplined by competing with a Chinese maker controlled by the Communist Party, dependent on massive subsidies, and built on stolen U.S. intellectual property.

Indeed, as the first two points suggest, it’s worth asking which is the more competitive free market that we should want American producers focused on: the global one for export or an insulated one for meeting domestic demand? Is our definition of an efficient and competitive producer one that provides well-paying jobs and protects the environment while delivering a better product at a lower price than another one held to the same standards, or is it just whoever can exploit labor most viciously and pollute with greatest impunity?

A 10% global tariff makes no sense, the critics argue, because now the TSMC plant in Arizona will have to pay 10% more for ASML’s most advanced EUV equipment for etching chips, and 10% more for the raw inputs like silicon. How is the plant supposed to compete with a Taiwanese one that can get its inputs tariff-free? The answer is that this is not the goal, and is not a plausible goal in the foreseeable future anyway. The tariff will tilt an American buyer’s choice toward the Arizona-made chip, because a chip from Taiwan will have the 10% tariff added to its entire value, whereas a chip from Arizona will have the tariff embedded only in the foreign elements of its supply chain. The tariff also, therefore, creates an incentive for TSMC Arizona to find domestic suppliers, and for foreign suppliers to set up shop on U.S. soil.

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Returning to Hammond’s assertion, he is right that “reindustrialization means more than protecting existing factories behind a tariff wall.” But he is wrong to leap from that point to a conclusion that the only alternative is “building new industries and pushing them to … export their products.” That’s the thinking of export-led development. But the United States doesn’t really have that option. Instead, its option is rebuilding industries and pushing them to serve the domestic market as domestic producers once did.

The mistake here mirrors the one that economists have made more generally in assuming that their blackboard theories of comparative advantage would guarantee that the United States would benefit from free trade in the first place. Yes, under a set of conditions that held 200 years ago when classical economists were describing the exchange of commodities nations with immobile capital, that was true. Under 21st-century globalization, it is not. Likewise, export-led growth is obviously the right strategy, under the conditions that developing countries were selecting strategies 50 years ago. But this is not some universal truth that will apply to a developed economy with a $1 trillion trade deficit competing against entrenched export-led developers.

Perhaps it is the marketing of economics as a “science” that leads to blinkered misapplications of prior principles that held in particular times and places. Regardless, economics done well begins from observation of the world as it is, and helps to solve the problems of the present.

Bonus Link: At American Affairs, Julius Krein provides an assessment of The Lessons of Liberation Day and describes how a more coherent strategy would look.

Bonus Bonus Link: Want a winning economic policy for America? Learn from Andy Grove. In the Financial Times, investor Michael Mortiz highlights the former Intel CEO’s support for tariffs in the context of a broader industrial strategy.

WHAT ELSE SHOULD YOU BE READING?

Grover Norquist Can’t Believe What He’s Hearing | Russell Berman, The Atlantic

As Republicans in the Trump administration and on Capitol Hill indicate their openness to raising taxes on the highest income households, the man behind the no-new-taxes pledge is getting frustrated. He recently posted a video on YouTube, calling the people in the White House who are considering this “weasels” and “bozos.” Those people include the President and the Secretary of the Treasury. Here he attacks “the idiot staffers in the White House.” As the reporter puts it, “Norquist’s opinion used to matter in the Republican Party.”

Stock Ownership Is What Really Divides Americans | Matthew Walther, New York Times

The obsession with the stock market’s fluctuations since Liberation Day is perhaps the best argument against promoting more widespread stock ownership through retirement plans, employee-ownership programs, and so on. Stock valuations will never be an effective proxy of the economy’s health. The direction of movement in response to a policy change will never answer the question of whether the change is a good one. But the more that people’s financial well-being is tied to those fluctuations, the more the question of what is best for corporate profits will exert a veto over our politics.

Anxious Trading Partners Promise to Buy American to Stave Off Trump’s Tariffs | Wall Street Journal

Another way of thinking about the paths available to the United States in closing its trade deficit and reindustrializing is to consider the kinds of deals it can pursue with trading partners. Forcing foreign producers to relocate production for the American market into the United States drives exactly the kind of investment and expansion needed. Signing deals where other countries promise to buy more American stuff tends to focus on agricultural products, energy, and weapons. At least until the U.S. has succeeded in building an economic and security alliance that blocks trade and investment with China, it’s hard to see how U.S. producers become a preferred exporter of manufactured goods.

The Conventional Wisdom Is That China Is Beating Us. Nonsense. | Tyler Cowen, Free Press

Cowen argues that AI systems, designed mainly in the United States and trained mainly on western content, represent an enormous soft-power victory for Americans. I found this useful mostly for what it does not do, which is provide any concrete explanation of how this “victory” actually benefits Americans. The ways that China is winning are quite tangible and obvious, indeed Cowen notes some at the top of the column. But the AI models will have my ideology embedded in them is exactly the sort of abstract achievement academics will hang their hats on while the typical American worker suffers the consequences of the nation’s actual economic failures.

AND AT COMMONPLACE

Commonplace continued to set the standard for informed commentary on the state of play after Liberation Day:

An Overdue Course Correction | Fred Bauer

A look back at what American history really suggests for an international trade order.

The Art of a Trade Deal | Henry Gao

How Trump’s reciprocal tariff agreements can reset the global trade agenda.

And when you’re tired of trade, be sure to check out a couple of the other pieces on more contemplative topics:

Leaving No Child Behind | Emile Doak

Confronting, not just complaining about, an unaccountable Department of Education can help all American students.

Protestantism's Conservative Catholic Converts | Carl Trueman

At Easter, a Protestant intellectual explains why many intellectually-inclined young people are leaving Protestantism for Rome.

But hopefully you’re not actually tired of trade at all, because on the American Compass podcast this week, my colleague Mark DiPlacido joined me to break down the worst of the arguments we’d had to address while making the case against free trade over the past couple of weeks.

As always, visit commonplace.org, follow us on X @commonplc, and subscribe for regular articles directly in your inbox.

Enjoy the weekend!