The United States and its Constitution are fundamentally about liberty. Americans are free people who possess certain rights, including the liberty to purchase goods and services sourced in the U.S. or to consume goods and services sourced from international markets.

The fundamental nature of free trade is embodied in the Constitution’s commerce clause.

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Congress regulates commerce in order to ensure the free flow of goods and services across the nation. When goods and services flow freely through the country, national prosperity and well-being are maximized. Free trade across the world is no different. When goods and services flow across international borders without the imposition of tariffs or other artificial, and often arbitrary, barriers on international commerce, all people benefit. 

Under free trade, the iron law of comparative advantage comes into play. Each nation’s citizens produce the goods and services that have the highest value for that society. Even if one country has a comparative advantage in producing all goods and services, that country will maximize its wealth if it focuses on producing goods and services with the highest added value. For example, the U.S. enjoys a comparative advantage in designing the most advanced semiconductors and in writing code for the most sophisticated software products. It also enjoys a comparative advantage over many nations in manufacturing satellite communication systems. The U.S. maximizes national welfare by focusing on production from the energy and agriculture sectors, where the country has a large economic advantage.

However, the U.S. does not have a comparative advantage in manufacturing clothes, shoes, and furniture. National prosperity is maximized when the U.S. allocates scarce resources, land, labor, and capital to high technology, communications services, energy, and agriculture but outsources lower value-added goods and services to other countries. Specifically, the wealth of the U.S. is maximized when Nvidia designs semiconductors, when Amazon, through the e-commerce channel, sells products across the world, and when Alphabet Google provides free search functions for the people of the world. 

U.S. wealth is not maximized by devoting scarce resources to building cars and light trucks. The U.S. does not have a comparative advantage in producing cars. Moreover, as free people, Americans have the right to purchase vehicles from any country. There are no national security problems involved with whether cars are manufactured domestically or in Canada, Mexico, Germany, Japan, or South Korea, for example. America should not emulate the former Soviet Union, where consumers could only purchase a poor-quality Lada. 

National prosperity and security are not compromised when the U.S. runs a trade deficit with other nations. In fact, Americans enjoy a higher standard of living and arguably greater national security when the country runs a trade deficit. By running a trade deficit, Americans are able to consume more than they produce.

That is a good thing, right? 

The U.S. dollar is the global reserve currency partly because the U.S. trade deficit is a source of global liquidity for international transactions. The deficit is the lubricant for global trade. The U.S. dollar’s status as the global reserve currency enhances national security. There is no economic advantage in producing more and consuming less. What is the sense in pursuing what is essentially an antiquated and economically repudiated economic system of the 19th and 20th centuries, mercantilism? 

Until recently, Germany practiced “mercantilism.” It ran a large trade surplus with other global economies. However, German households were economically worse off. They sent domestic production overseas. What was the point of that? 

President Donald Trump and his advisers believe trade deficits are bad, but what is their rationale? Why does Trump want American workers to produce more than they consume? This is not a welfare-maximizing strategy.

Trump seemingly does not understand that when Americans buy goods and services from foreign producers, those producers are paid in U.S. dollars. Americans send U.S. dollars overseas, but most of those dollars return to the U.S. in the form of capital investment or through the purchase of U.S. financial assets, equities, or treasuries. For example, when European car manufacturers build a vehicle plant in the U.S., they use U.S. dollars obtained through exports to the U.S. The U.S. trade deficit can actually increase capital investment in the U.S.  

Trump and his advisers also don’t seem to understand that many of the U.S. dollars that go overseas to pay for imports never come back to the U.S. For example, in many less economically developed countries, U.S. dollars are an accepted currency of exchange. Across Asia, Africa, and Latin America, owning U.S. dollars is preferable to holding the local currency. Do you think Venezuelans would rather have U.S. dollars or the Venezuelan bolivar?

Take Trump’s imposition of 25% tariffs on imported vehicles and vehicle parts. This is doing great harm to the domestic vehicle industry. The tariffs will also harm the vehicle manufacturers of our closest allies, which we need in order to contain and deter the existential threat posed by China and Russia. Trump’s tariffs are creating a global trade war, which could cause a global recession. After all, the Smoot Hawley tariffs of 1930 were a major catalyst for the Great Depression. 

Because of the integrated nature of the North American vehicle industry, Trump’s 25% tariffs will cause the American vehicle companies General Motors and Ford to hemorrhage money. Last week, the equity prices of the two companies plummeted. Importantly, stock prices are forward-looking. The market knows that tariffs harm the economy in the short and long run.

Another problem is that industries protected by tariffs tend to invest less and innovate less. They become complacent. Companies protected by tariffs compete in the corridors of Congress and the offices of the White House. Rather than investing in productivity-enhancing equipment and processes, such companies invest in lobbyists. This is not good for America. 

The U.S. steel industry is a case study of why tariffs and protectionism are economic and political folly. Tariffs on imported steel have been in place for many years, yet domestic steel producers remain globally uncompetitive. Steel companies have not taken advantage of the trade barriers to become more competitive. Rather, they have used profits derived from tariffs to repurchase shares. 

Moreover, steel tariffs have significant negative downstream effects. 

Steel-intensive U.S. industries, including manufacturers of auto parts and motorcycles, household appliances, farm machinery, and machinery used in mining, oil extraction, and construction, pay more for steel and become less competitive in global markets. In addition, such steel consumers pass through to customers the higher prices caused by the tariffs. It is a settled principle of economics that tariffs are inflationary.

Arguably, the best illustration of why tariffs and protectionism are poor economic policy is the impact that Trump’s tariffs are having on the U.S. oil and natural gas sectors. Last week, the Federal Reserve Bank of Dallas released the results of its quarterly survey of the shale oil and gas sectors in Texas and New Mexico. Companies responded to the survey by saying tariffs were having a harmful effect on their operations. 

Higher cost steel affected margins. 

STOP PRETENDING REPUBLICANS ARE CUTTING THE DEFICIT

Lower margins mean less drilling but higher prices for American households and businesses. 

The U.S. holds a significant comparative advantage in producing oil and natural gas. When tariffs harm these jewels of the American economy, there is demonstrable evidence that tariffs are terrible policy.

James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society. He can be reached at [email protected].